The arithmetic of retirement income: the case of zero interest rates

Back in 2009, I looked at the implications of the GFC for retirement income, working on the assumption that retirees could safely aim for a 2 per cent real rate of return. The bottom line was that current workers need

double contributions, to 20 per cent of income and shift the work-retirement balance, so that you work from 25 to 65 to finance an expected 20 years of retirement income.

Since then, the real rate of return on safe investments like government bonds has fallen to zero (maybe below). That means that you can treat your net worth at retirement as being equal to the amount you have to live on for the rest of your life. In particular, if you work from 25 to 65 and want finance 20 years of retirement income holding your consumption constant, you need to save one-third of your income.

When I wrote in 2009, the general view was that we were saving too little, so the increase in required savings seemed like a good thing for the economy in general. Now, the reverse is probably true.

34 thoughts on “The arithmetic of retirement income: the case of zero interest rates

  1. “20 years of retirement income holding your consumption constant”

    Personal consumption generally decreases by a good amount with age after an initial spree upon retirement.

    What’s in the retirement incomes report scummo and depressionberg are still sitting on?

    Retirement saving is now simply a scam benefitting the 1% and funds managers. Just a small part of that is the hugely unfair annual return received each and every year by the well heeled by way much reduced taxation on concessional super contributions.

  2. It is the case that finance practitioners have used the rate of return on US treasuries or Australian bonds as ‘a safe rate of return’, particularly before the GFC. But this investment is at most ‘safe’ in terms of the face value of these financial securities and the coupon rate if any, when held to maturity and not necessarily for all currency units.

    It seems to me the calculation of retirement income after retirement, assuming the value of the ‘savings’ at that time is entirely invested in government securities, is either artificial, or it pertains to a society where people are forced to look after their own retirement funds but lack elementary knowledge of investment opportunities and elementary knowledge of financial calculations and terminology.

    The foregoing scenario is not the case in Australia, at least not so far (the Age Pension as superannuation retirement payments)

    People in Australia are sometime criticised for investing their savings in ‘brick and mortar’ (rather than in ‘productive’ economic activity; ie shares). But long term data for many countries show that housing is at least as good an investment as shares and provide a significantly higher rate of return than so-called ‘safe assets’. Moreover, the variability of so-called safe assets is by no means zero.

    Click to access wp2017-25.pdf

    I would assume that self-managed super funds keep only a fraction of their portfolio in either cash or government bonds or both, whereby this fraction can be changed according to short term plans and economic conditions.

  3. I don’t know why there are so many blank lines between the second last and last paragraph. Sorry about this nevertheless.

    I’d also like to make a correction. The sentence, “The foregoing scenario is not the case in Australia, at least not so far (the Age Pension as superannuation retirement payments)”, should read:
    The foregoing scenario is not the case in Australia, at least not so far (the Age Pension as well as superannuation retirement payments)

  4. In theory, zero interest rates means a zero expectation of earnings. It means this trivially as in the case where I lend money at zero interest rate and expect zero earnings. It means this profoundly as in nobody, who is in power and in the know, expects or predicts that the real economy will grow any more in real terms. Zero interest rates appear to be a prediction of the end of growth. It is a prediction, as I say, by those in power and in the know.

    When it known (by those in power and in the know) that real growth has ceased effectively and forever, then it is known (by them) that we have entered a zero sum or negative sum game. This intensifies the competition to transfer wealth rather than to grow it. The pie cannot be grown any more. Now is the time to re-slice it. To pinch Ernestine Gross’s words and stretch them a little further by a specific amendment, persons who lack advanced knowledge of investment opportunities and advanced knowledge of financial calculations and terminology are put at a grave disadvantage.

    Zero interest rates and money creation of a specific form (Q.E.) are employed to implement wealth transfers.

    “(A) damaged banking system means that today banks aren’t creating enough money. We have to do it for them.” – Sir Mervyn King, then-Governor of the Bank of England, speaking in 2012.

