Thursday, February 02, 2006

Are diversified investments safer than non-diversified? Or, another AP misrepresentation?

I have a 401(k) plan. 401(k) is the section of the tax code that lets me contribute money into an account tax free (i.e., the money I put in each month is off the top, and not taxed), is allowed to grow tax free (i.e., no capital gains tax) which will eventually be taxed when I decide to take it out. My 401(k) money is invested in several mutual funds that generally invest in the stock market. I'm relatively young, and historically the stock market has produced higher returns than any other investments, so the bulk of my money is there for now. When I get older I'll start moving my 401(k) money into safer investments, with lower returns. When you are young, you can endure short-term swings in volatile, yet higher producing, investments. When you are older, your timeframes are shorter and you are less able to endure volatility.

This is all common sense. This should be taught in 8th grade. Diversifying your investments is safer than putting all your eggs into one basket. It is not always the best choice in hindsight - I would love to have put all my money in Google at the IPO price, then sold it for gold at the high end just before Google's latest earning report - but it is definitely the safest.

So why is the AP reporting that the growth in 401(k) funds, now with more aggregate money than "traditional" pension funds, is "a dramatic change that will force younger workers to plan more carefully for retirement"? A "traditional" pension fund is one where an employee puts all his eggs in one basket - the basket of your employer, ala Enron. This is, and has always been, foolhardy non-diversification.

United Airlines recently emerged from bankruptcy. As part of its Chapter 11 reorganization, "drastic cuts were made to the pension plans." If every employee had invested their money in a 401(k) instead of United's traditional pension plan, they would still have all their money because, surprise surprise, it would be their money, not some future promise of a pension. Worse, United's employees' union almost surely bargained for this form of compensation. It doesn't matter one whit to your employer how he compensates you - all cash, a mix of cash and health benefits, a mix of cash, health benefits, pension plan, etc. It's all the same to the employer. Anyone who can take all of their compensation in cash, but doesn't, is an idiot. (When I say "cash" I include anything that one has a present property interest in, which is not subject to some future promise.)

This is essentially why we need to privatize Social Security. It is a simple legal principal - title to my retirement money should be mine. Social Security is a mere unenforceable promise by today's politicians that tomorrow's politicians will pay you back something resembling what you are being taxed today - or in other words, a Ponzi scheme. Since the age demographics in this country will not support such a Ponzi scheme in the very near future, you (and me) can all kiss our "promised" Social Security goodby - just as United employees kissed their "pensions" goodby.

Both Social Security and United pensions suffer from the same basic problem - lack of diversification. Both plans are utterly dependent upon one, and only one, enterprise succeeding indefinitely. Social Security's Ponzi scheme cannot survive indefinitely. Though ignorant leftists once thought big corprations like United could never fail, this is obviously not true (TWA, Pan Am, Enron). The only way to keep your money is to keep your money - i.e., get it all under your legal control. This will not guarantee that you'll keep all of your money, as certainly your mutual funds will occasionaly invest in stinkers like Enron. But it is far better than Social Security or a "traditional" pension.

To sum up: The AP article leads with scaremongering that 401(k)s are somehow more difficult to manage or riskier than "traditional" pensions, which is not true. From this I discern that the AP reporter is either reflexively liberal (most likely) or an ignoramus (what's the difference? you say). 401(k)s are obviously better than "traditional" pensions, as any diversified investment plan is better than a concentrated plan. This is simple stuff, and shows why Social Security should be wholly privatized.

UPDATE: Even though no one reads this blog, I thought I should clarify one point made above. As the United bankruptcy demonstrates, employers actually do care about how they structure their compensation of their employees. Pension plans have been favorites because they allow the employer to keep the money (essentially by requiring the employees to "invest" their pension-allocated money in the employer rather than elsewhere) and are dischargeable if the employer ever files for bankruptcy. If an employer can give you a (potentially unenforceable) promise of payment later instead of cash now, well, it doesn't take a brain surgeon to figure out that it'll do the former. Social Security works on the same principal, except Social Security is 100% unenforceable.


Blogger Rex said...

Good post, I'm going to repost this on my blog, which also, nobody reads.

I've never thought of pensions as a promise, but that really is the case. Companies get to keep "your" money until it's time to pay out, and there's always the chance something can happen before it's time to pay out.

Also, they get to invest that money themselves and keep whatever you're not going to use.

9:14 AM  
Blogger andrew fields said...

Pretty good post. I just stumbled upon your blog and wanted to say that I have really enyed reading your blog posts. Any way I'll be subscribing to your feed and I hope you post again soon.

Private equity Bahamas

7:30 PM  

Post a Comment

<< Home