The Present Value Of Your Future

The Following Is A Full Feature Piece, Just Be Warned:

Flames lick the sides of overturned cars. The smell of burning rubber and tear gas penetrates the dense, grey air. High school and college students with makeshift weapons scream at the top of their lungs, law enforcement barely keeping the riot contained. Chaos reigns.

The government obviously earned this, though. They increased the age of retirement by two years, the most heinous of all crimes. And now the young citizens of France demand retribution.

----------------------------------------------------------------------------

In late October of 2010, the Sarkozy government instituted a reform to increase the age of retirement in France by two years, from 60 to 62 years of age. Though some 70% of the French population are said to be weary of the reforms, according to a French research poll, the role of youth is particularly surprising. This segment of the population is 40-45 years away from retirement, many of them still minors, yet they are disturbed by what is happening to retirement.

In the U.S., we haven’t seen this kind of outrage or violence, and we should denounce such actions as irresponsible and dangerous to civil discourse. But we can learn something from the passion of France’s youth. Our youth need to become aware of their uncertain future, and, more importantly, aware of what they can do about it. With simple financial planning in high school or college, this country’s retirement problems can be solved within a generation.

Benefits on a Precipice

Retirement has never been so uncertain in the history of the United States. In the early days of the Republic, people worked their entire lives, had grown children to support them, or let disease and early demise free them of choice altogether.  Intent on providing support for widows and other low-income individuals, the FDR administration altered this in the 20^th century, sweeping in a retirement safety net with the Social Security Act of 1935. Congress eventually expanded coverage to include all citizens. Social security has some complex specifics that were included to keep the system running smoothly, providing the necessary funds. For example, the age one can start receiving full retirement benefits depends on the year of birth. And before reaching full retirement age, one can collect partial payments based on their income, lower income individuals receiving more.

Unfortunately, the system escaped its initial constraints. The age of first benefit reception wasn’t indexed with life expectancy, and people continued living longer. Many wealthy individuals, who either continue to earn high incomes or just draw from saving accounts, still collect benefits. And the aging ‘baby boomer’ population is exacerbating the situation.

Social Security, as it stands today, has evolved into a Ponzi-esque structure, where current tax payers are supplying the funds for current retirees. If the rate of population growth was increasing or even stable this would hardly be a problem, because there would be more tax payers than recipients. However, this is not the case. We are instead witnessing the flipside of Zero-Population Growth, the policy of reducing the birth rate in order to increase GDP per capita and raise the quality of life. Without enough young taxpayers the system will collapse.

As journalist Mitchell Zuckoff writes in “Ponzi's Scheme”, Charles Ponzi didn’t intend harm or malice, and he even tried to mitigate damages instead of taking his earnings and fleeing. Ponzi got in over his head. The U.S. government may now be in a similar position. While Social Security likely won’t fail altogether, reduction of benefits or increase of the retirement age will be required to keep it afloat.

With all the trouble the politicians are in, they are not the sole players in this losing game. Small-Businesses and Large-Corporations alike play a significant role. Pensions are now just a memory, few companies offering fixed income payments at retirement. Fewer firms are independently investing in employee 401K’s and many are not even matching savings by employees.

These changes make a certain amount of economic sense given that younger workers have a much larger tendency to switch jobs than their older counterparts. Companies are not willing to guarantee benefits to employees who leave after four months of labor. The situation is far from ideal, but there seems to be no good incentive for companies to institute some novel approach to retirement.

Thus as it stands, there is no institution solution in sight, from government and corporation.

Taking Matters Into Our Own
 Non-Violent Hands

As a recent college graduate, I am particularly interested in what I can do to take away the uncertainty of retirement. What actions can someone my age due to prepare in the face of fraying safety nets?

Quite a lot.

            After scrounging around and researching different procedures, I have determined a decent path that is both flexible and plausible. In fact, I am in the process of starting an account for myself in order to experience and address any concerns readers may have.

A sustainable plan revolves around the familiar concept of compounding interest rates. Compounding truly works magic when leveraged with time. And while students and recent graduates may not have extensive funds, they certainly have time.

For an example of compounding, money invested in a savings account will accumulate interest, and then this new amount in the account (principle plus interest) will accumulate more interest. This interest on interest is the compounding effect, which has a big impact on how fast money grows.

