Bill Ackman, chairman of Pershing Square Capital Management, recently proposed an idea to “save” capitalism. Framed as a panacea for growing disillusionment with capitalism, he recommends that every child have a sum of money invested on their behalf. The idea is that an 8% annual return should make them millionaires by retirement. So is this idea viable? Can socialism save capitalism? And is it really the best way to “encourage greater financial literacy”?
Financial literacy is an admirable goal, yet there are a multitude of ways to reach that end. So let’s examine this proposal to pinpoint the exact flaws (and pose some alternatives).
Who Stands to Benefit?
Consider Bill Ackman’s position as a hedge fund manager—he, and more specifically his industry, would stand to benefit directly from this proposal. If the government were to artificially pump thousands of dollars into the market per newborn, the money managers of Wall Street would have a field day.
And on the back end, the government would reap the tax benefits. If you don’t believe me, just look at the qualified plan calculator.
People equate more risk with more reward, yet risk means “the likelihood of loss.” Volatile markets have a tendency to make money managers wealthy while the average investor loses. Other government programs, like the 401(k), have the same result—Wall Street Wins.
It’s not bad to make money, yet there are principles to doing so. And one of the most principled things we can do as advisors is to act in the best interest of the client. That means recommending products and solutions that are proven to accumulate wealth. And who do you know, Warren Buffet aside, who made their fortune on the stock market?
Which leads me to our next point…
Inflation, Inflation, Inflation
Inflation is the stealthiest “tax.” Consider what it took to go to college in the last century—what could once be accomplished by a summer job now has a generation of graduates paying loans into their 30s and 40s, or beyond.
The goal for these accounts is to accumulate $1 million dollars over the course of each person’s lifetime, so that they can retire a millionaire. Yet even at a mere 3% inflation rate, $1 million dollars would have the same impact as about $147,000.
Using the Present Value Calculator, we can see what that $1 million would feel like in today’s dollars:
Will that really be enough to get through retirement? If these account holders retire at 65, that $147k would have to stretch for 20, 30, or even 40 years. And life expectancies are only increasing…
If you’ve used Truth Concepts software much, you’re likely hyper-aware of the fact that average returns are anything but average. When you look at the history of the stock market, a first glance might look promising. The S&P (without dividends), for example, averages 7.34%. Yet in practice, it’s not what it appears to be.
Truth Concepts consistently demonstrates, using the real data, how those average returns actually perform. And unfortunately it’s not pretty. When there is a down turn in the market, the effects are detrimental to the growth of the account. In fact, it can take almost a decade, if not more, to fully recover from a bad year in the stock market. And that’s if the whole decade is in the green.
If we used the exact S&P market history for the last 65 years, shown below, the projected $1 million is only $636,855. And that’s an illustration using real numbers. There’s potential to do better, sure, yet there’s also potential for even lower yields.
This is one reason whole life insurance performs so well—accounts are protected from loss. Which means there aren’t periods of recovery. And in fact, the cash value of a life insurance policy can make other retirement accounts much more effective.
Additionally, that 8% is merely what it would take to earn $1 million in 65 years. It’s not a personal promise from Ackman. He doesn’t have some crystal ball that the rest of us aren’t privy to—it’s the return necessary for the desired outcome.
The lesson is to take projections and averages, or anything short of a guarantee, with a grain of salt.
More Gains = More Taxes
Not to rub salt in the wound, but in his proposition Ackman recommends that these accounts be able to grow tax-free until age 65. Compound interest may be “one of the great wonders of the world,” yet that also means that the taxes on the back end will be much more. And an increased tax obligation only further decreases the million dollar value of this plan.
Taxes, of course, are nothing new. Yet what Ackman is truly advocating for is a tax-deferment. And surely it will be a disappointment for many to learn that their million dollars is even less than expected.
One of the biggest myths of the financial “planning” industry is, “You’ll be in a lower tax bracket when you retire.” This leads millions to believe that there’s an entirely separate tax bracket for retired people. Unfortunately, the only way to be in a lower bracket is to have a lower income. Lowering the tax obligation would mean lowering retirement income, which may be necessary anyway, considering inflation.
One of Ackman’s main sources of inspiration is to solve income inequality. And he suggests that through the forced participation in capitalism, that problem can be solved. Yet the pieces don’t align.
For the government to sponsor the program is not a capitalist ideal, it’s a socialist one. It’s unlikely to rally people to capitalism, because they’re not truly participating in the system. Instead it’s a program that people would have no real involvement in until they turn 65. And even then the only involvement would be withdrawals.
Will this truly fix income inequality if a) people don’t realize the benefits until they’re 65, and b) everyone is more or less left with the same amount?
One of Ackman’s goals through this proposition is that people will gain greater financial literacy. Yet how can they do so with no real involvement in the program? The money is donated to their account at birth, managed by someone else, and locked up until retirement age. (Did we mention management fees?)
Greater financial literacy is a worthy goal. It’s one we strive for at Truth Concepts—empowering advisors to empower their clients. Yet it’s a passive program that requires only that you live long enough to receive the money.
Without control, there is no financial literacy. In order for people to learn how to better manage their money, they have to create good habits. Habits are established through active participation. If we can empower people, from a young age, to establish good habits, we’ll go a lot farther to establish widespread financial literacy.
…And No Access
And lastly, without access and control to these finances, people won’t be able to participate in the best part—enjoying their money. This goes hand in hand with control.
If we want to revitalize the strengths of capitalism, people need to participate in it. At best, this proposition wouldn’t have a significant effect on people’s live for another 65 years. At worst, people will have a false sense of security until they realize that their assets aren’t as powerful as they expected them to be.
Having access to capital allows people to make cash-flowing decisions, which will have a far greater impact on their lives. People will be more incentivized to participate in a system that truly benefits them and others.
So, Can Socialism “Save” Capitalism?
The idea is a flawed one to begin with. Remember, if it deems too good to be true, dig a little deeper.
What our country is lacking right now is real, honest financial education. Not education that benefits the government and Wall Street, but education that puts power back in the hands of the individual. Instead of handing out money that will just flow back to those institutions, what if we began financial education early?
There’s no shortage of ways to help children learn more about money and how to manage, and enjoy, it wisely. Good savings habits are among the most important habits of a financially literate person—have your clients open a savings account with their children, and help them save towards a specific goal. Then impart life skills—like doing chores, or starting a lemonade stand—that help them achieve that goal. In fact, there are even some compelling reasons to insure your children.
Become the Expert
It’s small things like the above that help a person learn the skills to thrive. And these are actionable things that anyone of any age can do.
Truth Concepts makes it easy to test different financial products and theories, in order to make the smartest personal financial decisions. And as a financial advisor, you have the important task of teaching your clients how to take control of their money. It’s not something that happens overnight, and it’s certainly not something that happens passively. It takes an active partnership.
To stay up-to-date on your own training, attend one of our live, in-person Truth Training events. With a software suite as expansive as Truth Concepts, it’s important to establish yourself as an expert. See here for pricing.