The centerpiece of retirement savings for millions of Americans is the 401(k) plan, in which a tax-sheltered portion of earnings is invested, along with some matching money from the company. But is this as good a deal as it sounds?
Not necessarily, says William Wolman, former BusinessWeek chief economist and co-author with his wife, Anne Colamosca, of The Great 401(k) Hoax. In this book (published by Perseus Books), they argue that even at the end of 15 years of stock market boom, the average American gained almost nothing in the purchasing power of his or her pension plan after adjusting for inflation.
Wolman discussed this issue, as well as his overall outlook for the economy and the market, in a chat presented June 13 by BusinessWeek Online on America Online. He was responding to questions from the audience and from Jack Dierdorff and Karyn McCormack of BW Online. Edited excerpts from this chat follow. A complete transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.
Q: About your book -- what is the 401(k) hoax?
A: The hoax is multifaceted...the promise that investing in stocks would somehow guarantee a comfortable retirement for the average American and would prove a far superior retirement system than either Social Security or old-style, defined-benefit pension plans, where the company sends you a check every month, has turned out to be a ridiculous claim.
According to very careful studies by such people as Professor Edward N. Wolff of New York University, based on a careful analysis of IRS data, that between 1983 and 1998 the average American had no more real purchasing power in his pension plan at the end of 15 years of stock market boom than he had at the beginning, when you correct for inflation. And that, mind you, was in a period in which stock prices increased by a factor of 10. What has happened since the market crash, of course, will make the picture a lot worse when the numbers come out.
Q: What choice do I have? A 401(k) is the only mechanism my employer will match contributions into.
A: That is an excellent question, and it describes the dilemma that now faces most Americans because of the prevalence of the 401(k) and the vanishing act that now besets old-style pension plans. The general advice in The Great 401(k)
Hoax is that the average person would be wise to invest extremely conservatively over the coming decade, and that means keeping a good portion of his money in bonds, and insofar as he has money in stocks, to have it in high-dividend stocks, preferably held in a widely diversified portfolio. This should be managed by a company with low management fees.
The problem is that the average 401(k) plan severely limits the scope of possible investments for plan members. This is a problem that we can do nothing about other than through political action, which would press Washington to change 401(k)s so that any individual plan member would have the right to manage his fund as if it were a brokerage account, or at least a self-directed IRA.... I would strongly recommend writing your congressman.
Q: What's the advice for (1) someone with an existing 401(k) and (2) someone deciding whether to sign up for a 401(k) to take advantage of employer matching?
A: Let me answer the second question first. The tax advantages of having a 401(k) are so great that you simply must be in one, given the current structure of pensions. I always forget to say that, and I always feel bad about it. So by all means, don't get out of your 401(k).
Work to make your company give you wider choices, and pay attention to what you're doing. Anne and I have recommended that employees start 401(k) clubs in their companies, just like some people belong to investment clubs. That's a great way of learning what's really going on in your company's 401(k), rather than what your company says is going on. They might not be exactly the same, as we have recently seen.
Now in terms of current management, insofar as your 401(k) allows you to diversify, hold a diversified portfolio, and depending on your age, you have to think about stocks somewhat differently. The closer you are to retirement, the higher the bond component should obviously be. This isn't original advice on my part, but it's correct.
Q: The market seems to be suffering from a lack of trust in Corporate America, especially with the latest charges against the former CEOs of Tyco (TYC) and ImClone (IMCL). Can the economy recover without investor confidence?
A: As we point out in The Great 401(k) Hoax, earlier stock market bubbles, when they unwound, revealed many cases of corporate and Wall Street deceptions and dealings. That was certainly true after the 1929 crash. There were also problems after 1966. Generally, these periods of corporate doubt tend to last longer than we expect them to. We're obviously getting a new, and sort of unexpected, scandal every week these days. That will continue.
I believe that the lack of confidence will hurt the recovery and make it harder to revive than it otherwise would be. It's particularly true that capital investment by business, which is the real key to a sustainable revival, is very sensitive to the concerns over corruption.... This that leads me to be much more skeptical about a strong second-half revival than most of my fellow economists.
Q: If you were in cash today, how would you invest?
A: It would depend on how much money I had to invest. For many people, a very sensible investment would be TIPS -- Treasury bonds that provide inflation protection. These bonds are now paying almost 4% a year, plus -- and it's a very important plus -- a cost-of-living or inflation allowance. So you're getting almost 7% on your money on a government-guaranteed investment.
Apart from that, there are lots of "strips" around, which sell the interest component of Treasury securities, and they pay a decent rate of return. You might also consider the other half of the coin, which are the principal-only bonds. They provide no current income, but the face value grows relatively rapidly.
Q: Money-market funds -- Bill, would they be a wise choice now, or is that too conservative? Not a great return, but they don't go down.
A: That's true. But I think you can go out a little bit longer than that and get a somewhat better rate of return. If you bought, say, a two-year Treasury, the yield is quite a bit higher than money funds, and your capital loss is obviously limited, since they mature in two years. In my view, I don't think giving up a couple years of liquidity is a bad idea here, because I don't believe that the stock market will go up much over the next two years -- if it goes up at all.
Q: What happens when Alan Greenspan retires? That would be the ultimate loss of confidence!
A: That's a serious matter. A great deal depends on who replaces him. I just hope that it's not a crass political appointment. By the way, there isn't a lot of reason to believe that Greenspan will retire very soon, particularly in the current environment.