Academic

MEGAN MCARDLE: The Great Stock Myth: Why the market?s rate of return?and your nest egg?may n?

By Glenn Reynolds

MEGAN MCARDLE: The Great Stock Myth: Why the market?s rate of return?and your nest egg?may never recover. “Once everyone believes that the stock market offers high returns for relatively little risk, that notion stops being true. And everyone apparently does believe just that?even after the 2008 crisis, the price-to- earnings ratio of the S&P 500 remains near the top of its average historical range. Paradoxically, the current high price may be supported in part by a belief that the old equity premium still obtains. . . . If the return on equities really has fallen, this decline poses a big problem for the average investor who planned to stick 5 to 10 percent of his or her annual income into stock funds and retire comfortably. At an annual inflation-adjusted growth rate of 8 percent, savings of just 5 percent of your income for 30 years will leave you with a nest egg big enough to replace almost half your income when you retire. Saving 10 percent will make you really comfortable. But if the return is 2 to 3 percent, you?ll need to save close to 40 percent to replace almost half of your income. And a 2 percent return seems to be a real possibility?in fact, it?s a hair above the 1.8 percent that Smithers & Co., an asset-allocation consultancy, forecast for U.S. equities over the next decade.”

But there’s no free lunch:

When confronted with the erratic performance of the equity market, many people start daydreaming of gold-plated corporate pensions, cushy civil-service jobs, or at least their Social Security benefits. But as it turns out, all of these dreams have drawbacks?and none of them escapes the tyranny of the equity market.

Start with private pension plans, which underpin nostalgic yarns about the golden age of the 1960s, when every man could raise a family on assembly-line wages and then retire in comfort. These pensions never were as widespread in fact as they are in popular legend?when the number of such plans peaked in the 1980s, they covered only about one-third of the workforce. And as it turned out, a lot of those plans failed catastrophically. Defined-benefit plans have a huge downside: they drastically discourage labor mobility. Not only do they make an economy less dynamic by tying workers to a given company, but they also leave the workers vulnerable if the company goes under, taking their retirement with it.

Indeed.

Full post as published by Instapundit.com on August 12, 2010 (boomark / email).