Do a better job of saving. You’ve got competition
Younger workers: You’re going to have a devil of a time getting a decent return on your retirement savings. For that, you can blame a large group of people on the other side of the globe who are even more avid about saving for their old age. That would be the middle class of China.
China, prosperous and frugal, is unleashing its savings into a globe already awash in savings. That pushes up asset prices and pushes down yields. Low yields mean low future returns.
High asset prices do help some savers, the ones at the ends of their careers. If you are now cashing in a piece of your 401(k) for a trip to Europe, you’re getting a windfall. Over the past 35 years the U.S. stock market has delivered an 8.5% real annual return (price gain plus dividends minus inflation). A dollar you put there in November 1982 is now worth $17 in 1982 spending power.
But what if you are just starting out? With asset prices high, the future is dim for you. Money you put into a 401(k) now is on target to deliver a 3% real return. (Explanation.) Over 35 years that will turn a dollar into a mere $2.80 of spending power.
So you should put away a large chunk of your paycheck for retirement. Most Americans do not. Already low at 10.8% in late 1982, the U.S. household savings rate—savings divided by disposable income—has shrunk to exactly a third of that.
As fast as people save, moreover, their government squanders. The U.S. Treasury’s savings rate is a negative 14%. It spends 14% more than its income. The nation’s tradition of self-indulgent consumerism will continue with the next tax cut.
The Chinese economy is made of different stuff. Households there set aside 38% of their income. Directly and indirectly, those households are pouring capital into the U.S.
The USA’s capital account vacuum ($461 billion in 2016) is the mirror image of its trade deficit. We’re spending more, on consumption (hamburgers) and investment (fast food outlets), than we produce. So we need help from abroad to make ends meet.
China has the reverse problem: too many people setting aside money for a rainy day, and too few good places to stash it. That nation puts an insanely high fraction of GDP, close to half, into investment. It may wind up with a large collection of empty apartment buildings and idle steel mills. Meanwhile, its capital flows across the globe in search of better opportunities.
Why are the Chinese such diligent savers? Several factors have been proposed. One is that, with the government providing not much of a safety net, families are mostly on their own for health costs and old age. Another explanation, explored by Columbia Professor Shang-Jin Wei, has to do with the fact that 122 Chinese boys are born for every 100 girls. The resulting imbalance in the marriage market motivates men and their parents to compete on marriageability with wealth accumulation.
Whatever the reason, the effect of hard work and frugality among China’s huge middle class is a worldwide glut of investment capital. Capital, in consequence, can command only a weak return. Each dollar put into an overpriced house in San Francisco, London or Shanghai buys you only a few cents of annual rental value. A dollar in GE or Tesla doesn’t buy much earning power. A dollar put into an inflation-protected Treasury bond earns you not even a penny a year in real interest.
There’s nothing you can do to alter these grim returns. What you can do: boost your savings rate—to 20%-25% of your paycheck.
If your employer is putting 6% of your salary into your 401(k), you should put in at least 14%. If 14% lands you over the limit ($18,500 next year for people under 50), then some of your savings will have to be done outside the retirement plan.
Fidelity Investments has a handy rule of thumb that says 35-year-olds should have twice their annual salary saved up, and 67-year-olds on the cusp of retirement should have 10 times their ending salary.
I agree with Fidelity’s 10x ending target, but not with its view of how you get there. Using returns from the stock and bond markets from 1926 to date, Fidelity calculates you will have a high probability of hitting the target while saving only 15% of your income.
But when asset prices are high, history becomes a hazardous guide to future returns. The U.S. had a shortage of capital and a wealth of good places to put it 91 years ago, or even 35 years ago. That’s not true any more. You should plan accordingly.
You should also acknowledge China’s role as the dominant economic power of the 21st century. Younger savers need an allocation to emerging-market stocks.
If you’re 30 years old and making $100,000, Fidelity says, you should have $100,000 in your retirement account. Here’s a moderately aggressive ETF portfolio for you: $40,000 in Vanguard Total Stock Market ticker: VTI, expenses: 0.04%), $30,000 in Schwab U.S. Aggregate Bond (SCHZ, 0.04%), $20,000 in Vanguard Total International Stock (VXUS, 0.11%) and $10,000 in Schwab Emerging Markets Equity (SCHE, 0.13%).
Originally published at Forbes