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Why Don’t Americans Have More Saved For Retirement?

Eduardo Porter has a piece in The New York Times blaming Wall Street for the fact that the average American is allegedly going to run out of money in retirement. According to Porter, the average working family nearing retirement has just $104,000 in retirement savings — obviously not enough to keep someone afloat for twenty or thirty years.

I’m not convinced that we are in fact facing a “retirement crisis.” But I want to set that aside. What’s interesting is who Porter blames for this problem.

The standard prescription is that Americans should put more money aside in investments. The recommendation, however, glosses over a critical driver of unpreparedness: Wall Street is bleeding savers dry.

What Porter has in mind is mutual fund fees. Wall Street, he argues, is steering Americans into high cost managed funds rather than low-cost index funds, which tend to outperform their more expensive counterparts. Porter goes on to support regulations that would force IRA advisers to act as fiduciaries, so that more people will opt for index funds.

Now it’s probably true that managed funds are a bad deal for the average investor — the literature here is pretty clear. But that is something that individuals should be free to judge for themselves.

More to the point, there is simply no basis for the claim that these fees explain much about how prepared Americans are for retirement. Consider this statement from Porter:

Assuming an annual market return of 7 percent, [Vanguard’s John Bogle] says, a 30-year-old worker who made $30,000 a year and received a 3 percent annual raise could retire at age 70 with $927,000 in the pot by saving 10 percent of her wages every year in a passive index fund. (Such a nest egg, at the standard withdrawal rate of 4 percent, would generate an inflation-adjusted $37,000 a year more or less indefinitely.) If she put it in a typical actively managed fund, she would end up with only $561,000.

Notice anything funny about this example? Under these assumptions, the difference between the actively managed fund and the index fund is $366,000. That’s a lot of money to leave on the table. But the difference between the actively managed fund and the $104,000 Porter claims the average American actually has saved for retirement is $457,000. Which is to say that the overwhelming driver of how much people have for retirement is how much they choose to save — not Wall Street’s fees.

In fact, there is some evidence for this. One recent study found that an individual’s savings rate was the main determinant of whether he would have enough money to live on in retirement. According to the authors, “Simply put, regardless of the rate of return you earn on your savings, if you save enough, you’ll be able to retire successfully.”

Porter thinks that by burdening Wall Street with more regulations, Americans will be in a better position to retire. But Americans already have the power to protect themselves from mutual fund fees. What we really need is to save more, and on that front there is something the government could do that would help: stop taking so much of our money — especially for programs like Social Security, which reduce our ability and incentive to save for old age.