Americans bet on markets to pay for retirement, education, and healthcare.
Common inflation numbers don’t tell the full story. While technology has brought the cost of many services such as communication, transportation, and entertainment down significantly over the past few decades, the costs of three of the biggest concerns of American adults have skyrocketed. Retirement has grown substantially more expensive as people live longer. Educational costs have risen dramatically as college campuses have made their sticker prices affordable to only a handful, forcing most families to rely on scholarships or loans to afford a level of education that has become the entry price to a decent job. Finally, healthcare costs have spiraled upward, well beyond the rate of inflation. While these costs get magically scaled back by insurance discounts, the list price has become absurdly expensive, making some form of insurance coverage an absolute necessity.
We are at the point where hard work and diligent saving alone will not allow the vast majority of citizens to secure these basic needs of education, healthcare, and retirement security. As such, we increasingly turn to the financial markets to solve these predicaments. By investing our savings, the hope goes, we can turbocharge our savings and, thus, be able to still afford those necessities we used to be able to pay for just through work and savings. While this approach is logical, it is hardly without risk. Financial markets offer few guarantees, and time horizons do not always align in practice as nicely as they may in theory. At the very least, the massive inflation in the price of these core needs has forced American savers to play the game at a much higher level of risk than did our grandparents. The days of the Bailey Building and Loan providing sufficient security to our families are long gone.
The first of our new breed of solutions is the 401(k) or similar retirement plan. Here, we take a long-term goal—saving for retirement—and match it sensibly to an activity with potential long-term benefits—investing in equities. The financial-services industry has done a good job in providing and improving these services, especially in the big-plan market. These plans today are generally well diversified; company stock is now the exception, not the rule. They make enrollment easy, encourage step-ups in saving, and offer streamlined choices such as targetdate funds that guide the investor toward a reasonable portfolio that takes on less risk as the goal nears. While these plans lack the security of a government or corporate pension, they can be a valuable tool in offsetting the rising challenge of retirements that are growing more costly.
If the stock market can rescue retirement, perhaps it can also solve the problem of the outrageous increases in academia. That’s the thinking behind 529 plans in the United States. The problem here is that the investor is not starting with a 45- to 50-year horizon, as with retirement, but instead just 18 years at best. That’s still a reasonable horizon for equities, but the investor must be ready to start downshifting pretty quickly, and the opportunity to recover from a bear market is sharply reduced. The prospect of the financial markets saving the day is far more limited. For parents who start these plans late, their utility is even more restricted. Still, these plans are a useful tool to counteract the almost unconscionable rise in tuition costs at our universities.
If the financial markets can address the problems of the rising costs of retirement and education, why not apply this magical elixir to the soaring cost of healthcare? Such is the thinking behind health savings accounts, or HSAs, which are beginning to attract more attention from investors, corporations, and politicians. Here, savers can set aside money from their paychecks that can be invested in financial markets and then used later to pay for healthcare. If the investor is fortunate enough to save more than is needed to cover health costs, the surplus can be added to retirement savings, thus solving two problems at once. The problem, of course, is that health costs are far less predictable than college and retirement costs, and the time horizon until the costs come due may be far shorter than the time horizon necessary for successful equity investing. That isn’t a reason not to try to grow the pot of earnings that need be directed to healthcare, but guarantees are far less sure here.
All of these are reasonable solutions to problems the financial-services industry did not create. The problem is that they all rely on the same engine. Moreover, they rely on the financial markets at a time when stocks are not cheap by historical measures and when bonds offer very limited yields. It’s a big bet with a weak hand. And if the bet fails, it will be the financial-services industry that takes the fall—not the Congressmen who failed to clamp down on health and education costs, not the price-gouging pharmaceutical companies, and not the self-aggrandizing college deans who caused the problem. Instead, the financial advisor who suggested the 529 plan or the corporation that offered the HSA or the 401(k) plan provider will take the blame.
The financial markets are great and powerful things, but they are not easily harnessed. You can’t just ask for x units of performance over y number of years. You get a range of returns that may exceed your needs or fall well short of them. The higher the valuation and the lower the yield at the point of embarkation, the greater is the probability of shortfall. And if you make essentially the same wager to address all three problems— retirement, education, and health care—you run the risk of catastrophic failure, meaning you could lose on all three bets at the same time. That’s not the type of diversification wise planners seek, but this triple-down risk is one many Americans feel pressure to take. Now more than ever, the well-being of Americans rests in the hands of the financial markets.