Reflecting on retirement

I’ve been wrapping up the taxes for 2008, which always includes a look back at the year-over-year change in the household accounts.  As would be expected given the economic situations, 2008 was a dismal year.

As with many US households, the long-term financial goal is to achieve ‘critical mass’, where investments generate enough interest to provide  income for retirement.  Those finances, in turn, rest on four pillars: the house, the savings, stock options, and retirement accounts.  The general advice had been to contribute regularly, take some risk, diversify, don’t sell on bad news, limit debt, and live within your means.  All of that advice sounds hollow now.

It feels like everything got hit at once: diversified accounts that were supposed to be uncorrelated all sank together. Interest rates have dropped to less than 2%, so bank CDs,  money-market and bond investments generate almost nothing. The wild swings in exchange rates have hammered overseas accounts: the euro is down 45 cents on the dollar in a year, the pound is down 60 cents.  Stock options are entirely worthless for the foreseeable future.  Fortunately, the house value is still holding up in our corner of the market. But pension programs, which shifted from defined benefit to defined contribution years ago, have probably lost half their value as 401(k) and IRA investments got hit as the global markets dropped in sync across asset classes.

I don’t think that this situation is unique: everyone says that their nest egg has shrunk 30-50%.  As people lose their jobs or suffer cuts in benefits, they have to draw from savings, compounding the problem.  There’s a temptation to cling to whatever diminished job remains in hopes that things turn around in a few years, restoring the assets needed to generate retirement income.

This isn’t going to happen: A whole generation of baby boomers is about to move into retirement without enough money to live off of.  It takes two and a half million dollars to generate $50,000 per year when CD’s are paying 2%.  Most people have far less than that now, and cannot make it up in this financial climate.

This is, potentially, a huge social problem: what happens when the self-directed retirement system crafted since the Reagan years fails to deliver on it’s requirements?  Government and industry can’t and won’t, respectively, take on the role of providing a net.

We will need to scale down and work longer than anyone realizes over the coming decades.  It’s going to be a big change in plans, and I suspect that people won’t go quietly once they realize it.