Quotulatiousness

January 16, 2013

When is a retirement fund not a retirement fund?

Filed under: Economics, USA — Tags: , , — Nicholas @ 00:02

When you draw it down long before retirement to pay ordinary living expenses:

This trend has been in place since the financial crisis, but the fact that it is accelerating is extremely disconcerting. First off, this is not the kind of behavior that should be witnessed in an “economic recovery.” Second, we need to remember the huge percentage of Americans on food stamps and/or disability. As we have discussed previously, many of them also have jobs. So essentially, a wage and a check from the government is still not enough to survive. They still need to tap into a loan from their 401k plans.

From the Washington Post:

    More than one in four American workers with 401(k) and other retirement savings accounts use them to pay current expenses, new data show. The withdrawals, cash-outs and loans drain nearly a quarter of the $293 billion that workers and employers deposit into the accounts each year, undermining already shaky retirement security for millions of Americans.

    [. . .]

    “We’re going from bad to worse,” said Diane Oakley, executive director of the National Institute on Retirement Security. “Already, fewer private-sector workers have access to stable pension plans. And the savings in individual retirement savings accounts like 401(k) plans — which already are severely underfunded — continue to leak out at a high rate.”

    A report due out this week from the financial advisory firm HelloWallet found that more than one in four workers dip into retirement funds to pay their mortgages, credit card debt or other bills. Those in their 40s have been the most likely culprits — one-third are turning to such accounts for relief.

January 7, 2013

Discounting for total political dysfunction

Filed under: Business, Economics, Government, USA — Tags: , , , , , — Nicholas @ 10:30

The Economist reports on last week’s “deal” in Congress and why the markets are still able to function in spite of the almost unprecedented level of political uncertainty:

Markets now live in the policy equivalent of Beirut in 1982. They have adjusted to perpetual political dysfunction. Over the last eight weeks, as the fiscal cliff talks stumbled, revived, collapsed, then came to life again, market movements were surprisingly narrow, and much of them could be explained by tax considerations as investors prepared for higher capital gains and dividend rates. The sang froid perplexed many of us who follow the policy process for a living and knew how high the stakes were. But perhaps we were too close to it. You can steep yourself in the intricacies of political coalitions, the electoral calendar, the makeup of the executive, senate and house, the interaction of permanent and temporary fiscal policy and such arcana as reconciliation, filibusters and blue slips, and yet still not know how to model the outcome. The fiscal cliff perfectly illustrated this: the people closest to the process didn’t know any better how it would end than those reading the newspapers, or not reading the newspapers, for that matter. There were just too many moving parts.

Richard Bookstaber once attributed the evolutionary success of the cockroach to coarse decision rules: it ignores most of the information around it and responds only to simple signals. Investors do something similar when confronted with hopeless complexity. They boil it down to a binary question: disaster/no disaster. Then they ignore all the idiosyncratic inputs and ask: what does experience suggest the probability of disaster is? Four times in the last two years, politicians went up to some do-or-die deadline without going over: in December, 2010, when the Bush tax cuts first came up for expiration; in April, 2011, when the federal government nearly shut down for lack of discretionary spending authority; the following August, when Treasury was days away from hitting the hard debt ceiling; and December, 2011, when the payroll tax cut first came up for expiration. In each case, one side, or both blinked; tax rates never went up, the government never shut down, and Treasury did not stop paying bills, much less default. It was, arguably, a better record than in 1995-96 when the federal government shut down twice and Bill Clinton threatened to suspend social security payments if Newt Gingrich’s Republicans didn’t raise the debt ceiling. Ignore the specifics of the latest episodes, and the logical conclusion is that despite their differences, both sides have powerful incentives to avoid disaster, so they will.

And who are the policy experts to say otherwise? For all the twists and turns, the cliff negotiations ended up where the median market participant a few months ago assumed they would: with a short-term fix and the remainder stuffed in a can and kicked down the road.

What’s that odd whistling sound coming from Wall Street?