    “The problem was that the money created through QE was used to buy government bonds from the financial markets (pension funds and insurance companies). The newly created money therefore went directly into the financial markets, boosting bond and stock markets nearly to their highest level in history. The Bank of England itself estimates that QE boosted bond and share prices by around 20% (Source). In theory, this should make people feel wealthier so that they spend more. However, 40% of the stock market is owned by the wealthiest 5% of the population, so while most families saw no benefit from Quantitative Easing, the richest 5% of households would have each been up to £128,000 better off (according to Strategic Quantitative Easing, p28, by the New Economics Foundation).

    Very little of the money created through QE boosted the real (non-financial) economy. The Bank of England estimates that the first £375 billion of QE led to 1.5-2% growth in GDP. In other words, through QE it takes £375 billion of new money just to create £23-28bn billion of extra spending in the real economy. It’s incredibly ineffective, because it relies on boosting the wealth of the already-wealthy and hoping that they increase their spending. In other words, it relies on a ‘trickle down’ theory of wealth.” – positive money dot org “How Quantitative Easing Works”.

    Often, the assumption is made that those who run the UK and US governments and the Bank of England and the US Federal Reserve want to “save the economy” for all. This is not true. They want to save the economy for their class and their class only (the monied class). Zero interest rates and Q.E. are the perfect vehicles for this action. There are four basic circuits of money (as markets) worth talking about and they are relatively insulated or sealed from each other. These are;

    (1) Common consumer goods and services.
    (2) Luxury consumer goods and services.
    (3) The major capital goods market.
    (4) The bonds and shares market.

    Q.E. money goes into number 4 above and mainly inflates asset values in this class. Some leakage occurs to number 3 above (one would expect significant capital goods inflation though I haven’t been able to check this yet). One would also expect significant inflation in the luxury consumer goods and services market but the super rich are so rich they can’t significantly lower their wealth by even the highest consumption of luxury goods that they can manage [1]. Most of the money stays in the share market and major capital goods market. Little of the money trickles down to workers so relatively little enters the common consumer goods and services market. The destruction of small businesses and the increase in monopolization and the size of (the fewer) TNCs and conglomerates keeps profits up in the common consumer goods and services market sector. In addition, the TNCs and conglomerates play the bonds and shares market in any case and get access to the essentially free Q.E. money at zero percent interest.

    In summary, zero interest rates and Q.E. should be viewed as a purely deliberate and intentional policy arrived at by premeditation. In the 1960s, Milton Friedman advocated setting the nominal interest rate at zero (Friedman rule). This monetary policy is now fully adopted, at least by the US and UK, and largely rules economics now. It’s the perfect tool for re-slicing the pie for the rich. Privatized superannuation dovetails into this system and allows the financially naive to be asset stripped. The correct course of action is fiscal stimulus and national super run by the Federal government. National super would best take the form of the current pension system with extra volunatry payments into it to buy a higher pension when retired (up to a limit equal to of Full Time Adult Average Weekly Total Earnings). The private super industry could exist to take extra investments if anybody wanted to make them. These investments would attract no tax assistance whatsoever. Of course, none of this will ever happen. What will happen is the asset stripping of the poor and then the middle class. World total production will decline as climate benignity and resource supplies collapse. I don’t need to spell out what comes next.

    Note.

    1. Bill Gates mansion is supposed to be worth about US$120 million. Estimates suggest that Bill Gates makes about US$40 million per day. So poor Bill probably needs 3 days to make enough money to pay for his mansion and another day (maybe?) to pay all his taxes.

  5. Correction above. Where I wrote

    “There are four basic circuits of money (as markets) worth talking about and they are relatively insulated or sealed from each other.”

    I should have written:

    “There are four basic circuits of money (as markets) worth talking about and they now are relatively insulated or sealed from each other in terms of inflationary pressure.”

    Even this second formulation requires refinements and caveats but I will let it stand.

    If someone could show that under the current Q.E. regime in US / UK:

    (1) Common consumer goods and services inflation is less than
    (2) Luxury consumer goods and services inflation is less than.
    (3) The major capital goods market inflation is less than.
    (4) The bonds and shares market asset inflation…

    then my theory would gain some credence I think. However, I don’t know how to research this. Of course, if the above is not shown then my theory takes a hit amidships.

