By: Dividend Sensei
Social Security was formed in 1935 during the Great Depression. It was initially meant to serve a dual role. First it was meant to alleviate poverty among the elderly. Second and more importantly it was meant to allow older Americans to quit the workforce and make room for hiring the massive amount of unemployed younger workers. Today Social Security is arguably the most important, but also least understood, government program. According to the Social Security Administration 63 million Americans (including 43 million retirees) will be receiving benefits in 2018.
The Social Security Administration just published it annual report on the status of a program that has important implications for the retirement plans of all Americans. So let’s take a look at three critical facts, while also debunk some dangerous myths, about this crucial program. Along the way we can hopefully help you better plan for your own retirement to maximize the chances of a prosperous golden years.
Social Security Isn’t Supposed To Replace All Your Income
According to the 2018 OASDI Trustees Report (the people overseeing the program), on average Social Security Benefits make up 33% of retiree income. The program’s original goal was to replace 40% of a your working income during retirement. Since the average person spends about 80% of what they did after retirement this means that social security was originally intended to provide about half your income in retirement. So you’d think that with the average retiree relying on the program for just 33% of their income things should be going well for the program and America’s elderly. However that is not the case.
According to the Social Security Administration fully 23% of retired couples and 43% of retired individuals rely on their social security for 90% or more of their total income. Given that the average 2018 monthly benefit will be $1,404 per month ($16,848 per year per person), this means that roughly 14 million Americans will be forced to live extremely frugally. This is largely because of three connected historical trends.
First private pensions have largely been a thing of the past. According to a 2017 report from analyst firm Willis Towers Watson in 1998 59% of Fortune 500 companies offered new workers a pension. In 2017 that figure was down to 16%. Instead companies have switched to 401Ks, in which individual employees are responsible for saving for their retirements. In theory this isn’t a problems since many companies even offer to match your contributions (usually between 3% to 6% of your salary). This represents free money to help people build their nest eggs. However there are three major problems in reality. First, Americans are notorious for a low savings rate.
Currently the US savings rate is 3.1% and has been falling for several years. Financial advisors usually recommend a savings rate of 10% to 15%, invested in low cost stock and bond index funds. It’s been roughly 33 years since the US savings rate has been at even the low end of the recommended range. Thus the US retirement crisis is a problem that’s been a long time coming, but one that’s not purely the fault of Americans not saving enough.
Another issue is that the mutual funds offered by by companies in their 401Ks are actively managed, with high expense ratios that means 95% of them will underperform the market over time. Often HR directors receive kickbacks from fund companies to exclusively offer certain funds to a company’s employees.
Finally there’s investor psychology. Simply put most people are absolutely terrible at market timing, yet due to risk aversion (it hurts twice as much to lose a dollar as make a dollar), most people simply can’t help themselves. This means pulling money out of one’s 401K when stocks are falling, and increasing contributions when stocks are rising. Or to put another way, most investors are experts at buying high and selling low.
This is why, according to a study by JPMorgan Asset Management (4th largest asset manager on earth), over the past 20 years the average investor generated total returns of 2.6% annually. That’s worse than every other asset class and just 0.5% above the rate of inflation.
This combination of low savings, poor mutual fund options, and terrible market timing, is why, according to the Economic Policy Institute, the average family aged 56 to 61 has just $163,577 in retirement savings. That might sound like a lot but in reality it’s nowhere near enough to live comfortably on during retirement, even factoring in Social Security. How much does the average person need to have saved up? The answer is rather shocking and a bit depressing.
I'm an Army veteran and former energy dividend writer for The Motley Fool. I'm a proud co-founder of Wide Moat Research, Dividend Kings, and the Intelligent Dividend Investor. My work can be found on Seeking Alpha, Dividend Kings, iREIT, and the Intelligent Dividend Investor. My goal is to help all people learn how to harness the awesome power of dividend growth investing to achieve their financial dreams and enrich their lives. With 24 years of investing experience, I've learned what works and more importantly, what doesn't, when it comes to building long-term wealth and income streams and achieving long-term financial goals.
October 14, 2020
May 22, 2019