December 18, 2012

Don’t expand the Canada Pension Plan: reform it

Filed under: Cancon, Economics, Government — Tags: , , , — Nicholas @ 10:52

Andrew Coyne briefly praises the CPP before advancing a plan to (eventually) supplant it entirely:

By most measures, Canada’s retirement income support system is an outstanding success. The poverty rate for Canadian seniors, with just 4.4% living below half the median income, is among the lowest in the world. The Canada Pension Plan, once careening towards insolvency, is now on a sounder footing. Millions of Canadians contribute to their Registered Retirement Savings Plans every year, with a view to replacing more of their income than the 25% covered by the CPP; Tax-Free Savings Accounts are a fast-growing alternative. For most people, then, the pension system works well. There is no evidence of a generalized pension “crisis.”

[. . .]

Suppose an additional levy were tacked onto CPP premiums. Only instead of going into the regular CPP pot, the funds would accumulate in the contributor’s own personal fund — like an RRSP, only compulsory. To avoid wasting money on management fees, funds would be invested strictly passively (ie buying the indexes), with the particular asset mix varying as the investor aged: more stocks when younger, more bonds when older.

Any increase in benefits would thus have to be fully funded; at the same time, since legal title to the funds would rest with the contributor, there would be no way politicians could raid the kitty. Moreover, with such a direct link between contributions and the size of their nest egg, contributors would be less likely to see the rise in premiums as a tax increase, and more as savings, mitigating labour market effects, at least on the supply side.

On its own, this would be vastly preferable to CPP expansion. If we liked the results, we might even think of going further. Over time, one could imagine migrating more and more of the regular CPP over to these mandatory personal accounts, allowing the CPP fund to be slowly wound down. Rather than simply expanding the CPP, the challenge of population aging presents an opportunity to reform it.

October 23, 2012

Canada’s foreign investment “net benefit” test is a farce

Filed under: Bureaucracy, Business, Cancon, Government — Tags: , , , , — Nicholas @ 10:15

Andrew Coyne scrambles to find the right words to describe the indescribable:

The existing rules, as readers will know, require that a foreign takeover be of “net benefit” to Canada. How this is to be demonstrated, how it is even defined, is a secret to which the bidder is not privy — understandably enough, since it is not known to the government either. The result may be compared to a game of blind man’s bluff, only with both players wearing blindfolds. The bidder makes repeated attempts to hit the mark, while the government shouts encouragingly, “warmer… ” or “cooler…” depending on its best guess of where the target happens to be at the time.

I’m joking, of course. In fact, there’s a perfectly clear definition of “net benefit.” As set out in section 20 of the Investment Canada Act, the minister is required to take into account the effect of the investment on “the level and nature of economic activity in Canada,” specifically (but “without limiting the generality of the foregoing”) “on employment, on resource processing, on the utilization of parts, components and services produced in Canada and on exports from Canada.” Clear enough, right?

[. . .]

All told, I count more than 20 different criteria to be applied, vague, elusive and contradictory as they are. Whether it is possible to measure even one of them in any objective fashion, still less all of them at the same time, may be doubted — but even if you could, the Act provides no benchmark of what is acceptable, separately or collectively. Neither does it say what weight should be given to each in the minister’s calculations, or even whether he strictly has to pay any of them any mind at all (“the factors to be taken into account, where relevant, are…”).

In other words, the whole thing is a charade, applying a veneer of objectivity to what remains an entirely subjective — not to say opaque, arbitrary and meaningless — process. Which is good, since any attempt to define such benchmarks, weights, etc would be even more arbitrary and meaningless. Because there isn’t any objective definition of “net benefit,” at least in the sense implied, nor is it necessary to invent one. We don’t need to clarify the net benefit test. We need to abolish it.