  6. Don’t calculations of how much is needed in retirement depend on the incentive, ability and willingness of owner-occupiers to access wealth tied up in their principal residence? The calculation depends overwhelmingly on where owner-occupiers live. Existing taxation and social security arrangements are bizarre.

  7. So to plan for their retirement people need to save 20% of their income. In other words, reduce their current spending by 11% presumably on the basis of a legal edict that they must save. That would hurt!

    I wonder about using bond yields as an indicator of rates of return. Most super funds are invested mainly in equities where, for example, BHP currently earns nearly 5% yield and Commonwealth Bank 4.5%. According to Ernestine’s article, housing investments yield about equity returns too with less volatility.

    Official interest rates were zero or negative during the Great Depression and the Second World War. Things will change from the current situation where we are still in the aftermath of 2008 and Covid-19.

  8. The world will progress like this;

    NOW – Persons who lack advanced knowledge of investment opportunities and advanced knowledge of financial calculations and terminology are put at a grave disadvantage.

    NEXT – Persons who lack membership of large polities with large military forces will be put at a grave disadvantage.

    FINALLY – Persons who lack the ability to live on bark and insects will be at a grave evolutionary disadvantage.

  9. The world will progress like this;

    NOW – Persons who lack advanced knowledge of investment opportunities and advanced knowledge of financial calculations and terminology are put at a grave disadvantage.

    NEXT – Persons who lack membership of large polities with large military forces will be put at a grave disadvantage.

    FINALLY – Persons who lack the ability to live on bark and insects will be at a grave evolutionary disadvantage.

  10. Oops, I meant to post this.

    The world will progress like this;

    NOW – Persons who lack advanced knowledge of investment opportunities and advanced knowledge of financial calculations and terminology are put at a grave disadvantage.

    NEXT – Persons who lack membership of large polities with large military forces will be put at a grave disadvantage.

    FINALLY – Persons who lack the ability to live on bark and insects will be at a grave evolutionary disadvantage.

  11. The arithmetic of retirement under neoliberal doctrine is the arithmetic of arid formalism. It bears no relationship to the potential trajectories of the real economy and the real world.

    “Rethinking economics requires re-politicizing economics. Political disruptions shift the battlefield from a place where the elites hold the advantage (on the field of faux-scientific formalism) to one where revolutionaries hold the advantage (in the field of politics).” – Keith Harrington, “Can a band of rebel economists change economic thought before it’s too late?”

    http://kickitover.org/notebook/

    Although, as an old dog and cynic, I would say that the reactionaries still hold the advantage in the field of politics too. Biden might be elected President but does anyone seriously think that Biden will change the main policies that suit the rich or even be permitted to do so? When this system collapses into austerity and poverty for the great majority, as it inevitably will, then we MIGHT then see real positive change. I don’t feel particularly confident though and my theories about this will take us too far off topic.

  12. Ernestine Gross says: “But long term data for many countries show that housing is at least as good an investment as shares…”

    Thanks Ernestine,

    The linked paper shows that long term for 16 developed countries the averaged returns on housing and equities are about the same, give or take, but that housing has a two to three times lower standard deviation, ie, housing carries two to three times less risk.

    However, if I understood correctly, that risk is for an equivalently widely diversified housing portfolio that most home/owners/investors of the 99% variety could not be expected to own. The paper touched on diversifying through listed REITs, but there the large proportions of commercial real estate held seems to break the comparison.

    So, broadly held equity and housing investments return about the same on average. Housing broadly held carries less risk, but most cannot hold sufficient to achieve that diversified lowering of risk. Does this not then push available limited housing investment long term risk higher than readily available diversified equity investment for those people belonging to the 99% class? Can they hedge their bet on a particular house long term as adequately as they may by placing a similar sum on a diversified equity portfolio?

