Thursday, May 2, 2013

Yglesias Nails it On 401ks

I think Mathew Yglesias gets it exactly right on our 401k world, it sucks.

Here's the essential shape of 401(k) as a backbone of the retirement system:
— Poor people get absolutely nothing.
— Wealthy people who would have had large savings anyway get a nice tax cut that offers no meaningful incentive effect.
— For people in the middle, the quantity of subsidy you receive is linked to the marginal tax rate you pay—in other words, it's inverse to need.
— A small minority of middle-class people manage to file the paperwork to save an adequate amount and then select a prudent low-fee, broadly diversified fund as their savings vehicle.
— Most middle-class savers end up either undersaving, overtrading, investing in excessively high-fee vehicles or some combination of the three.
— A small number of highly compensated folks now have lucrative careers offering bad investment products to a middle-class mass market based on their ability to swindle people.

Another problem he is spot on about is that the dominant business strategy for companies marketing 40lk products is to market inferior products because it is possible to make more money on them. There is so little money to be made on better products that it doesn't make any sense to market them; when this is the case market mechanisms can't work to create good outcomes.

This situation isn't confined to 401ks either. Many goods are set up so that dominant business strategies are often terrible for the consumer (one example, health care and the dominant strategy of not publishing prices). In cases like these market incentives can't lead to good outcomes, the mechanisms just don't work.

To briefly broaden the focus, I think this is a general problem with the insistence on the merits of exposing individuals to risk. Basic economic thinking implies that we should all be sorting towards are individual comparative advantages, setting up institutions that mean particular skills heavily influence outcomes, like financial management, are terribly inefficient. Most people will reach a point where they are no longer capable of working, why should the outcome of their life after this point depend so strongly on financial skills they may or may not possess any talent for? Why do we create institutions that drive this result and advantage those with these skills rather than simply creating an even playing field that those skilled could enjoy additional advantages but everyone would be comfortable. It wouldn't be a problem if the financially savvy could use their skills to retire a year or two earlier, we should all enjoy the fruits of our talent and labor, but it is a problem that those that work hard but suck at finance have a poor retirement while those that are skilled in this area might be able to retire 10 years early due to all the subsidies they enjoy. What good does this do the country?


  1. Interesting how Yglesias gives a shout-out to Vanguard when most of us are locked in to a single investment provider. Having had my dad drill into me the importance of low cost funds early on, I have my personal savings and IRAs in Vanguard but I'm restricted to Charles Schwab for my 401(k).

    I also think Yglesias is batty when he suggests a CPF-style statist replacement. He doesn't quite seem to have the authority to talk about it - and Singaporeans gripe about it all the time - and doesn't seem to grasp that what he bases his faith in amounts to CalPERS times about three times the contributor base. In short, not scalable. Think about the political football and equity WMD a US Central Provident Fund would be... we could dwarf the Government Pension Fund of Norway's $700 bn easily by contributing 5.5 percent of GDP. One can see a prediction of what would happen in the US in the political struggles in Norway over the SWF's investment practices, and they hold a measly 1% of the world's equity value. Imagine what kind of incentives a politically managed US SWF would have, and who would lobby for investment or divestiture...

    1. Great points. Yglesias did a good job pointing out problems, I basically skimmed over his mention of alternatives. Sovereign wealth funds are great for small, open economies, not so good for developed nations. Even China's is likely to be problematic in the long run, though with the degree of financial repression there the issues are rather different. But a US SWF would basically swamp private actors making a mess of financial markets. Much better to just bet on US growth. Which would mean doing the obvious thing and expanding Social Security.

    2. To be perfectly honest I've never been convinced of the necessity of forced savings programs. SS has always been something of a mental thorn in my side because I really liked the original idea of what amounted to life expectancy service, but its shift to retirement savings bothers the hell out of me. If the goal is to make sure that people have some basic level of subsistence in retirement, my instinct was always some variation of a minimum basic income.