In case you thought that when you're 60, or thereabouts, you'll just keep right on working, think twice. Not too many employers hire people over 60. They typically like to think every new hire will spend ten years or more with the company, and the odds of a 30-year old staying (and being productive) just seem better to them than the gray-haired applicant.If you're smart, you will invest with a view to have the freedom to spend the rest of your life in a financial position where you don't need to work. How Much? Let's imagine you are the manager for the pension fund that's committed to pay me $60,000 a year till I die. Life insurance companies and pension funds approach the problem with what they call an endowment -- an amount of money which will yield enough cash every year to pay the $60,000. That amount comes from a combination of interest or dividends and a gradual depletion of the principal. So how much money will you need as an endowment to pay me my $60,000 a year? Mathematically, you calculate this the same way you calculate the amortization of your home loan: Every payment has an interest component and a principal component, and the pot is empty at the end of the term. Let's say you think I'm going to live another 20 years, and you can get a yield of 4 percent per year from safe bonds. For that scenario, you'd need an endowment of about $825,000. Now, let's say interest rates drop to 3 percent because the Fed decides to expand the money supply. That drop will require an increase in the endowment to about $900,000. As pointed out above, our life expectancy is increasing, so let's say I live another 30 years instead of the 20 you were counting on. For that, the endowment would need to be approximately $1.2 million -- a significant jump.
You see the problem: At the time of my retirement you had to make a decision on how much to set aside. Two changing circumstances caused the endowment to be underfunded by 44 percent. And both those changes are happening before our very eyes, so this is not purely hypothetical.By the way, this is exactly how Social Security has come to be underfunded: Since the time they made their funding determinations, interest rates have dropped and life expectancy has increased. It turns out that making funding decisions is similar to being a Denver weather anchor -- you know you're going to be wrong most of the time, but you have to do the job anyway. Of course, interest rates could go up, which would improve things a lot. Should interest rates climb to 6 percent, the amount needed drops again to just over $830,000, even with the longer life expectancy -- pretty close to the original endowment. You can see the problem. Making determinations about the future is tricky at best. The people who do it have to choose a set of assumptions and act accordingly. Everyone knows they'll be wrong, but nobody knows by how much. And everyone hopes that something good (like rising interest rates) will come along to bail them out. This fuzziness is giving rise to another problem, however. Those who make these decisions answer either to politicians or CEOs, and that spells trouble. Let's say a CEO is a little short on earnings for a particular quarter. It's easy for him to step over to the company's pension fund manager and say, "Hey, assume an extra 0.5 percent on the yield." The pension fund manager has to follow orders or lose his job. The result is the company's pension fund suddenly is over-funded. The company takes back the over-funding and -- voila! -- the CEO met his earnings target and collects his nice, fat bonus.
The same happens at governmental pension funds. The first crack in the dyke came in 2006 when the Northern Mariana Islands, a US commonwealth consisting of three major islands in the Western Pacific, declared that it didn't have enough funds to cover the commitments to future retirees and attempted to declare Chapter 11 bankruptcy. The Detroit situation last year is better known because it's bigger and closer to home. The problem is the same, though -- the amount set aside is insufficient to cover the promises made.You can expect to see more and more pension funds for folks like firefighters, cops, teachers and other governmental employees encountering the same trouble. Lower yields and higher life expectancies will render earlier endowment funding decisions inadequate. As a nation, we're about to find out what the authorities will do to solve this problem but, as it stands, there is an enormous problem brewing before our very eyes. The upshot of all of this is that you will increasingly be on your own. Your retirement (however that looks for you) will probably be longer than you anticipated, and whatever provision you had will probably be insufficient. Any provision promised you by others may well turn out to be for less, and for a shorter period, than you were counting on. Forewarned is forearmed. The solution Invest more, starting today. Investing is a thing of patience and time. How long you invest has as much of an impact on your eventual fund than the return you get. Will it entail sacrifice? Almost certainly. But what's the alternative? Many people don't want to learn how to invest. They think it's too complicated, too risky or too time-consuming. So is eating. If you leave your investing to others, you are courting disaster. Some may have been lucky, but many ended up starring in American Greed or other horror tales of unsound, if not unscrupulous, investment middlemen. It's your future. Like it or not, there promises to be more of it. And that may make it worthwhile to become more involved in how you are going to fund it.