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July 26, 2010

A Cautionary Retirement Tale

Neil Bhatiya

When President George W. Bush introduced his proposed overhaul of the U.S. Social Security system, the cornerstone of which would have shifted a portion of workers’ payroll taxes into personal retirement accounts, he all but guaranteed that the available investment vehicles would be safe and provide a reliable source of income over the long-term . Based on the historic returns of U.S. stock indices for much of the latter half of the twentieth century, many conservatives argued that such a move would provide a safe source of growth. In light of the recession that began in 2007, resulting in a precipitous loss in value for most investments, Social Security privatization turned out to be a bullet that was fortuitously avoided.

The idea of a publicly-funded pension system remains under attack, however, especially as more public attention shifts to the deficit “crisis.” Further evidence of the risks of moving away from a fixed-benefits pension and retirement system to one which relies more on individual investments can be found in the recent performance of Australia’s retirement system. It utilizes three methods of building retirement savings: voluntary savings, an old-age pension built on tax revenue, and what’s called a “superannuation guarantee” – a defined contribution which individuals can invest in the stock market. The system seemed to work pretty well during the 1990s and 2000s, as global markets rose. When the recession hit, however, many Australians lost a key foundation of their retirement strategy. According to Reuters, over the first ten months of 2008, pension funds suffered a loss in value of close to $200 billion, which caused a rush on public pensions by potential retirees who could no longer afford their post-employment plans.

This uncertainty has been further undermined by the perception among Australia’s population that they are at a disadvantage when it comes to receiving sound financial advice. This fear was highlighted this past week, when it was discovered that Ross Tarrant, a well-known financial planner, received a “marketing allowance”—essentially an undisclosed commission—to steer business to a particular fund company. As the blog Bronte Capital pointed out, when the objectivity of investment advice is compromised, its not a surprise that many are wary about trusting a large portion of their retirement savings to brokers and financial planners. While not Madoff-esque in scale, this revelation further weakens the idea that a privatized retirement program, based on income from investments, can provide a predictable retirement future for its participants. 

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