    Advice given to the federal reserve bank of san francisco may be rather different to that given to an individual of ordinary means per Òscar Jordà, lead author, “The rate of return on everything: 1870-2015” (with Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick and Alan M. Taylor). The Quarterly Journal of Economics, 134(3): 1225-1298. 2019.:
    https://sites.google.com/site/oscarjorda/
    https://economics.ucdavis.edu/people/ojorda

  13. “ Very little of the money created through QE boosted the real (non-financial) economy. The Bank of England estimates that the first £375 billion of QE led to 1.5-2% growth in GDP. In other words, through QE it takes £375 billion of new money just to create £23-28bn billion of extra spending in the real economy.”

    The calculation should be between GDP post QE and GDP without QE.

    GDP + QE resulted in a steady economy, QDP sans QE would have been a global depression.

    In the short term Bernanke and Brown rescued the global economy however there are ongoing issues, as always.

  14. The better path was and is QE + FS where FS = Fiscal Stimulus. FS needs to be a very large number: so large that QE could be smaller, perhaps much smaller.

    “Governments around the world are responding forcefully to the COVID-19 crisis with a combined fiscal and monetary response that has already reached 10% of global GDP. Yet according to the latest global assessment from the United Nations Department of Economic and Social Affairs, these stimulus measures may not boost consumption and investment by as much as policymakers are hoping.The problem is that a significant portion of the money is being funneled directly into capital buffers, leading to an increase in precautionary balances. The situation is akin to the “liquidity trap” that so worried John Maynard Keynes during the Great Depression.” – Which Economic Stimulus Works?
    Jun 8, 2020 Joseph E. Stiglitz , Hamid Rashid.

    QE launches lifeboats for the exclusive use of the rich while denying even life preservers to the poor.

    “During the COVID-19 pandemic, billionaires’ fortunes reached a total of $10.2 trillion, the highest amount of money ever owned by the world’s wealthiest. Meanwhile, millions of the world’s most vulnerable are being pushed into extreme poverty.

    A new report from UBS and PwC Switzerland found that the world’s billionaires grew their wealth by 27.5% at the height of the crisis from April to July. That translates to an additional $2 trillion in billionaires’ hands.” – Global Citizen.

    Plain fact of the matter: QE is by the rich, of the rich and for the rich.

  15. A 2% real rate of return is a bit low so instead retirement savings could be invested in things such as shares which historically have about an 8% real return. Because their value goes up and down which can upset people, the solution is to have a government super fund that provides the average real return. While the average real return from shares could potentially fall, it seems likely to remain above 2%.

  16. “The better path was and is QE + FS where FS = Fiscal Stimulus. FS needs to be a very large number: so large that QE could be smaller, perhaps much smaller.”

    “A 2% real rate of return is a bit low so instead retirement savings could be invested in things such as shares which historically have about an 8% real return.”

    Left wing superstition followed by right-wing superstition. Bleeding red ink everywhere is a gift to the rentier class but it brings no new resources to the table and it is not a form of demand management. Its a redistribution of income to the rich and usually the foreign rich.

    The right wing religion of thinking that investing in shares, that are not new issue, as equivalent to investment in producer goods. Maybe that worked in the past when periodic monetary crunches threw all the speculators out of the window (sometimes literally) but it is a fantasy now.

    There are two valid methods of demand management. Not three, not four, not red ink, not subsidising the banks with cheap interest. There are only two valid demand management measures and there are only ever going to be two valid demand management measures.

    The way forwards to help our old people is:

    1. Always run surplus budgets, federal, state and local. No exceptions. Not in a recession. Not under war conditions. No excuses.

    2. Build better government owned, fuel efficient, debt free infrastructure. And give the old guys a free ride. Its an embarrassment that places like Switzerland or Singapore could have better infrastructure than us. We should have white fists and tears in our eyes vowing to set things right and have the best debt-free government infrastructure. And old guys and aborigines get the free ride.

    3. Be kind to old people. Give them a good pension. Not with debt. Not with strings attached. What is wrong with kindness? They are not going to turn that money into overbreeding and feral children, so in the wider scheme of things it costs us nothing or very little. We have to be kind to solo mums too. But that can get a bit problematic and scary if we start turning out welfare families. In the case of our old girls, its costs us almost nothing. Compared to big unnecessary public sector or banking salaries its a small cost and one we ought to pay with gladness in our hearts.

