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Americans Put Retirements on Hold as Fund Real Valuations Have Collapsed

Personal_Finance / Pensions & Retirement Aug 01, 2008 - 12:54 PM GMT

By: Andy_Sutton

Personal_Finance Best Financial Markets Analysis ArticleEveryone knows the story of the little boy who found that he was able to get into the cookie jar while Mom and Dad were busy doing chores around the house. First he took one cookie and rearranged the remaining morsels around so nobody would notice. Soon enough, however, he had to have another and repeated the process. We all know how this story ends. Eventually, the little guy had eaten so many of the cookies that it is no longer possible to hide the fact that there were but a few left. No amount of shuffling or jumbling could hide it any longer. Sadly, this is rather analogous to the state of retirement savings for many Americans today.

Let's take a step back for just a bit and think about the last 9 months or so. Back in October 2007, the headlines screamed of new record highs in the DOW and S&P and forecasters were saying that 2008 would be the year the NASDAQ would start the ascent back to its pre-2000 prominence. Ironically, we were already 2 months past the mainstream acceptance of the credit crisis, and while that should have taken precedence, it did not as Wall Street and the media preferred to focus on the soothing tonic of Fed rate cuts.

During this same period, Austrian economists and commentators were focusing on the deteriorating fiscal condition of America and, in particular, what to do about Social Security and Medicare as the baby-boomers edged closer and closer to taking the pyrite watch and assuming retirement status. We pointed to the fact that debt levels were sky high, the housing market was getting worse, despite calls of ‘bottom' from every direction, and inflation was becoming a serious problem.

Many mainstream financial commentators have delved into the problems facing retirees over the past year. While these commentators have correctly identified many of the challenges facing retirees such as health insurance, living on a fixed income, and a decreased ability to tap equity from their homes, they have missed an important aspect of this situation.

Easy to lose, difficult to recover

While many recent headlines have highlighted the problems of Fannie Mae and Freddie Mac, precious little attention has been paid to the dire straits that current and rising retirees now find themselves in. While the financial firms now have the explicit backing of the Federal government, the retiree has no such luxury. How much damage has been gone to the retirement funds of these individuals since October 2007's record highs? For example, the Dow Jones Wilshire 5000, which is the broadest measure of total market capitalization here in the United States has lost over $3 trillion in shareholder value since the highs of 9 months ago. This represents a 20% haircut. Granted, much of that money was lost by brokerage houses and large institutions, but make no mistake about it, boomers anxiously awaiting retirement saw their portfolio values plunge too; at precisely the wrong time.

The truth of the matter is that it generally takes years to recover a 20% loss. Let's say for example that someone had $100,000 in a retirement account and lost 20% of that since last October. Let's assume that starting today, market conditions return to normal and the individual can expect to earn 8%/year in the stock market; a charitable theory given the times we're in. The following would represent their recovery using conventional investment rationale:

Today: $80,000
End of Year 1: $86,400
“ Year 2: $93,312
“ Year 3: $100,776

In this baseline case, in nominal terms, the portfolio takes less than 3 years to return to its original value of $100,000. This is the scenario often sold to investors by Wall Street and the media.

To be realistic, however, we must demonstrate the devastating affects of taxes and inflation on this scenario. Since our retiree will be living on a fixed income, this is analysis is essential. Let's assume that the headline CPI is the actual rate of inflation and let's assume that it will remain at a constant 4% through the duration of our exercise; another charitable theory. Let's assume a 15% level of taxation since our retiree's withdrawals are taxed (Trad IRA/401).

We arrive at 8(1-.15)= 6.8% after taxes. 6.8%-4%(headline CPI) = 2.8% real return:

Today: $80,000
End of Year 1: $82,240
“ Year 2: $84,542
“ Year 3: $86,909
“ Year 4: $89,342
“ Year 5: $91,844
“ Year 6: $94,415
“ Year 7: $97,059
“ Year 8: $99,776
“ Year 9: $102,570

Using this more realistic scenario, it will take over 8 years for the portfolio to retain its original value of $100,000. Keep in mind this assumes what will likely be an inflation rate that is much too low, and relative market calm which is also not likely, however, the exercise is still useful for illustrative purposes. The bottom line is that what took 9 months to lose will take almost 9 years to recover. In the case of the 30 something working individual, this is not necessarily a big deal. However, in the case of the retiree, this amounts to a permanently reduced standard of living. For the retiree, life has changed forever; almost overnight.

Imagine then, what happens if you take a situation where the rising retiree has had to take hardship withdrawals to meet housing payments or to fill the gap because student loans were unavailable for his children? Can you see why this was the absolute worst time for the markets to lose 20%? Not only does the retiree find himself set back due to the fact that he's had to make withdrawals, but in addition he finds that his remaining funds have lost 20% of their value as well.

Hitting the Cookie Jar

In 2007, First Fidelity who is the largest administrator of retirement plans in the country reported that early withdrawals had increased 17%. 2008's numbers will not be available for some months, but there is little doubt they will be much worse. According to Vanguard another 401(k) administrator, the average hardship withdrawal in 2007 was $6,194. A Vanguard executive indicated that “in many cases individuals are removing the majority of their account's assets.” If a mere $6,194 represents the majority of many people's accounts, our baby boomers are in serious, serious trouble. In another sign of the times, the number of early withdrawals by Vanguard account holders rose from around 29,000 in 2003 to almost 50,000 in 2007. 2008 is expected to be much worse as more and more individuals try to stave off foreclosure on homes and meet increasing living expenses.

Borrowing from 401K plans has been sold to the public under the guise that they're only borrowing from themselves much in the same way that the national debt has been explained to people over the years. This could not be further from the truth. When an individual borrows from their retirement savings, they take from that savings the ability to grow during the time that the amount is being repaid. Similarly, when a nation puts purchases on the national credit card, it steals the productivity of the nation. In the case of hardship withdrawals, these sums are rarely repaid, thereby sacrificing future retirement funds and the retiree's standard of living.

“On Hold?”

In summary, we ask the question of ‘How many retirements have been put on hold, postponed, or ended prematurely just in the last few months?” Imagine this. You just quit your job, you've got your gold watch for 30 years of service, and you're ready for some serious R&R. Then you open your investment statements at the end of June and realize you lost over 20% of your money in a few months time. Suddenly retirement is not so much fun. You were counting on that money to live. The sad fact is that this could have been avoided.

The American public for two long has taken a passive approach to its finances. Big firm brokers will commonly tell people to ignore their monthly statements; that the long run is what matters. While in certain cases this may have some modicum of truth, it doesn't apply to the rising retiree, nor is it a justification for investor apathy. This approach has cost investors dearly just in the past decade as they were blindsided by the bursting of first the technology bubble followed immediately by the real estate bubble, and now the credit bubble. Perhaps we can finally set aside the passive mindset, become more proactive, and take control over our financial destiny. Have we finally learned our lesson? Hopefully our recent battle scars will serve us well in this regard. Ask questions. Demand answers.

By Andy Sutton

Andy Sutton holds a MBA with Honors in Economics from Moravian College and is a member of Omicron Delta Epsilon International Honor Society in Economics. His firm, Sutton & Associates, LLC currently provides financial planning services to a growing book of clients using a conservative approach aimed at accumulating high quality, income producing assets while providing protection against a falling dollar. For more information visit

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