The effect of dividends works in much the same way, as long as dividends are reinvested back into the stock market. Mutual funds, for example, will payout dividends quarterly from the stocks it holds. Dividends can then be automatically reinvested, buying more shares of the fund. More shares mean more dividends as each share is entitled to a certain percentage of dividends.

An important tool and concept, but how does one utilize this information? Save some money, move it into some type of personal IRA retirement account, and make sure the IRA is invested in a vehicle with decent returns. It’s simpler than it sounds.

Saving Our Retirement

            At $10 an hour working 40 hours a week, 50 weeks a year, you would take home $17,000 every year ($20,000 gross, 15% Federal bracket). This isn’t much, but if one is young living expenses are likely low. If at age 16 they put aside $1000 a year in a market mutual fund earning an average return of 10%, they would have about $1.8 million dollars in a retirement account at age 70.

            Assuming an inflation rate of 3%, the real value of this money is around $500,000. This certainly isn’t as impressive, but the interest alone on this money is $25,000 a year in 2010 dollars (assuming a bond paying 5% annually).

            What about a high school student or college student? Would they realistically be able to scrounge up the necessary funds? Given that most high school students are supported by their parents, they have little to no expenses of their own. If they were to garner a part-time or summer job, they could easily earn a $1000 to put away every year. In a society that apparently values consumerism, it may be difficult to convince a young person to put that much away per year, but it is within reach financially. It’s the equivalent of a $4 cup of coffee, 5 days a week.

            As for a college student dealing with tuition, living expenses, and student loans, it is not as feasible for them to save. This is alright as the education is a human capital investment in itself, resulting in a higher income and a greater ability to save after four or more years. College is a good investment.

Take, for example, one 18 year old that immediately joins the workforce after high school and a peer that goes to college for 4 years. If we assume the worker saves $1000 for the rest of his life, he will have $1.5 million at age 70.

In contrast, the student goes to college for 4 years, gets a job paying twice as much, pays off some loans, and now has the ability to save more. If the student saves nothing for the first 6 years but puts away $2000 a year thereafter, she will have $1.7 million at age 70.

This method is a powerful and simple path to stable retirement, regardless of what happens with government or business options. But even if you were to make this commitment, where do you put the money and how do you set up the account?

IRA’s and Mutual Funds

            An IRA, Individual Retirement Account, is a fund with special tax properties, as defined by the Federal government. Instead of investing directly into stocks, bonds, mutual funds, or even precious metals, it is beneficial to encapsulate the funds in an IRA to save on taxes.

There are two versions of IRA’s, Traditional and Roth, with some similar properties. Neither of them allow withdrawals before the age of 59 ½ without a 10% penalty. The maximum contribution per year for IRA’s, Roth and Traditional combined, is $5000. Only earned income can be added to the account, and thus gifts, lottery winnings, and investment interest cannot be used. Money can be withdrawn before the age of 59 ½ if it is for higher education expenses, or if used by a first-time homeowner as a down payment on a house ($10,000 maximum). One key difference separates Roth and Traditional IRA’s though.

For a Roth, taxes are paid up front and never again. (You would have to pay these taxes anyway if you spent the money, so saving it instead is no penalty.) Once in the Roth, interest, dividends, and capital gains are not taxable. This is a huge advantage as all the money remains in the account to collect interest, as we will soon observe. At retirement, the money is withdrawn without taxes.

For a Traditional, there are no taxes upfront at all. Like the Roth, the money accrues tax free, the huge advantage. At withdrawal however, dues have to be paid, taxed at your tax bracket in retirement.

Generally for a young investor, a Roth IRA is the superior vehicle because tax rates are lower as a student than they will be at retirement. A middle-age couple at the height of their earning potential would instead find helpful the tax-deferral of a Traditional IRA as they expect to have a lower bracket as they enter retirement.

Let us again examine the 18 year old worker that invests $1000 yearly. If it were in a regular fund, taxes would be paid yearly on the earnings, and there would be less money to compound. The effects are significant. At age 70, he will have $1.2 million in a regular taxable account, but if he had invested in a Traditional IRA he would have $1.4 million. A Roth IRA would yield $1.5 million, all else held constant.