    This idea of forced investment in shares. Thats just a fund for the financial parasites to loot over and over again. Its not the same as buying new manufacturing equipment. Really its not.

  17. Why use the assumption of consuming the same amount as during ones working life?

    When people retire they have less money but a lot more free time. That is a pretty good deal for a lot of people. Individual preferences of course will vary, in my view by a huge degree. But many would likely be happy with 70 or 60 % of their working income. It can also be easy to save money when you dont have the stress of working to worry about.

    I feel like this is a huge blind spot in Johns thinking.

  18. We need freeze dried food stocks to beat a blockade or a natural disaster. But though those food stocks can last 25 years they ought to be recycled a lot earlier. So this represents a kind of natural welfare for our old guys. I consider 3-5 storey spacious government high-rise, adjacent to a country railway station as equivalent to fuel-efficient infrastructure. So if we do things right we have a kind of natural welfare that costs us very little.

    If the poorer old guys retire to these properties there is great scope for giving them a fine life-style with even a moderate pension. We have to integrate policy and be thinking about fuel efficiency 24 hours the way that some of the office girls think about chocolate.

    I agree with Kyle. We can arrange for the old guys to have the good life without them having to have access to cash like they did when they were working full time. Why the forced savings? Oh please no. Forced savings being invested in what? They will be invested in the share-trading wizards new hobby farm. We cannot presume to compete with these sharks. We have to simply starve them of loot.

  19. The problem with cutting expenses once you go on the pension is that for people who don’t own their home they spend money on three things: housing, food, and utilities. Sure, they could cut their expenses by a third… which third do you suggest they give up?

    There’s far too much fantasising about how everyone is either rich or temporarily embarassed, and not enough admitting that after 40 years of deliberate impoverishment of the working class we have a much greater poverty program than we used to. The pension *has* to be enough to keep old folk alive because that’s all a lot of them have left. Well, or we could in best capitalist fashion say “they obviously don’t value being alive and therefore have ceased to purchase that good. It’s a free market”.

  20. Moz they no longer have unremitted work expenses! A Qld ALP seniors card energy rebate, free LNP bus, train concessional fare, cheap vehicle and boat rego could help a lot toward taking dog food off their table. They could sell the car, the boat, the dog, and eat better still. They could liveaboard the boat and live better still! Free seafood!! They could share house together with others and many may additionally benefit from the company gained (and forestall aged care institutional risk). More than a third there, and start their own or join a community food garden, etc.

  21. Svante – I assume most retirees that do not own a house also don’t own a boat. Let alone own a boat they could live in.

  22. Trent, you make poor? assumptions. If their boat don’t suit they can swap it for one that does. There are tons of boats suitable for living aboard and coastal cruising at market prices below those of the car you assume they must have – let alone it’s running/depreciation costs. If they’ve a preference for protected/semi-protected waters start with a 3.6m pontoon or scow houseboat with more room than a grey nomad’s 12ft caravan let alone a Hilux campervan, neither of which will have a shaded sundowners/fishing deck! Get over to Bums’ Bay at Surfers and live the life of Riley well below cost! They could even keep the dog – many do.

  23. Surely thats the answer to all poverty. Just keep trading up with ones boats until you live in a boat palace. We must take Svantes boat-trading solution to poverty to the teeming masses.

  24. Living on a bolat on a trailer somewhere with no car to move it would be really unpleasant. Living in a moored boat with no funds for maintenance would at least be briefer than the trailer idea. A boat is a hole in the water that you fill with money…

  25. Svante says “If they’ve a preference for protected/semi-protected waters”.

    “Hiro heads north to where the Raft, a huge collection of boats containing Eurasian refugees, is approaching the American coast. The center of the Raft is L Bob Rife’s yacht, formerly the USS Enterprise nuclear powered aircraft carrier.”