October 10, 2012

Is “national security” just another term for “protectionism”

Filed under: Business, Cancon, China, Government, Technology — Tags: , , , — Nicholas @ 10:16

Daniel Ikenson at the Cato@Liberty blog:

Chinese telecommunications companies Huawei and ZTE long have been in the crosshairs of U.S. policymakers. Rumors that the telecoms are or could become conduits for Chinese government-sponsored cyber espionage or cyber attacks on so-called critical infrastructure in the United States have been swirling around Washington for a few years. Concerns about Huawei’s alleged ties to the People’s Liberation Army were plausible enough to cause the U.S. Committee on Foreign Investment in the United States (CFIUS) to recommend that President Bush block a proposed acquisition by Huawei of 3Com in 2008. Subsequent attempts by Huawei to expand in the United States have also failed for similar reasons, and because of Huawei’s ham-fisted, amateurish public relations efforts.

So it’s not at all surprising that yesterday the House Permanent Select Committee on Intelligence, yesterday, following a nearly year-long investigation, issued its “Investigative Report on the U.S. National Security Issues Posed by Chinese Telecommunications Companies Huawei and ZTE,” along with recommendations that U.S. companies avoid doing business with these firms.

But there is no smoking gun in the report, only innuendo sold as something more definitive. The most damning evidence against Huawei and ZTE is that the companies were evasive or incomplete when it came to providing answers to questions that would have revealed strategic information that the companies understandably might not want to share with U.S. policymakers, who may have the interests of their own favored U.S. telecoms in mind.

It’s not just the United States, either: Canada is also getting wary of Huawei.

The Canadian government has said that it will be invoking a “national security exemption” as it hires firms to build a secure network, hinting that Chinese telco Huawei could be excluded.

The exemption allows the government to kick out of the running any companies or nations considered a security risk, which coming in the wake of the US report earlier this week labelling Huawei and ZTE as security threats, strongly indicates they’re out of the bidding.

Prime Minister Stephen Harper’s top media spokesman refused to say for sure whether the government had Huawei in mind when invoking the exemption.

“The government is going to be choosing carefully in the construction of this network and it has invoked the national security exception for the building of this network,” he said, according to the Calgary Herald.

September 4, 2012

TANSTAAFL is not the whole story

Filed under: Economics, History, Liberty — Tags: , , , — Nicholas @ 12:25

At The Freeman, Sandy Ikeda points out that the handy little saying “There ain’t no such thing as a free lunch” is not enough to explain modern prosperity::

Economics teaches us the importance of TANSTAAFL and capital investment. Again, the trouble is they are not the whole truth.

As I’ve written before, however, there is such a thing as a free lunch, and I don’t want to repeat that argument in its entirety. The basic idea is that what Israel M. Kirzner calls “the driving force of the market” is entrepreneurship. Entrepreneurship goes beyond working within a budget — it’s the discovery of novel opportunities that increase the wealth and raises the budgets of everyone in society, much as the late Steve Jobs or Thomas Edison or Madam C.J. Walker (probably the first African-American millionaire) did. Yes, those innovators needed saving and capital investment by someone — most innovators were debtors at first — but note: Those savings could have been and were invested in less productive investments before these guys came along.

As McCloskey, as well as Rosenberg and Birdzell, have argued, it isn’t saving, capital investment per se, and certainly not colonialism, income inequality, capitalist exploitation, or even hard work that is responsible for the tremendous rise in economic development, especially since 1800.

It is innovation.

And, McCloskey adds, it is crucially the ideas and words that we use to think and talk about the people who innovate — the chance takers, the rebels, the individualists, the game changers — and that reflect a respect for and acceptance of the very concept of progress. Innovation blasts the doors off budget constraints and swamps current rates of savings.

[. . .]

Indeed, innovation is perhaps what enables the market economy to stay ahead of, for the time being at least, the interventionist shackles that increasingly hamper it. You want to regulate landline telephones? I’ll invent the mobile phone! You make mail delivery a legal monopoly? I’ll invent email! You want to impose fixed-rail transport on our cities? I’ll invent the driverless car!

McCloskey’s book has shown up a few times on the blog.

