Old Age, Re-designed
A grumpy analysis of future trends from a member of the Grumpy Generation.
Decline and Fall of Philadelphia
In 1900, Philadelphia was described as the largest commercial (ie non-capital) city in the world. By 1929 it was flat on its back, and never recovered its former position. Why did this happen?
It now may seem hard to believe, but in 1900 many people referred to Philadelphia as the richest city in the world. By 1948, when I first arrived there, it was dirty, defeated old wreck. The Gilded Age was pretty much forgotten. What makes a city first rich and then poor? How could that happen so quickly? I asked people who might likely know answers and got back an astonishingly wide variety of them. Some answers were pretty trivial, like the one which emerged from an old fellow who, in all seriousness, said he thought everyone at that time had two houses, and in 1929 most of them had to sell one house. So they sold the one in Philadelphia with the higher taxes, and the greater cost to heat. Others made more thoughtful answers, but probably wrong ones, like Digby Baltzell's book on Quaker Philadelphia and Puritan Boston, which essentially says Quaker diffidence discouraged people from getting rich. What he really seems to be saying is the Quaker trustees and officers at the University of Pennsylvania had kept it from becoming Harvard by not donating enough.
So let's temporarily skip to some answers which attract an influential following. At the moment, that group notably includes John Bogle, who founded Vanguard Group in 1974 and now has a customer base worth roughly three trillion dollars. Vanguard is now busy adding international offices in London and Melbourne, presumably to be able to provide 24-hour daily trading to a stock-trading world which is increasingly Vanguard's own little oyster. It's true their near competitor, Fidelity in Boston is largely owned by Ned Johnson and his family, whereas Vanguard is a mutual company owned by its customers. The consequence of that simple decision for the Johnson family emerged later: the Johnsons are immensely rich while the Bogles are merely prosperous. But mutualization of ownership does allow Vanguard to be slightly cheaper than Fidelity, which Fidelity makes up for, by providing better personal service. Perhaps we should wait until both companies have been through the inheritance tax meat-grinder, before judging who made the better choice of the corporate form. We may find Fidelity was somehow warped in its approaches by its need to escape inheritance taxes.
Essentially, the three-part Bogle message is: Random investment in the whole market through index funds, has a slight performance advantage over stock-picking and market-timing; taxes are reduced by a buy-and-hold philosophy, and eliminating stock-picking reduces overhead costs. The Bogle method is called "passive investing" whereas more conventional approaches are called "active investing". The differences are small but consistent, essentially providing an easy way path for converting 1% advantages into a comfortable retirement if you just start but forget about them, for fifty years. The system thus has appeal for the relatively small investor who does need a retirement income but has neither training nor interest to devote to his investment portfolio. Over a major portion of a lifetime, small differences can amount to a truly important set of advantages, particularly the ability to make a purchase, forget it, and remain reasonably confident he won't be cheated by his agents. One by one, kings and democracies cheat by inflating the currency, while hired money managers routinely cheat their employers. It doesn't seem to matter whether you are the slave or the master; the final outcome is rather similar. John Bogle offers the common man a method he can understand, trust-- and neglect.
The price the common man must pay is to surrender the hope of getting rich while young enough to enjoy life in youthful ways. He won't get rich unless he invests most or all of his savings, for major portions of his lifetime, employing a process known as "dollar-cost averaging". The pay-off comes later in the thirty extra years of unexpected longevity, which would otherwise be a bleak time for most of them. Even the long term Nirvana is clouded by occasional thirty or forty year cycles of "black swans", or market-wide swings in the value of the 1929 Crash variety. If a person's life happens to superimpose long-cycle crashes on top of life's major expenditures, as it would with a sudden major illness, or convulsions of some sort in his primary source of livelihood, he definitely won't get rich, ever. He can however still expect to perform better than he would with active investing. This style of passive investment is best suited for people who have some other source of income, who nevertheless save a small amount for a rainy day. It's also well suited for endowments and perpetual non-profits, who tend to get large lump-sum gifts at infrequent intervals, have relentless expenses from their charitable mission and are managed by experts in some special field, other than investing. The endowment situation can also be characterized as a rich person entrusting his funds to the management of non-rich employees whose financial competence is not entirely trusted by the donor. It's transparent, but it is both simple and safe.
