Plan Ahead

Over the past several months, Ways of the World has included a series of articles on consumers and their everyday use of money. In response to a Resolution passed at June's General Convention, No. A102 "Culture of Debt", we've talked about how much debt consumers bear, what they buy and why they buy it, and how much they save.

All of this is good to know about and it raises further questions about stewardship that will concern us again in the future. But in one sense, these discussions have been more complex than needed. Some brand new survey work just being reported by researchers at Dartmouth College and the University of Pennsylvania puts these issues in a much simpler context:

"Have you thought about your retirement?"

This question is part of the "Health and Retirement Survey" conducted every two years by the University of Michigan. The Social Security Administration helps fund this work, and we will also visit it later on when we look at the country's aging population. For now, Annamaria Lusardi (Dartmouth) and Olivia Mitchell (Penn's Wharton School) composed a section of it to study the wealth of people who are nearing retirement age. Their questions were asked of participants aged 51-56; the latest result – for 2004 – is compared with the same age group in the 1992 version and described in a Working Paper published just a few weeks ago by the National Bureau of Economic Research*. Lusardi and Mitchell want to know about the adequacy of people's assets as they approach retirement. How do people who have some retirement wealth differ from those who haven't saved much or might even be net debtors?

The question "have you thought about your retirement?" had four choices of answer: (1) hardly at all (2) only a little (3) some and (4) a lot. In both survey periods – 12 years apart – people who thought about retirement even "only a little" had 2.2 TIMES as much net worth as those who had "hardly thought about it at all". The accumulation of net worth by people who said they think about retirement "some" or "a lot" was larger, but only modestly.

So thinking ahead – "only a little" – during our peak working years before age 50 is a potent factor in helping us plan for retirement and build up assets toward that later stage in life.

Interest on Interest
As well, the act of "planning" is less complicated than we might believe. Apparently, according to this analysis, we just need to understand one basic notion: compound interest. Another survey question:

"Suppose you have $200 in a savings account that pays 10% interest. How much would there be in the account at the end of two years?"

Stop here and answer this for yourself. Of the nearly 2,000 people polled in 2004, only about 360 got the right answer. Of those who missed, about half made the same mistake: they didn't realize that in the second year, you get interest on the interest you received in the first year, so you don't merely add $20 each year. The amount of interest you earn increases every year and continues to do so as long as you leave the interest in the account:

Year 0 $200.00
Year 1 10% x $200.00 = $20.00 $220.00
Year 2 10% x $220.00 = $22.00 $242.00
Year 3 10% x $242.00 = $24.20 $266.20
Year 4 10% x $266.20 = $26.62 $292.82

Seeing this compounding effect helps put in perspective the investment returns open to us. Note too that the interest on some debt, especially credit cards, also compounds! So you are paying interest on your interest!

Social Security and Other Pensions
Participants in the Health & Retirement Survey were also missing other important, but very fundamental facts about their retirement finances. Only 40% had any clue how large their social security benefit might be. Further, more than half believe they will be eligible for the full benefit at an earlier age than the law now allows.**

Many respondents did not know what kind of private pension plan their employer offers: defined benefit, defined contribution or hybrid. Fewer than half knew when they would be eligible to receive these benefits.

It's Never Too Soon
So basic facts are important. These come through in "planning" of even the most rudimentary kinds. What Lusardi and Mitchell found is that people who take care to learn just these simple facts are making measurable progress toward accumulating the resources they'll need for retirement. We can consult Suze Orman and The Motley Fool and other financial advisors (and Ways of the World will do so!) but a journey of great distance begins with the first step. Here it is. Think ahead. Think about your retirement. Think about saving more and debting less. Learn the provisions of retirement plans you already have. Do these simple things when you're 45 or even younger; it's never too soon to start.

*Annamaria Lusardi and Olivia S. Mitchell, "Baby Boomer Retirement Security: The Roles of Planning, Financial Literacy, and Housing Wealth". Cambridge, MA: National Bureau of Economic Research, Working Paper 12585, October 2006.

**The Social Security Administration (SSA) is now sending us all annual statements with this information. If you discarded yours or believe you never got one, you can request one. Visit the SSA website: www.ssa.gov/mystatement/.