August 12, 2012

China’s economic situation in Keynesian and Austrian terms

Filed under: China, Economics — Tags: , , , , — Nicholas @ 09:27

Tyler Cowen in the New York Times:

Keynesian economics holds that aggregate demand — the sum of all consumption, investment, government spending and net exports — drives stability, and that government can and should help in difficult times. But the Austrian perspective, developed by the Austrian economists Ludwig von Mises and Friedrich A. Hayek, and championed today by many libertarians and conservatives, emphasizes how government policy often makes things worse, not better.

Economists of all stripes agree that China may be in for a spill. John Maynard Keynes emphasized back in the 1930s the dangers of speculative bubbles, and China certainly seems to have had one in its property market.

[. . .]

The Austrian perspective introduces some scarier considerations. China has been investing 40 percent to 50 percent of its national income. But it is hard to invest so much money wisely, particularly in an environment of economic favoritism. And this rate of investment is artificially high to begin with.

Beijing is often accused of manipulating the value of its currency, the renminbi, to subsidize its manufacturing. The government also funnels domestic savings into the national banking system and grants subsidies to politically favored businesses, and it seems obsessed with building infrastructure. All of this tips the economy in very particular directions.

The Austrian approach raises the possibility that there is no way for China to make good on enough of its oversubsidized investments. At first, they create lots of jobs and revenue, but as the business cycle proceeds, new marginal investments become less valuable and more prone to allocation by corruption. The giddy booms of earlier times wear off, and suddenly not every decision seems wise. The combination can lead to an economic crackup — not because aggregate demand is too low, but because the economy has been producing the wrong mix of goods and services.

Lots of earlier discussion of the problems in China’s economy here.

July 2, 2012

What value do speculators offer?

Filed under: Economics, Food, Liberty, Media — Tags: , , , — Nicholas @ 10:17

In most newspapers, you don’t need to wait long to read some journalist beating up on evil speculators for the “damage” they do and the claimed “uselessness” of their activities. Tim Worstall points out that speculators are actually essential to smooth operation of free markets:

What is it that the speculator in food manages to achieve? They move prices through time. At the moment, there’s a drought, and so we think there will be less corn available for consumption next year, so its price goes up.

What would we like to happen? Should prices stay stable? We would all carry on using the amount of corn that we originally thought we’d get. And we’d run out — there may even be a famine. People tend to die in famines.

So what we’d actually like to happen is for people to prepare by consuming a bit less corn this year.

Some of this should come from substitution: farmers will feed wheat to animals not corn. Consumers might move from grits to weetabix for breakfast. Perhaps the fools putting corn into cars will move over to sugar cane to make ethanol from.

We would also like a supply effect: those who are currently growing corn might add a bit more fertiliser, take more care in harvesting, make sure less gets spoiled or lost in transport.

Rising prices causes both of those pretty neatly. Put up the price and people will use less, while suppliers will make more. And what is it that the speculators on the futures markets have done in response to this report of drought? They have raised prices.

February 3, 2012

Lemonade stand economics and government accounting

Filed under: Economics, Government — Tags: , , — Nicholas @ 10:14

An amusing illustration of the differences between real world profit and loss and the government’s accounting methods:

Parents, wanting to encourage the idea that working and making money is a good idea, drive around to buy the lemon, sugar, designer bottled water, cups, spoons, napkins, a sign or two, and probably a paper table cloth.

Aside from time and gas, the outing adds up to something north of $10. At the opening of business the next day, the kids find business is slow to nonexistent at $1 per cup. So, they start to learn about market demand and find that business becomes so brisk at only 10 cents per cup that they are sold out by noon, having served 70 cups of lemonade and hauled in $7.

[. . .]

There is a strand of economics, we’ll call it the K-brand, that sees all this as worthwhile. They add together the $10 spent by the parents to back the venture and the $7 spent by the customers and conclude that an additional $17 of spending is clearly a good thing. Surely, the neighborhood economy has been stimulated.

To the family it is a loss, chalked up as a form of consumption. If this were a business enterprise it would be a write-off. In classical economics it is a “mal-investment.”

