Continuing with the theme in Part One of this series—admitting my errors—I’ve got to say that I understood how compound interest benefits banks way before I understood how it could benefit me.
At the risk of showing my age, I bought my first home for $22,000 at an interest rate of 6 per cent. Yes, I know you can hardly get a new car for that now, but that’s not my point. When I looked at an amortization schedule and realized I would pay over $25,000 in interest over the life of the loan, I was gobsmacked.
Since every blade has two edges, I should have realized then that if I started saving small sums at a very young age and let the interest compound, the result would be quite a wad over my lifetime. Twenty bucks a week at five per cent over 40 years is $115,967. By the time that dawned on me, I didn’t have 40 years left.
I had no plans to ever retire, but if I had thought of retirement as something realistic, I would have heard a common metaphor in the financial planning racket, the “three-legged stool.” A government historian claims that metaphor came from the private sector, not government.
Whoever thought it up, the idea is that income in retirement should come from three major sources: Social Security, a pension from your employer, and your savings.
You can tell it’s an old metaphor, because it assumes workers will get a job and stay with it long enough to earn a pension and that employers offer a pension. Those things are no longer true, and that makes a problem for those of us who don’t die young, because there are only so many positions for greeters at Wally World.
Some people have doubts about the long-term health of Social Security, and I have no space to enter that argument beyond saying that if Social Security dies, retirement will be the least of your problems.
So this metaphorical stool has, for sure, only one leg. One in four Americans is currently saving nothing for retirement. That’s a goose egg, not a nest egg. Interest compounded on zero for 40 years is zero.
If you laughed at me when I admitted to never having planned for retirement, and if you are one of those one in four, then I might make jokes about you eating cat food in your elder years…. but I don’t think that’s funny.
In much of Indian country, “elder” and “poor” go together like generic macaroni and commod cheese. Your mileage may vary if your kids earn enough to take care of themselves and you as well. How common is that where you live? Not very common in my neighborhood, either.
If you can do something with the personal savings leg of that broken stool, you might at least look forward to Blue Buffalo cat food rather than Alley Cat. At my credit union right now, most savings accounts pay .5 per cent. Nothing pays over 1 per cent. The latest inflation figures from the government place it at 1.5%. Therefore, money in a savings account does you only marginally more good than money buried in a coffee can in the back yard.
This is part of what drove me to the Wall Street casino. (The other part was wanting to prove that you don’t have to study business to pick stocks.) It’s a rule of thumb that the higher the return you expect to earn on your money, the higher the risk you must be prepared to take.
Remember the worst financial catastrophe in U.S. history, the Great Depression? It’s represented in popular culture, when it’s represented at all, by well-dressed gentlemen hanging up the phone after talking to their brokers and then hanging themselves or jumping out a window.
Will Rogers said at the time, “When Wall Street took that tailspin, you had to stand in line to get a window to jump out of, and speculators were selling space for bodies in the East River.” The spike in suicides, contrary to folklore, was not confined to Wall Street.
In the Great Recession of 2008, Google recorded a spike in the search term “suicide methods.” Lots of people followed through on that impulse, because the most significant suicide triggers are unemployment and mortgage foreclosure, both of which spiked. While the rate of suicide is not as high as in the Great Depression, the absolute numbers are higher because of a larger population.
Thanks to the Federal Deposit Insurance Corporation, nobody lost their savings held in banks. In the Great Depression, over 1,500 banks went bust and the money people had in those banks was just gone. Between 2008 and 2011, 414 banks failed and were liquidated; many others arranged to be bought out before they were insolvent. The FDIC paid out $88 billion to banks and as a result nobody lost money from small accounts. Most of the bank liquidations were done on Fridays and the FDIC was set up to pay all the depositors within the insurance limits by Monday, if it had not arranged a takeover by a solvent bank. In the Depression, all those savings would have dried up like water on a hot rock.
Our safety net is better now, but the people who had stocks in 401k plans or individual retirement accounts (IRAs) had a lot to be depressed about as Mr. Market cut those savings in half at the very same time the real estate market went south, devaluing the major asset of most people. This was serious gloom and doom for those who track their net worth—which few of us do until we think about no longer working.
The gloom is what it is, but accepting the doom at face value overlooks that, when you own stocks, you have not made money or lost money until you sell. Taking the historical view, it’s easy to miss the fact that if you invested in the stock market in 1931 and watched the market dive 71 per cent but held onto your portfolio, you would still have broken even in about five years. If you bought in at the worst of the panic rather than before it, you would have made out like a bandit… although not quite as well as Golden Sacks made out from the 2008 debacle.
It’s true that some 20,000 companies went bankrupt and stock in those companies became worthless, but if you were invested in a variety of stocks–what we call “diversified”—your losses were only paper losses that quickly disappeared. That’s history, but, as I said in an earlier column, I entered the stock market in 2008, just before the second biggest crash in modern times.
I not only did not sell along with everybody else, I continued buying all the way down. When the market rebounded in summer of 2009, my tens of dollars had turned into hundreds of dollars. Was I smart or just lucky? A little of both.
When I went into the market, I knew I intended to retire and that it was too late to accumulate much savings by saving. I was conservative in not putting in any money I could not afford to lose, but I was reckless in that I knew, at my age, I had to play high risk-high gain or not play at all. The Great Recession was steeper than the Great Depression and that was scary. The market dive was not as great in the Great Recession, but it happened over just 18 months. The Depression took three years.
Since I did not quit work until the end of 2009, I was putting money in every month right though the crash. As the market continued to dive, it became obvious to me that some really good companies were “on sale.”
I did not teach at Indiana University long enough to earn a pension, and during the recession, I watched my retirement account get cut in half. It took two years for that to come back, and all I lost was two years of “dead money.”
How could I continue to sink money into a falling market when I knew I was about to retire? Teaching was my second career, and I had a pension from my first. Therefore, I had two legs of the metaphorical three-legged stool to hold me up. Most people are not so lucky, and I do want to be clear it was luck, not planning.
My secondary reason for entering the market—to prove that a good liberal arts education is as good a preparation for stock picking as studying business—also does not apply to most of my readers. I understand that, as I understand that most readers do not have the time or the inclination to learn stock-picking.
In the next part of this story, I will share how the person who can only put aside $10 at a time and who does not want to pick individual stocks can still make money on Wall Street. If there are enough readers of this series to keep it going, I will eventually get to picking stocks, but that is not a necessary skill for repairing the three-legged stool that is supposed to support your retirement.