    Snow Crash
    By Neal Stephenson

    https://en.m.wikipedia.org/wiki/Snow_Crash

  26. You guys clearly know little of boats, and less about living on boats, and even less about how people can actually arrange their affairs to live pretty well on an aged pension. I’m happy that while your views align with the conventional money grubbing ASFA et al hypnotised conformist rat-race suburban consumerist majority all going to hell in a hand basket together, any aged pension I might receive in future can only increase! The biggest financial worry many pensioners have is hiding their accruing savings from the banks, ATO, Centrelink, and periodic DHS deemed income reviews! (This shouldn’t be told to just anyone, but the secret seems safe here 😉

  27. The subtle gap between “many” and “all” is something that hopefully Svante never has to worry about. And pensioners who do own their homes don’t have to worry about hiding that asset.

    Although if I ever need a character witness I know where to go “Moz left many people alive, so therefore cannot have killed anyone”.

  28. Oh dear, Moz, best see above.

    As for exceptional worries, it aint actually own home owning that’s exempt, but it is principle place of residence owning, which a properly conceived and built structure as in “boat” amply satisfies. Indeed, a boat is the exemplary exemption!

    Houses, are but badly built boats so firmly aground that you cannot think of moving them. They are definitely inferior things, belonging to the vegetable not the animal world, rooted and stationary, incapable of gay transition. I admit, doubtfully, as exceptions, snail-shells and caravans. The desire to build a house is the tired wish of a man content thenceforward with a single anchorage. The desire to build a boat is the desire of youth, unwilling yet to accept the idea of a final resting-place.
    – Arthur Ransome, Racundra’s First Cruise (Chapter 1), 1923

    A house is but a boat so badly built it will not float. – Anon

  29. Ukelele Layby, I didn’t say trading up was the answer. What with? I proposed where applicable a boat-trading solution of swapping out. It’s a fairly bog standard strategy:

    .Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.” ― Warren Buffet

  30. But Svante what you are saying, and I agree with this, is that if you have your act together, and are pretty rich, you can nut out a very low cost retirement. I noticed that the private school boys were able to get pretty high paying jobs during the Christmas holidays and people of substantial means can wangle themselves onto a low cost wicket with a bit of thoughtfulness.

    This is great. But its no general welfare strategy. And your point that older successful people don’t need to have their full more youthful income, when they are older, is well made. Thats a successful riposte to arguments on this thread. I’m just making the minor point that its not a general welfare strategy.

    The people who were experienced boaters in their younger days had a big boat, a big vehicle to tow that boat around, another small flash car for trips that didn’t require that much torque, yes another car for their lady friend, and they had a huge house and land package to be able to store all these toys. They needed insurance for everything. Had to keep their licenses current. They had it all going on.

    So if your argument is that a rich 40 year old can wingle wangle an exceptionally low-cost life-style, should he choose it, when he is 65, your point is well made. So yeah. No 20% of our income for forced savings to set up a fund that the financial sharks can loot periodically. Thats crazy. Forget all of this nonsense. If we simply decide that Keynesianism is lies (there are many right-wing lies too) then we can do everything on surplus budgets, state, federal and local. Thats where the forced savings should be. The government should be forced to save to improve their prioritisation and so the rest of us don’t have to.

    The only forced savings in our lives should be forced onto governmental entities at all three levels. Keynesian red ink advocacy is a lie. And its too late in the game to be tolerant of these lies now. Things have gotten too desperate.

    Its not funny any more.

  31. Back on topic, I’ve been obsessing about real long run interest rates and the implcations for retirement incomes policy in Australia for over 30 years now. It was one basis for my opposition to compulsory super in the early 90s, for example – the whole thing was predicated on the then-current 8% safe real returns continuing for the next 50 years. Even then anyone who had paid attention to growth theory, let alone monetary theory, could see that was never going to happen.

    For several reasons, long run rates of return in Australia were always headed strongly downward for a very long time. Simple slowing population growth is one (Solow-Swan anyone?). The various secular stagnation stories – Piketty’s Marxist point about declining rate of profit relative to growth, relative technological stagnation, population aging (old people don’t borrow to invest and anyway loathe Schumpeterian creative destruction) – all constitute others.

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