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Longtime Worry

Ken Cutler

IS A STORM COMING? Long before I discovered HumbleDollar, I regularly read articles by Scott Burns. Now in his 80s, Burns was a popular financial columnist who wrote for the Boston Herald and later The Dallas Morning News. He’s a graduate of Massachusetts Institute of Technology, so he’s comfortable presenting quantitative arguments. Burns is an advocate of low-cost index funds, and he helped popularize couch potato investing, using a low-maintenance 50-50 mix of stock and bond index funds.

One of the books in my financial library is his work The Coming Generational Storm, coauthored with Laurence Kotlikoff. It came out in 2004, so its 20th anniversary is approaching. It was on Forbes’s 2004 list of the top 10 business books.

Here’s a sample from the back cover: “In 2030, as 77 million baby boomers hobble into old age, walkers will outnumber strollers; there will be twice as many retirees as there are today but only 18 percent more workers. How will Social Security and Medicare function with fewer working taxpayers to support these programs? According to Laurence Kotlikoff and Scott Burns, if our government continues on the course it has set, we’ll see skyrocketing tax rates, drastically lower retirement and health benefits, high inflation, a rapidly depreciating dollar, unemployment, and political instability.”

As you might imagine, the book was an uncomfortable read. The twin threats of unfavorable demographic shifts and unsustainable government debt are laid out in stark terms. The generational storm thesis can be summed up by these two sentences from the epilogue: “The American dream is becoming prohibitively expensive. And unless we act soon, the Greatest Generation will be the last to leave its children and grandchildren a better country.”

The biggest reason we’re facing this generational storm, according to the authors, is an implicit asset problem. “The three most important implicit assets are Social Security, Medicare, and employer-provided pensions…. Raw demography is creating promises of implicit assets faster than the underlying economy is growing.”

Given that two decades have passed since the book came out, it might be time for a progress report. I’ll leave it to HumbleDollar readers to determine for themselves the extent to which we’re experiencing the ills listed on the book’s back cover. What about the authors’ personal-finance prescriptions? Here’s a summary of five key take-aways, along with my assessment of how each has worked out for me.

Avoid excessive fees. The authors include a chart showing the potential financial drain from advisor fees over an investing lifetime. I heeded that message, and have favored low-cost index funds for many years. The weighted average annual cost of my 401(k) holdings is currently 0.11% of the assets I have invested.

Buy a house. The book emphasizes the importance of “imputed income” in an inflationary, rising tax environment. Owning a home free and clear provides “tax-free invisible income in shelter services.” The non-cash income from your own home—the fact that you’re effectively renting to yourself—doesn’t show up on your tax return and yet its value will rise with inflation. Our home is paid for, so we have this box checked.

Build an alternative portfolio. To mitigate the effects of what they saw as major inflationary pressures and a weakening dollar, the authors recommended putting together an alternative portfolio. This portfolio is meant to supplement, not supersede, a traditional portfolio of low-cost stock and bond funds.

Some of the items they recommend including in an alternative portfolio are Series I savings bonds, inflation-indexed Treasury bonds, precious metals funds, energy funds and international stock funds, with an emphasis on China. I didn’t get carried away with this recommendation—which is probably just as well.

For most of the 20 years after the book was published, inflation remained quite low. I’ve held a decent amount of Series I bonds over that period. They’ve returned, in the aggregate, less than 5% a year. I’ve never bought any precious metals funds, though I do have a small clutch of physical gold. I have about 15% of my retirement portfolio in international stocks. I would never prioritize investment in China, out of both political and economic convictions.

Pay Caesar upfront. The authors’ contention: “The more successful you are as an earner and saver, the greater the odds are that you will pay taxes at higher and higher rates when you take money from qualified plans.” One of the key ways to address this concern is to fund Roth accounts, which don’t offer an upfront tax deduction, but where all withdrawals are potentially tax-free.

I have dutifully funded Roth IRAs for myself and my wife for the past dozen years. I do, however, have significant tax exposure through my traditional 401(k), where every dollar withdrawn will be taxed as ordinary income. I haven’t yet taken anything out of my 401(k). Since I have income from both a pension and part-time work, I don’t need spending money from my 401(k) right now, plus withdrawals would be taxed at a steep rate, given my other income.

By the time I’m forced to take out money from my 401(k), I expect the tax bite to be painful. I may have a few years to make small tax-advantaged withdrawals after I completely stop working and before I begin taking Social Security. The math, however, is not in my favor.

Eat broccoli. “Like it or not, the health care problem will be topic number one for the rest of our lives.” While as an individual, there’s not much I can do to influence the fiscal realities we face as a society, I can heed the authors’ advice to take responsibility for my personal health.

The authors have a section about DALE, or disability-adjusted life expectancy. DALE, a World Health Organization metric, starts with life expectancy, and then subtracts years lost to ill-health, disability and early death. At the time the book was written, the average DALE in the U.S. was 70 years, lower than many other countries.

After a scare with my heart a couple of years ago that—fortunately—turned out to be just that, I’ve been consciously reducing consumption of red meat for the first time in my life. I’ve gotten more disciplined about going to the gym. Next on my list: lose some weight. None of this guarantees that I won’t suffer a major health setback down the road. But I hope these actions will extend my healthy retirement years. Working in my favor is that I’ve never smoked or abused alcohol.

Although the two decades since this book was published haven’t unfolded exactly as predicted—for example, inflation stayed low for most of the period—I think the underlying arguments and analyses are still worth considering. So far, we may have successfully kicked the can down the road. But how much longer will it be until that can hits a brick wall?

Ken Cutler lives in Lancaster, Pennsylvania, and has worked as an electrical engineer in the nuclear power industry for more than 38 years. There, he has become an informal financial advisor for many of his coworkers. Ken is involved in his church, enjoys traveling and hiking with his wife Lisa, is a shortwave radio hobbyist, and has a soft spot for cats and dogs. Check out Ken’s earlier articles.

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