Unfortunately, it's an approach unlikely to make anyone rich. The profits in the long run equal the profits of the entire stock market, or at most the profits of the whole nation's economy. Those profits have been remarkably consistent, and even with multiple wars and "black swans", have averaged 8%, plus or minus one standard deviation (i.e. seventy percent of the time), and requiring reserves to carry through 3 or 4 years of black swan dips, every 25 years or so. That's 8 percent, but inflation averages 3%, so real returns will average 5%. Since recent governments frown on perpetuities, most non-profits are required to disburse 5% a year. In theory, an endowment could last forever if the rules are precisely followed, but a single lifetime's retirement period is a more realistic goal than perpetuity within a culture which distrusts perpetuities. It will serve, as "active investing" will not serve, for the two main purposes of saving money, and can certainly justify accumulations in the trillions of dollars per nation. Three cheers for John Bogle.
But, it won't make us rich. Not if we expect to start poor, like Horatio Alger, and accumulate a fortune. A five percent disbursement, required by a Federal tax system which leaves little room for State taxation, will survive quite a while, but eventually will encounter unexpected difficulties, and start a downward spiral. A retirement system is similarly dependent on only working for forty years out of ninety-year longevity, and supporting the remaining fifty years on small incremental savings magnified by 5 percent. Although the long, long term picture is that of a cheap cure for cancer and Alzheimer's disease rescuing the retirement costs, no one now alive had the better count on such a rescue from very narrow calculations. Some people will borrow money at just the right time, and pay it back at just the right time, thus leveraging the savings or gaming the black swans. But many more people will go broke trying to get away with it. The Bogle system simply will not work for 350 million people, without a discouraging number of people falling off the wagon on the way. And all of this omits to mention thermonuclear adventures, collisions with asteroids, or global warming bringing the ocean beaches to Omaha. John Bogle can rightly be proud of devising a system which can make millions of people comfortable. But it isn't going to make very many people rich.
Who wants to be rich, when the alternative is to be comfortable? To get back to the plight of Philadelphia, the city simply must have more people get rich. To have a rich city, it needs to contain a lot of rich people. So the two problems are really only one problem: what sort of system will make a lot of people rich? Under the surface, that question amounts to asking what kind of people are we going to elevate? Are we talking about making poor people into rich ones, or are we talking about making a lot of borderline millionaires into billionaires? If you ask a large number of people how to get rich, most of them will answer, "Start a business". Some of them will say, "Rob a bank", and others will say, "Become an outstanding athlete." To be outstanding at anything has a scarcity limit, and robbing banks is what George Washington was thinking of when he repeatedly intoned, "Honesty is the best policy." That's been our message to immigrants, ever since, and it is discouraging to Americans to see that most of the other billions of people on earth, still need to be convinced of it.
Two-thirds of all new businesses go bankrupt in a year or two, and some of the survivors find the courage to start a second time. We can even give credit to another Philadelphian, Robert Morris, for the bankruptcy laws which make it possible to get on your feet and continue fighting. It's easy to see why so many people prefer to play it safe with a steady job or profession; it's even possible to see the attraction of working in the public sector. But I'm sorry, if you want to start a business, you have to be willing to take the risks of failure. You have to take the risk of becoming poor. And do you know, some people are risk-takers and some people aren't. The so-called head-hunters, who examine dozens of employment resume's every day, notice a curious thing. Those whose first job was in the public sector, tend to remain in the public sector all their lives, and those whose first job was in the private sector, tend to stay in that sector in subsequent jobs, similarly. You can interpret this finding in several different ways, of course. Some people are sheep, and other people are goats. The political lines recently are drawn in a way that a few employers really will not employ some kid who has been tainted by a brief tour of the wrong sector. But without getting into social philosophy, one point does emerge. Once a community tilts past the tipping point of risk versus security, a downward economic spiral has begun.
Originally published: Sunday, February 01, 2015; most-recently modified: Tuesday, May 21, 2019