[. . .]

But that is not how it works in government accounting. While a private business must adjust its books to reflect the losses from an intended investment that went bad, governments never do that.

When a government “invests” in, say, an airport in Johnstown, Pa., all the expenditures for labor and materials are recorded as investments and are additions to national output. Never mind that when it is later discovered that only three people a day want to fly to or from the airport, no adjustment to national wealth will reflect the folly of this “mal-investment.”

If the airport had been financed by purely private, commercial enterprises, the initial expenditures would have been recorded as investment spending, but when reality struck and the entire project was written off as a total loss, the business-profit component of national output would decline. That is, a previous bad “investment” reduces, rather than augments, current national income.

February 2, 2012

Is Sino-Forest a typical Chinese company?

Filed under: China, Economics, Government, Law — Tags: , , , — Nicholas @ 09:52

Colby Cosh posted an initial article on the investigation into Sino-Forest’s business back in June:

Timber company Sino-Forest is locked in a fascinating battle for survival against Carson Block, a stock analyst with a mixed record of publicity attacks on Chinese-based enterprises. With professional analysts reluctant to say what they make of Block’s “strong sell” report on Sino-Forest, I’m in no position to endorse it as a piece of financial advice or investigative journalism. Considered strictly as entertainment, however, the report is remarkable.

Block has documented that Sino-Forest operates with extraordinary opacity for a company whose holdings are surely very widely distributed — particularly, one assumes, within Canada. Sino-Forest claims to be doing hundreds of millions of dollars’ worth of sales through mostly unidentified “authorized intermediaries” in China — traders who are apparently happy to let the company buy title to trees, hold them as they appreciate, take on the bulk of the costs and risks in the meantime, and then snap up revenues when the trees are eventually converted into wood products. Block, having poked around a bit in the literal Chinese backwoods, questions whether much if any of the reported underlying activity is happening.

[. . .]

Sino-Forest is refusing, despite intense pressure, to make a full disclosure of the identities of the “authorized intermediaries” who are making its money. The company claims that to do so would put it at a competitive disadvantage, which makes one wonder why its business model ought to depend so heavily on sheer obscurity. One possible answer is that Sino-Forest’s real, fundamental business is some sort of cryptic regulatory arbitrage; that seems like a game potentially worth playing with paper assets in places that have a strong rule of law, but it is surely a dangerous one in a nominally Communist country, where a nationalization could be arranged in the space of an afternoon. (Or where some regional Party functionary could simply be bribed to “lose” crucial paperwork.)

Today, he posted a follow-up report:

Could a curious investor look at actual maps of timber controlled by Sino-Forest agents, you ask? Well, you see, it’s not exactly kosher for foreigners to carry around maps of remote parts of China. You can borrow them from forestry officials if you really need to. Will the local forestry bureaus confirm Sino-Forest’s claims about plantations operated by its agents? Well, sometimes they’ll give you a certificate of sorts, for all the good it might do. “The confirmations are not title documents, in the Western sense of that term,” the committee report notes. (As I understand it, the Western meaning of “title document” is that it gives one an unquestioned, justiciable claim to ownership of something, whether the Party or the Army or the good Lord in heaven approve or not.)

[. . .]

The impression given is that you need influential “backers” to do business in China. The question for the Western investor, though it’s probably now moot, is whether the real role of these backers is to help exploit Chinese resources for the benefit of the Western shareholders or to help fleece Western shareholders for the benefit of Chinese suppliers and bureaucrats.

As Jon, my former virtual landlord puts it, this is a hobby horse I like to ride now and again.

December 13, 2011

Japan’s even-worse-than-Greek debt situation

Filed under: Economics, Japan — Tags: , , , — Nicholas @ 12:13

By way of Monty’s daily DOOOOOOM post, here’s some disturbing information on Japan’s eyewatering debt situation:

It seems “debt,” “Greece,” “crepe,” or any other words that might relate to the current Euro crisis prompts a flurry of activity on stocks around the world. But if you thought Greece’s and Italy’s debts were high, there exists a country with an even higher debt-to-GDP ratio. Surprisingly, it also has some of the lowest government bond rates in the world. Let’s take a look at this macro mystery.

