OPINION:
Stocks may be your best bet for retirement savings.
In the 1990s and early 2000s, the U.S. economy enjoyed a period of reasonable price stability. Convinced that a bit of inflation was good for growth, the Federal Reserve kept it close to 2%. Now, after cutting inflation by more than half from its 2022 peak, getting it back to that golden mean will require tougher policies than the Federal Reserve may have the stomach to impose.
Before COVID-19, Americans benefited from the digital revolution — vast improvements in computing power, easier access through the internet and cloud and smartphone apps boosted productivity.
Consider taxi dispatchers.
Before smartphone apps, taxis cruised streets or queued at airports and hotels to find passengers. People who did live or work near where cabs aggregate could call a taxi company. Dispatchers would look at markers on maps or rely on memory to locate cars and juggle competing requests.
Now, Uber and software available to cab companies have eliminated most dispatchers and optimize assignments.
Globalization and economic reforms brought first Japan, then smaller Asian economies such as Taiwan and ultimately China into the Western supply chain. Cheap hands became inexpensive televisions and computers.
Unemployment in the West became a chronic policy concern, but that kept wages and inflation down.
All of that has flipped.
Artificial intelligence has replaced the internet as the driver of change, but the chatbot ChatGPT poses quite different challenges. Taxi dispatching requires basic literacy, whereas AI is tasked with replacing workers with complex skills — for example, insurance adjusters — and judgment will prove harder to displace than repetitive mental tasks.
Declining birthrates and partisan squabbling that block immigration reform have created labor shortages. Expensive college degrees often don’t translate into marketable skills. All of this creates wage pressures at restaurants and software shops, as well as inflation.
Economic reforms made China richer, but also more menacing. Shifting manufacturing to Vietnam, India, Mexico and other countries and reshoring semiconductor production is costly.
Combating climate change entails replacing capital as much as expanding it. Replacing a serviceable fossil fuel electrical plant with solar panels and fueling stations with charging ports for electric vehicles does not necessarily augment capacity. Displaced capacity is a deadweight loss and adds to inflation.
National governments will continue to overspend to beef up their armies and navies if they don’t cut social programs. Budget deficits will force central banks to choose between tolerating higher interest rates and printing money to purchase the resulting debt.
Inflation more in the range of 3% to 4% than 2% is likely. And as baseline inflation rises, so does volatility. Spikes to 7% are more painful than spikes to 3%
All of this is tough on an aging population.
Teacher pensions in Virginia are adjusted annually up to 3% for inflation. Above that, retirees hired before 2010 get half the rate, up to 5%. Those who came aboard afterward get just 3%.
Many defined benefit pensions pose similar issues, as do many annuities sold to retirees by insurance companies.
Most Americans plan for retirement through tax-deferred accounts established by employers or must find a way to save by investing in individual retirement accounts and similar vehicles.
Older adults are often encouraged to invest in equities according to the 100 minus age rule. If you’re 65, that’s 35% stocks and 65% bonds. A spike in inflation and interest rates on new bonds reduces the purchasing power of payments from existing bonds and the market value of those bonds for retirees who are gradually selling securities to meet living expenses.
Higher inflation will require Americans to take more risk by investing more in stocks — for example, an S&P 500 index fund.
According to data maintained at New York University’s Stern School of Business, over the last 25 years, the average annual return on the S&P 500 was 9.2%,10-year Treasuries 1.8% and homes 5.3%
If you can own a home for about as much as you can rent, buy only as much house as you need.
Otherwise, the money is better invested in equities. In retirement, you can’t sell bedrooms vacated by adult children as you need cash. Downsizing is costly — real estate fees, renovations and relocation costs add up.
Bonds and other fixed income instruments such as annuities provide ballast, but at the cost of eroding purchasing power. Over a 20-year retirement, losing 2% a year to inflation diminishes the redemption value of a bond by 33%, and 3% by 45%.
Investing mostly in stocks and then gradually reducing your equity holdings to 50% over the 10 years prior to retirement appears to be the safest course.
The more you save for retirement, the easier it is to endure the volatility of the stock market. If you enter retirement, half in stocks and half in 10-year Treasuries, the average annual return should be about 5.5% and beat inflation.
• Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.
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