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Hope I save before I get old

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IF YOU reach the age of 65 in the OECD, you can expect to live for another 19 years  or so (more if you are a woman, less if you are a man). If you stop work earlier than 65, and live a bit longer than average, you could easily be retired for 25-30 years, almost as long as you were in work. But people find it very hard to get interested in pensions, even though their financial future depends on them; retirement is too distant a prospect and the issue seems too complicated.

This blog has written a lot on the subject so it is time to summon some farewell thoughts. The executive summary: pensions are more expensive to fund, employers are less willing to do so, so you will need to save more (a lot more) and/or retire later. 

All pensions are paid for by the next generation. This may seem counter-intuitive; aren’t we contributing money every month? State pensions are paid for by current taxpayers (yes, there is a US Social Security fund, but it is invested in Treasury bonds, which are a claim on taxpayers). Most state pensions run on a pay-as-you-go system; this year’s benefits are paid for out of this year’s tax revenues. When it comes to private sector pensions, many schemes have a fund, which is invested in bonds, equities, property etc. But what gives those equities, bonds and properties value in 2030, or 2050, when the pensions get paid? It will be the workers and taxpayers of 2030 and 2050 who will generate the income needed to pay the dividends on the equities, the interest on the bonds and the rent on the properties. As a consequence of this…

Pensions are a heavier burden when the elderly population expands, relative to the working cohort. In other words, fewer young people are supporting more retirees. In 1950, there were 13.9 people in the OECD aged over 65 for every 100 of working age (20-64). As of 2015, that figure had doubled, to 27.9; by 2050, it will have nearly doubled again, to 53.2. In some countries (Greece, Italy, Japan, Portugal, South Korea and Spain), the ratio will be more than 70 by 2050. In part, this is down to lower fertility rates (below the 2.1 needed to keep the population growing) and in part because of improved longevity. Since 1970, the life expectancy of the average OECD retiree aged 65 has risen 4-5 years. At its heart, this is why state retirement ages have been trending upwards. On top of this…

Even ignoring longevity, paying pensions has become more expensive. A pension is an income and the yield on income-producing assets has fallen. In other words, the amount of income that can be generated by a given savings pot has declined. The way that savers can guarantee an income in retirement is to buy an annuity; in Britain, the income from a £100,000 annuity has dropped from £15,000 in 1990 to £5,000 today, a decline of two-thirds. That explains why annuities are unpopular, and why the British government stopped the requirement for people to buy them. But the alternative is to put your money in cash, where rates are even lower, or in riskier assets like equities. The latter may generate a higher income but there is a risk of capital loss (imagine if you had retired in 1929 in America, or 1989 in Japan). 

Companies that provide defined-benefits (DB) pensions face exactly the same risks as individuals. There is a market for offloading a corporate pension liability; it is called the buyout market and it involves the insurance sector. The cost of a buyout has risen sharply as yields have dropped. Accountants and regulators can see this and have required companies to account for the risk; that implies higher contributions. So private sector employers have retreated from DB pensions and offer defined-contribution (DC) pensions instead. These don’t guarantee to pay anything; the worker gets a pot on retirement. The employee now carries the investment and longevity risk. 

What you put in is not always what you get out. That is pretty clear for public pensions. People may have to contribute for a set number of years. By and large those who earn more, pay more into the system whereas the pension is either a flat rate, or a benefit that pays a higher proportion of final salary to the lower-paid. In the case of private sector DB pensions, it is the employer who usually makes the biggest contributions and is on the hook for any shortfall.* Were workers to get their own contributions back (plus investment return) they would get a disappointing pension.

But in a DC scheme, what you put in matters hugely. Employers may match contributions but even in a generous scheme, you would do well to get 15% of payroll. The cost of a DB equivalent is 25-30% or more. The running costs of a DC sheme are usually higher. So a DC employee cannot expect to get the equivalent of DB benefits (two-thirds final salary after 40 years). Worse still, the vagaries of the market mean two people who contribute exactly the same cash amount over their lifetime could get wildly different pensions. So you need to save more (at least another 10% of salary), and/or prepare to retire later. This is not really complicated; it is just maths. Alas, very few people get it.

