Normal People Shouldn’t Need To “Invest”

It’s difficult, psychologically, to put aside an adequate amount of retirement savings over the years. The problem is not helped by the fact that, as Felix Salmon notes, it’s rather logistically difficult to acquire and maintain a balanced portfolio and avoid high fees and fraudulent investment advice. I also think these two problems feed into one another. People know that to save prudently takes at least a little bit of forethought about savings vehicles, which becomes another excuse for delay. All that said, I think the real issue here is that as a society we’ve gotten away from the old-time insight that financial markets are no place for average people.

The kind of “savings” that it makes sense for typical working and middle class households to engage in is the sort that banks offer with demand deposit accounts. A low-yield FDIC-insured account is safer and more convenient than sticking a pile of cash in your sock drawer, it lets you smooth consumption across the course of the year (sometimes you’re on vacation, sometimes you need to buy Christmas presents) and build up a generic insurance buffer against the fact that weird expenses come up from time to time. Saving, in this sense, is the prudent alternative to carrying high-interest credit-card debt as your way of coping with the ups and downs of ordinary life.

But the best way to “save” for retirement is to live in a country with a properly functioning Social Security system. The way a system like this works is that a certain share of national income is set aside to support the living standards of elderly people. That share is collected as taxes from working people and paid out as benefits to retired people. The benefits received are proportional to the taxes you paid when working, so incentives to maximize earnings are preserved. This way everyone “saves” (i.e., reduces consumption below income) while working in exchange for a payoff that’s properly calibrated to overall long-term economic growth without needing to act as an “investor.” At the same time, since it actually does make sense for wealthy individuals to act as investors, you cap taxable payroll at a certain level so that rich people can go save/invest and use their Galt-ian magic to steer the economy forward or lose their nest egg or whatever else they want to do with it. It’s a very nice, elegant system. To be sure, it’s run into a couple of snags since we’ve let the share of payroll subject to taxation fall, and we’ve allowed the rate of population growth to fall, but these are conceptually simple issues to fix. The larger problem is that Social Security was never big enough. Instead, just as we made up for the lack of a national health program with employer-provided insurance we made up for Social Security’s inadequacy with firm-level defined benefit pensions. Given a large enough and sufficiently durable firm, a defined benefit pension can be a perfectly sensible idea. But no firm is nearly as big or durable as the entire United States of America, so it would have made a lot of sense to address the substantial problems with defined benefits pensions by moving to a bigger Social Security program. Instead we moved in the opposite direction, turning tens of millions of middle class Americans into “retail investors” who don’t know what they’re doing and don’t save enough.

The result is nice, I guess, for the guys who collect the management fees and print the 401(k) brochures, but it makes no sense as a social arrangement. It doesn’t work as a way of ensuring that people have adequate financial resources in old age, and the idea that a mass market of retail investors ineptly attempting to maintain a balanced diverse portfolio serves a useful role in steering capital to productive uses doesn’t pass the laugh test.