How does one open a Roth IRA though? Almost all financial institutions have these accounts, from credit unions to online brokerage firms. I recommend the mutual fund company Vanguard because of low yearly expenses, lack of transaction fees, and load-free funds. An account can be opened with as little as $1000 in their STAR mutual fund, or $3000 in most other funds. More can be added on a monthly or yearly basis from your local bank without charge. (Just ask them to use the Automated Clearing House system instead of a wire transfer.) Vanguard’s website is simple to navigate and the process to open a Roth account is straightforward, with quality customer service.

As far as the taxes go, when filing your Federal tax form in April, just report how much you added to your IRA’s for the previous year.

Once the money is in the account, it can be moved around penalty-free due to the tax-free nature of IRA’s. Normally, each sale of a mutual fund would result in taxable capital gains, but not under IRA provisions. After $3000 is accumulated, one can invest in a total market mutual fund, owning a piece of every stock in the U.S.

Over the course of its history, the US stock market has averaged 10% a year, the figure used in previous examples. This average even includes the Great Depression and all other recessions. If one were to retire during the Great Depression, however, they would be out of luck, whereas if they waited till after WWII, they would have again been in decent shape. The lesson here is that youth can invest in riskier accounts because they have time for a recession to turn around. As they get older though, they should start holding more bonds than stocks to decrease the variance and risk. As we are talking about a young person here, it makes sense to start with the large majority in stocks.

As the years go on, one can continue adding a consistent amount of money to the IRA, in good and bad times, to hopefully earn the historical average of 10%. Make sure capital gains and dividends are being reinvested into your fund.
Now wait for retirement.

Best Case Scenario

What if the government gets their act together and social security is fine? What if businesses have a change of heart and start supplying generous pensions? Well, Social Security certainly doesn’t cover the full cost of retirement, nor usually do pensions. Savings are still essential to the equation: The more saved, the more luxury you can afford and the earlier you can retire.

In the interim, you have not only purchased a comfortable future but also the peace of mind that your future is secure. And as mentioned before, $10,000 can be used for the purchase of a house without penalty, and more can be withdrawn with a penalty in an emergency.

So save the money you were going to spend on arson, and open a retirement account.

Be Good,

Enjoy Life,

Yaffe

The Idea of Writing (and Employment Brief)

I routinely jump out of bed and run to my desk after ten minutes of attempted unconsciousness. It could be two in the morning and I’ll still make the effort. If I do not, I may lie there an hour more.

Excitement about tomorrow’s events, a quiet environment for thoughts to float around, unlimited time to develop and brainstorm. Imagining, visualizing, planning. It doesn’t matter if the plans are realistic or not. Sometimes the most intriguing ideas are the ones that seem stupidest upon waking.
What matters is that the ideas will badger me, lead me further and further from my pursuit of unconsciousness.

How could they not? My own ideas of how my life could actually be? They are far better than the most wonderful sleeping dream, for they provide a realistic illusion that doesn’t disappear with an alarm.

So I write. I can deal with the issue later. Write more about it another day. Turn it into a column.
And in doing so, the idea becomes more solid. If I don’t write an important idea down, I likely won’t remember it. And if I don’t write more about it, explain it in logical form with clear structure so that it makes sense to others, the idea will become lost in practice.

What is the practical message here? Write ideas down all the time. And then clear them up and make them presentable to others through solid logic. If you do this, your dreams won’t get shot down before the dreams have time to develop. Hasn’t this happened to you? A perceivably great idea shot down in flames (ain’t it a shame?) because you proposed it -- with all accompanying flaws -- before developing it?
Hurts, doesn’t it.

You think up a charity organization that would distribute portable huts to the homeless, structures easily erected and taken down. So you tell your friend.
And then you listen: “Wait… where are you going to get the funding? You want these people to get used to being homeless? You want to fill the streets and fields with ragged tents? Don’t you need some non-profit license for that? What about shelters that already exist? How is your idea different? Who is going to make the huts?
Why do you and your ill-conceived ideas hate the poor?”

Writing is a fundamental tool, if only seen by your own eyes, to clarify and structure ideas so that they have a fundamental foundation. Isn’t that the purpose of a college essay, business plan, or resume? To explain a hypothesis, to show potential investors your idea’s reliability, to reflect on who you are professionally.
Otherwise, you could tweet your professor your thesis and obtain your grade.