Japan’s 2011 gross public debt as a percentage of GDP is estimated by the IMF at 234%. Compare this to down-but-not-yet-out Greece’s at 139% and Italy’s at 119%, and the United States’ at 99%. With those numbers, you may ask how Japan hums along while investors berate Europe for their lack of strict budget controls and U.S. politicians wrestle to cut the deficit.

This is because of one main difference: 95% of Japan’s debt is Japanese-owned. Compare this to Greece, which owns 29% of its debt. The Japanese have been happy to fund their government at incredibly low bond rates, currently around 1.1% for a 10-year bond. Why don’t the Japanese invest elsewhere for higher returns? For one, Japan likes to keep its yen in the country. This is due to a natural bias to favor one’s domestic investments (home bias), the strength of the yen, and domestic institutions’ required participation in bond auctions. Also, it’s difficult to find domestic positive returns. The Nikkei, since Japan’s trouble in the early 1990s, has lost about half its value

November 30, 2011

Is “innovation” today’s buzzword equivalent of “excellence”

Filed under: Government, Technology — Tags: , , , — Nicholas @ 09:07

Stephen Gordon thinks that the term “innovation” is well on the way to being just another way of saying “corporate handout”:

The theory of economic growth includes roles for such well-defined concepts as investment, human capital, research and development, productivity, and technical progress. I don’t know where innovation fits into this. My guess would have been that innovation is another name for R&D, but apparently there’s an ineffable distinction between innovation and R&D.

There are well-known policy instruments at the government’s disposal for increasing investment in human and physical capital and for increasing R&D activities. (Their relative effectiveness is another question.) But so far, the only proposals I’ve seen for an innovation policy consist of programs in which governments give money to deserving firms. This is problematic on a couple fronts.

Firstly, there are already many — too many — ‘economic development’ programs whose purpose is to channel public money to companies that enjoy the favour of the government. It’s hard to believe we need more of them.

September 26, 2011

Why are gold and silver down in this market?

Filed under: Economics — Tags: , — Nicholas @ 12:15

It’s a question I’ve been asking too (my miniscule portfolio is taking a beating in both equities and in precious metals). Mike “Mish” Shedlock offers some likely answers:

1. Fed Did Far Less than Expected
The Fed did not do what everyone thought, which is to say something far more than “Operation Twist”. [. . .] In short, the Fed did not print, or even threaten to print. Moreover the Fed committed to a strategy not through the end of this year, but all the way through June of 2012. Perhaps the Fed does more in the interim, perhaps not. [. . .]

2. Mutual Fund Redemptions
Mutual fund cash levels are at or near record lows. In general, mutual funds were not prepared for the market selloff and sell orders came in. Rather than sell garbage like Bank of America at $6, mutual funds unloaded stuff like gold, taking profits.

3. Margin Calls at Hedge Funds
Hedge funds unloaded gold and silver for the same reasons as mutual funds, but also because they mistimed the play and what Bernanke would do. Leverage works both ways.

4. China Growth Story Fading
Commodities in general have been clobbered along with currencies of commodity producing countries because the global economy is slowing rapidly.

September 11, 2011

The Canada Pension Plan and moral hazard

Filed under: Cancon, Economics, Government — Tags: , , , , — Nicholas @ 11:37

An interesting post at Worthwhile Canadian Initiative looks at the overlooked failure in pension markets. I found this bit of information to be quite interesting, as it addresses a conversation I had with Dark Water Muse a few months ago:

Governments provide pensions in one of two ways. Pay As You Go (PAYG) plans use current contributions to fund current benefits. The Canada and Quebec Pension Plan were, when they were first introduced, PAYG plans. The moral hazard risk a worker faces with these plans is political: a politician will design the plan so as to maximize his or her chances of re-election.