* There are some who would argue this point, on the grounds that pension contributions are deferred wages. While that is technically true, people don’t act as if it were so. If it were, people who work for companies that offer DC pensions (where employers contribute much less than in DB) would get much higher pay than those in DB schemes. They don’t. Note also that if the company goes bust, guarantee schemes like the PBGC and PPF cap the amount of benefit, regardless of how much you contributed. 

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Japan still has great influence on global financial markets

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IT IS the summer of 1979 and Harry “Rabbit” Angstrom, the everyman-hero of John Updike’s series of novels, is running a car showroom in Brewer, Pennsylvania. There is a pervasive mood of decline. Local textile mills have closed. Gas prices are soaring. No one wants the traded-in, Detroit-made cars clogging the lot. Yet Rabbit is serene. His is a Toyota franchise. So his cars have the best mileage and lowest servicing costs. When you buy one, he tells his customers, you are turning your dollars into yen.

“Rabbit is Rich” evokes the time when America was first unnerved by the rise of a rival economic power. Japan had taken leadership from America in a succession of industries, including textiles, consumer electronics and steel. It was threatening to topple the car industry, too. Today Japan’s economic position is much reduced. It has lost its place as the world’s second-largest economy (and primary target of American trade hawks) to China. Yet in one regard, its sway still holds.

This week the board of the Bank of Japan (BoJ) voted to leave its monetary policy broadly unchanged. But leading up to its policy meeting, rumours that it might make a substantial change caused a few jitters in global bond markets. The anxiety was justified. A sudden change of tack by the BoJ would be felt far beyond Japan’s shores.

One reason is that Japan’s influence on global asset markets has kept growing as decades of the country’s surplus savings have piled up. Japan’s net foreign assets—what its residents own abroad minus what they owe to foreigners—have risen to around $3trn, or 60% of the country’s annual GDP (see top chart).

But it is also a consequence of very loose monetary policy. The BoJ has deployed an arsenal of special measures to battle Japan’s persistently low inflation. Its benchmark interest rate is negative (-0.1%). It is committed to purchasing ¥80trn ($715bn) of government bonds each year with the aim of keeping Japan’s ten-year bond yield around zero. And it is buying baskets of Japan’s leading stocks to the tune of ¥6trn a year.

Tokyo storm warning

These measures, once unorthodox but now familiar, have pushed Japan’s banks, insurance firms and ordinary savers into buying foreign stocks and bonds that offer better returns than they can get at home. Indeed, Japanese investors have loaded up on short-term foreign debt to enable them to buy even more. Holdings of foreign assets in Japan rose from 111% of GDP in 2010 to 185% in 2017 (see bottom chart). The impact of capital outflows is evident in currency markets. The yen is cheap. On The Economist’s Big Mac index, a gauge based on burger prices, it is the most undervalued of any major currency.

Investors from Japan have also kept a lid on bond yields in the rich world. They own almost a tenth of the sovereign bonds issued by France, for instance, and more than 15% of those issued by Australia and Sweden, according to analysts at J.P. Morgan. Japanese insurance companies own lots of corporate bonds in America, although this year the rising cost of hedging dollars has caused a switch into European corporate bonds. The value of Japan’s holdings of foreign equities has tripled since 2012. They now make up almost a fifth of its overseas assets.

What happens in Japan thus matters a great deal to an array of global asset prices. A meaningful shift in monetary policy would probably have a dramatic effect. It is not natural for Japan to be the cheapest place to buy a Big Mac, a latté or an iPad, says Kit Juckes of Société Générale. The yen would surge. A retreat from special measures by the BoJ would be a signal that the era of quantitative easing was truly ending. Broader market turbulence would be likely. Yet a corollary is that as long as the BoJ maintains its current policies—and it seems minded to do so for a while—it will continue to be a prop to global asset prices.

Rabbit’s sales patter seemed to have a similar foundation. Anyone sceptical of his mileage figures would be referred to the April issue of Consumer Reports. Yet one part of his spiel proved suspect. The dollar, which he thought was decaying in 1979, was actually about to revive. This recovery owed a lot to a big increase in interest rates by the Federal Reserve. It was also, in part, made in Japan. In 1980 Japan liberalised its capital account. Its investors began selling yen to buy dollars. The shopping spree for foreign assets that started then has yet to cease.

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