How do you show others all the ideas you have? Explain in clear prose. That’s one reason I am writing this column.

All parts of life become easier to talk about and clearer to think about.

Be Good,
Enjoy Life,
Yaffe

EMPLOYMENT UPDATE BRIEF:

Apparently, online applications take just as long or longer than the in-person screenings I had at the coffee shop. I received two calls today from different companies. I am excited to know that I am not completely forgotten! 

I feel I deserved it from my job-search project I undertook today, though today's searching and today's calls are completely unrelated. 

I went out and drove to local wineries, inquiring about open jobs. Beautiful landscape out there, rolling hills. Private enterprises, some family owned and operated, with jobs ranging from agriculture, to food service, to tasting room monitoring, to management and paperwork.

I worked up the courage, disregarded the 'Open For Business' times, and asked about job openings (or 'employment opportunities' at the highest class establishment). At a few places, I couldn't find anyone. At another I was kindly directed to their website, an employee saying that she had indeed obtained employment in this manner. A sociable office manager of another said there might be some part-time work coming up (and also noted that her son is at UC Davis now, my recent 'alma mater'), and an owner at another location suggested I call one of his managers about a recent opening. So, there is much potential in this arena should other paths fall short. Life is good.

Turning Towards Corporations

A few weeks ago, I discussed (is it a ‘discussion’ if I am the only one typing?) the potential for obtaining a job at a small mom-and-pop coffee shop. I want to work in a small business and see how it runs, from top to bottom, a much clearer view when the business structure is short in stature. Unfortunately, I was turned down for employment, due to an old employee coming back to fill the space. I completely understand this move as the company doesn’t have to spend time training, nor do they have to take a risk with a potentially unreliable new employee. They save time and reduce risk. An intelligent business move, but I am still unemployed.

I learned a rather important lesson though: Hedge Your Bets.
I could have applied to other companies at the time too, but I was a bit too certain that there would be an open position. Instead of waiting around for two and a half weeks, I could have been applying other places and conducting interviews. I figured that I would waste the time of other companies if I put in an application, that they would conduct an unnecessary interview. A noble enough thought, but apparently not too realistic.

With little in the way of other mom-pop alternatives, I turn to corporate America. It isn’t the small-business case study I hoped for, but it has other benefits.
For starters, corporate jobs are easily transferable from one place to another. If I decided to live in another part of the country for a time, it would a matter of transferring to another branch or franchise instead of finding another small-time job.

Also, once in the retail or fast-food industry, I figure that most companies are interchangeable. If you can sell a product you know little about for one company, you can learn about a new product you know nothing about for another company. If you work up to manager in a chain, you have manager experience for any other venture. Even when obtaining a master’s of business degree (MBA), it is rarely in a particular field, but rather broad principles that will add value any company.

With specialization in a certain type of job, managers, sales, cashiers, cooks, and retailers are more interchangeable. Human interchangeable parts. Knowledge of how a company actually functions remains with only a few people. Companies are less transparent to themselves, their workers, and their investors. The owners or CEO may not even know how a company quite functions. I recall some recent reality show where a CEO worked the job of an entry employee and wasn’t able to do it at all correctly. Put the CEO in the office of another company and he would fair alright.

I’m not sure if this is good or bad.
It implies that there is much horizontal mobility and opportunity to move anywhere in the country or world. Each worker too may be better at their niche, which increases the productivity of the company as a whole. People can focus on working in what they are interested, or at least where they have expertise.

But it comes at the cost of small business knowledge and vertical mobility in a company. People may be less and less interested opening their own business if they only know how to run a small portion of a venture. And workers may never find the job for which they are best suited or which they will most enjoy.

At this point in my life, I see what career(s) I end up selecting as quite important. I will be doing it 5-6 days a week for most of my life. If a job is just a means to fund the rest of existence then it doesn’t matter much. But laboring 8+ hours a day is working for more than a third of your life. That’s a rather large chunk of life not to enjoy. However, I suppose if you can find happiness and fun for whatever job you have, life will be good regardless.

Be Good,

Enjoy Life,

Yaffe