The design of Canada and Quebec Pension Plan has created large benefits for the first generation of recipients (current voters) and a much lower rate of return for future recipients (future voters). Now those gainers were the generation that entered the labour market in the Great Depression and fought in World War II, so one could argue that the windfall gain they experienced was merited on equity grounds. The point here is merely that the design of PAYG pension plans reflects the interests of the designers (for re-election) as well as the interests of the contributors and recipients.

The Canada and Quebec Pension Plans are now transitioning into fully-funded plans. The Canada Pension Plan Investment Board was, as of June 30th 2011, managing $153 billion in assets. Some is managed directly by the board, the rest is managed by “partners” ranging from Istanbul-based Actera Group to New York-based Welsh, Carson, Anderson & Stowe. I suspect that the CPP, roaming the world with billions to invest, is able to negotiate low management fees, and there must be savings associated with economies of scale in investing. But the possibility of moral hazard — someone getting rich by diverting away a tiny percentage of the return on $153 billion, or a politician exerting pressure on the CPP investment board to make electorally-sound investments — remains.

In sum, while private pension markets suffer from moral hazard, it’s not clear that governments can solve the problem.

In my discussion with DWM, I claimed that the CPP was a PAYG system (in extreme examples, like the US social security system, this can be compared to a Ponzi Scheme), while DWM — claimed that the system was fully funded from investments. As the quoted section above shows, we each had part of the answer.

It’s hard to believe that the CPPIB (the organization that handles the investments of the CPP) can remain immune to government meddling — buy this company’s stock, invest in that company’s risky-but-located-in-a-marginal-riding new venture, etc. As long at the CPPIB can remain independent of political pressure, the system might work.

September 5, 2011

False ideas about investment risk

Filed under: Economics — Tags: , , , , — Nicholas @ 10:25

Dan Ariely points out that most people have no idea at all about some of the key questions on investment risks:

To this point, we’ve run a number of experiments. In one study, we asked people the same question that financial advisors ask: How much of your final salary will you need in retirement? The common answer was 75 percent. But when we asked how they came up with this figure, the most common refrain turned out to be that that’s what they thought they should answer. And when we probed further and asked where they got this advice, we found that most people heard this from the financial industry. Sort of like two months salary for an engagement ring and one-third of your income for housing, 75 percent was the rule of thumb that they had heard from financial advisors. You see the circularity and the inanity: Financial advisors are asking a question that their customers rely on them for the answer. So what’s the point of the question?!

In our study, we then took a different approach and instead asked people: How do you want to live in retirement? Where do you want to live? What activities you want to engage in? And similar questions geared to assess the quality of life that people expected in retirement. We then took these answers and itemized them, pricing out their retirement based on the things that people said they’d want to do and have in their retirement. Using these calculations, we found that these people (who told us that they will need 75% of their salary) would actually need 135 percent of their final income to live in the way that they want to in retirement. If you think about it, this should not be very surprising: If you add 8 hours (or more) of free time to someone’s day, they will probably not want to spend this extra time by going for long walks on the beach and watching TV — instead they may want to engage in activities that cost money.

You can see why I’m confused about the one-percent-of-assets-under-management business model: Why pay someone to create a portfolio that’s 60 percent too low in its estimation?

And 60% is if you get the risk calculation right. But it turns out the second question is equally problematic. To show this, we also asked people to tell us how much risk they were willing to take with their money, on a ten-point scale. For some people we gave a scale that ranges from 100% in cash on the low end of the risk scale and 85% in stocks and 15% in bonds on the high end of the risk scale. For other people we gave a scale that ranges from 100% in bonds on the low end of the risk scale and buying only derivatives on the high end of the risk scale. And what did we find? People basically looked at the scale and said to themselves “I am a slightly above the mean risk-taker, so let me mark the scale at 6 or 7.” Or they said to themselves “I am a slightly below the mean risk-taker, so let me mark the scale at 4 or 5.” In essence, people have no idea what their risk attitude is, and if they are given different types of scales they end up reporting their risk attitude to be very different.

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