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Retirement Planning > Saving for Retirement

Saving and Spending in America

By Alexei Bayer

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Arriving from New York to Los Angeles amidst turbulence on Wall Street, it is not surprising that the conversation with James P. Smith, a senior economist at Rand Corp., quickly turns to the decline in the Dow Jones industrial average over the previous nine months, the longest downturn in stocks since the early 2000s.

Being an economist, Smith has a long view and sees no need to panic.

“If you look at any time chart of stock market performance, anything that spans a period longer than a couple of decades, you won’t even notice this decline,” he observes calmly. “The only drop in the Dow that is clearly visible on a long-term chart is the Crash of 1929 and the Depression.”

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Who: James P. Smith, Senior Economist, Rand Corp.Where: Rand Corp. Cafeteria, Santa Monica, Calif., April 8, 2008On the Menu: Sushi, salad and intergenerational asset transfers

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Since we’re unlikely to witness a calamity of such proportions this time, Smith sees this as a mere temporary blip. Otherwise, he points out, the rise of the stock market over time has been steady and relentless. His approach to retirement savings, therefore, is common-sense. He emphasizes the importance of staying in the market and — more to the point — putting aside a portion of your income regularly. This is how he approaches retirement savings both professionally and in personal finance, and it’s an approach that has paid off in his case, Smith maintains.

Saving 5 percent to 10 percent of what you earn over a period of 30 years or so provides for an adequate retirement income, replacing close to, or even more than 100 percent of your pre-retirement income.

An Optimistic ViewIt may seem a fairly unexciting bit of advice. After all, advocacy of the apparently vanishing American virtue of thrift goes back at least to Ben Franklin. Smith, for one, practices what he preaches. Even though Research is paying for his lunch, he opts for the moderate prices and modest offerings of the Rand cafeteria. Rand Corp.’s Santa Monica headquarters is the kind of ideal setting for a sage or a philosopher reminiscent of Ancient Greece, a sheltered Ivory Tower from which to observe the foibles of humanity. Even though Smith had an outside meeting later in the day, it’s hard to blame him if he is reluctant to face the wider world.

Perhaps because of his Arcadian vantage point, Smith, who is a Rand Chair in Labor Market and Demographic Studies, has a generally sanguine view of the world. Unlike many of his colleagues, moreover, he is upbeat even about labor market and demographic trends.

For example, based on research conducted by Smith and his group at Rand, thrift may actually not be in such great danger of extinction in America as we have been repeatedly told by other economists. Those Americans who are now in retirement are replacing around 80 percent of their pre-retirement income, on average. This is quite adequate to maintain a high standard of living — and it is also remarkably similar to how much retirees in major Western European countries are currently replacing.

The difference is, however, in the composition of retirement income. In Europe, particularly in the U.K., government pensions play a much greater role than private savings in providing retirement incomes. Americans typically get pensions from three sources, which include Social Security and corporate pension plans. However, the difference in the quality of life in retirement is provided by the private savings of American retirees and the incomes they generate.

The current generation of retirees, argues Smith, has a very nice lifestyle, much better than the average senior person has ever enjoyed in the past. The problem, however, is the future. It is no secret that government lacks adequate resources to continue paying generous pensions indefinitely. Based on Smith’s analysis, Western Europe will have a more difficult time of it. However, the United States will not be immune to future difficulties either.

“Our biggest problem is medical care,” he observes. “Our health care system is much better than what they have in Europe, but there is no way around it: It is expensive.”

Smith says that there would be no contest if he had to choose where to go for medical treatment — to the socialized U.K. health care system or to a private doctor in the United States. But he warns that this country will not be able to afford this system in the long run, especially as life expectancy continues to rise.

This problem will not be easy to solve. It defies facile solutions, such as letting in more immigrants. True, the average age of the population is lower in the United States than in Europe or Japan, largely because of a steady influx of immigrants. But the economic impact of more immigration is not as clear-cut as some proponents claim. Smith’s research shows, in particular, that immigrants, while contributing to the labor pool, also use up considerable resources.

In other words, what society gains from having a larger labor force, it often spends on providing services to new immigrants, their families and children. These expenses are not always fully compensated by larger tax receipts.

Lack of CertaintyBecause American retirees rely more on their private savings, and because their expectations that Social Security will be around in the future are low, Rand research shows that they all too often live below their means. They limit their spending to what they earn on their capital, not drawing down their assets. Effectively, they are enjoying a lower standard of living than they could have had given the value of their assets.

“This is wrong,” he says. “You should consume your assets.”

The reason why they don’t, Smith admits, is uncertainty.

“If you knew exactly when you were going to die you would not be very happy, perhaps, but you would at least be able to do a better job of planning.”

Now, there is even more uncertainty for retirees than ever, since uncertainty goes up with life expectancy. Chances are increasing that the current crop of retirees will outlive their income.

So, it is a tricky balancing act. The alternative to consuming it all yourself, says Smith, is leaving it to your children. Smith has studied the issue of intergenerational asset transfers. What he found was that, aside from the top one-tenth of 1 percent of the super wealthy, whose behavior is difficult to generalize in any case, asset transfer among most middle-class Americans has not been a major factor in the average family’s standard of living.

To start with, the sums involved are not very large. On average, they measure around $10,000 to $20,000. It is not just that very few of the really big fortunes have been started with an inheritance, but, for most ordinary people, it is far more important what their parents have given them early in life, such as a good education or a signature on their first mortgage application.

This is why Smith doesn’t see the tax on inheritance, which some opponents have dubbed the Death Tax, as an economic issue.

“But then again, if the choice is between consuming all your money or paying a large portion of it to Uncle Sam, I know what my priority would be.”

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Alexei Bayer runs KAFAN FX Information Services, an economic consulting firm in New York; reach him at [email protected]. His monthly “Global Economy” column in Research has received an excellence award from the New York State Society of Certified Public Accountants for the past five years, 2004-2008.

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