Addendum to Ridiculous Pessimism

About the Article

The writer’s calculations may have been more involved than my own. This is always a possibility when a writer suppresses the details of his calculations.

I believe that my simplified calculations still have merit. They provide us with a good understanding as to what is going on.

The article addresses retirement the way that a Governmental agency might view retirement. It does not look at retirement from the viewpoint of individuals. Nor does it take advantage of the opportunities available to individuals.

Individuals can take advantage of opportunities when they arise. Individuals do not have to assume that valuations will stay sky high forever. Individuals can look forward and align their plans to match future events.

Even if history is far from the mark, the outlook is still bright. History tells us that, if we wait for favorable valuations and then invest heavily in stocks, we can expect to withdraw 6% (plus inflation) for 30 years without losing ground. This is not based on the most favorable valuations of the past. This is at reasonable valuations. This is with a high degree of safety.

General Comments

The writer focuses on today’s investments at today’s prices with today’s likely returns. Competition among Baby Boomers has driven stock prices into record territory. This implies that future returns are almost certain to be lower than the historical average. The trend toward earlier retirements has a similar effect. Increased competition for investment income, regardless of cause, reduces the return percentage.

The work-to-retirement ratio is the wrong ratio. The article should focus on the size of the retired population relative to the active workforce. Each group benefits the other. The active workforce supplies products. The investments by the retired population enable the active workforce achieve higher productivity. A localized shortage of active workers does not necessarily preclude retirement. In theory, but not necessarily in fact, retirees have access to the global workforce.

The investment goals of retirees differ from those of active workers. Retirees need steady income streams. Younger workers need growth. Retirees have shorter timeframes. Younger workers have longer timeframes. All of this can be complementary. Most likely, however, no one in either group invests in a manner that someone else considers optimal.

Those planning to retire in the future are not bound to today’s investment choices. They can wait. They can take advantage of opportunities. My numbers show that those opportunities are likely to be tremendous.

Annuities

To a good approximation, a single premium immediate annuity with an inflation adjustment is priced today as if it were an inflation-matched cash equivalent that lasts as long as one’s life expectancy. The insurance company pockets interest from its investments (e.g., TIPS). It balances its long-term liabilities to those who live longer than expected with the windfalls from those who die earlier than expected. Typically, buying an annuity is a poor choice for a young retiree. It can be a good choice for an older, traditional retiree.

Have fun.

John Walter Russell
September 24, 2005