Tonight, on the eve of the U.S. presidential election, much of the United States is going to be glued to a TV, computer, or mobile screen watching the voting results get counted.
I equate the election media frenzy to watching paint dry — Boring as hell!
Instead, let’s talk about an issue that’s really important! An issue that could have a significant effect on how everyone needs to be planning for retirement.
Have you ever heard of secular stagnation? Unless you constantly read business and economic news, probably not.
It’s actually a very old economic term — created in 1938 by an economist named Alvin Hansen. Hansen used the term to describe the state of the U.S economy following the Great Depression. In layman’s terms, secular stagnation describes a state of no economic growth (or very little) for a extended period of time in a market based economy.
As we all know from high school history class, the Great Depression ended in earnest with the start of World War II. Government spending and the subsequent baby boom following the war set off an incredible period of economic growth in the United States. The times were pretty good for the baby boomers.
In recent years, this concept of secular stagnation has started getting a lot more attention. The large (4% or greater) growth rates our economy used to experienced appear to have come to an end.
A few very smart economists (most notably, Larry Summers) are now talking about this idea of secular stagnation again. Big media outlets like Time, The Economist, Bloomberg, and the Wall Street Journal seem to generally agree with this theory. Why?
Low interest rates used to stimulate the economy seem to be barely working. Growth rates have been minimal in the U.S. following the Great Recession.
|Date||Real GDP Growth*|
|Jun 30, 2016||1.28%|
|Dec 31, 2015||1.88%|
|Dec 31, 2014||2.49%|
|Dec 31, 2013||2.66%|
|Dec 31, 2012||1.28%|
|Dec 31, 2011||1.68%|
|Dec 31, 2010||2.73%|
|Dec 31, 2009||-0.24%|
|Dec 31, 2008||-2.77%|
* Real GDP values courtesy of multpl.com
Those numbers are about half of recorded post war GDP growth averages. Economic growth has been slowing…and economists are scratching their heads as to exactly why.
Maybe it’s demographics, with all those baby-boomers now retiring. Maybe it’s because people don’t have as many babies anymore — birth rates slowed after the last recession. Without population growth, it’s harder for the economy to grow.
Or, perhaps it’s because productivity growth has lagged in recent years. A good bet is that it’s some combination of all of those reasons.
It’s not just the United States seeing this phenomenon either. Many European countries and Japan have also experienced similarly low growth rates. Interest rates are now negative in several major economies, like Germany and Japan; all in an attempt to stimulate economic growth.
Japan (in particular) has been dealing with secular stagnation for the past 20 years, with little change in sight.
It’s a hard problem to solve.
Why Should I Care?
So why does any of this matter to you? You could be watching the voting results on TV goodness sake!
I get it — GDP numbers and economic forecasts seem boring! But if you plan to retire early, or even plan to retire at all, GDP growth is extremely important.
Why is that, you ask? Most of us entrust our retirements to the stock market via 401k’s and index funds. These are very broad investments that cover most segments of the economy. When GDP growth lags, so will company earnings….and ultimately that means stock prices will lag too.
Your Retirement Depends On Economic Growth
Let me throw out a wild idea that many will probably reject: The average citizen’s ability to retire is entirely dependent on economic growth.
I probably need to explain this a little further — Most individuals use standard 401k investment plans and have low retirement savings rates (~10%). Their retirement plan assumes enough stock market growth over 30 years to cover their retirement.
But what if it didn’t grow? I believe the vast majority of people won’t have enough saved for retirement if the stock market stays flat for an extended period of time (i.e. secular stagnation).
In a flat economy, stock prices really shouldn’t go up because earnings won’t be going up. They’ll bounce around, positive one year and negative another year. On average, real investment gains after expenses are going to be minimal.
Let’s not forget either — most retirement plans utilize some form of withdrawal rate because retirees frequently spend down capital, not just investment income.
Under such a scenario, the choice a retiree has is to either: 1. Continuously draw down precious capital. 2. Live on interest and dividends alone (however small). 3. Go back to work.
None of these are bad strategies, just make certain they’re the strategy you actually WANT rather than the one you are FORCED to take.
What About The 4% Rule?
Personal Finance bloggers love to hold up the 4% rule as the “safe point” when savings are great enough to retire. The Trinity Study created this magic number by back-testing stock market returns from 1925 to 1995….and the vast majority of those back tested years were periods of greater GDP growth (with the exception of the Great Depression).
I’ve argued in the past that the Trinity Study is actually pretty optimistic given current GDP growth rates (which are half of historical averages).
Think about it….why would the stock market provide similar results for retirees when economic growth is half of what it used to be?
Hell, even John Bogle (the founder of Vanguard) is suggesting returns are going to be lower in the future. He believes returns of 4 to 5% may be the new normal.
When smart people talk, I try to listen. Maybe you should too?
Hope, Optimism and Planning
You’ve probably heard the phrase “Hope for the best, but plan for the worst” at least once in your lifetime. I think it’s good advice.
For myself, I’m optimistic that things will turn around. Whichever candidate gets elected tonight, I hope they kick-off a new era of economic growth and prosperity. My hope is that the future will be brighter tomorrow than it is today.
But when it comes to planning my financial life, I’m far more cautious. What worked “theoretically” in the past may not work in the future. I prefer to base my plan on data, not hope.
I think my family’s financial plan can handle a potential future with lower market returns: We’ve adopted the 3% rule for planned retirement spending and we’re attempting to live off investment income, not capital. The numbers indicate it should be enough.
Some personal finance bloggers like Stockbeard @ HowToRetireEarly tell me I’m overly conservative. Maybe he’s right. If he is, it’s one of those instances where being wrong is going to feel pretty damn awesome.
I’ll be overjoyed if economic growth improves and stock market gains continue at rates similar to those seen in the past.
Live long and prosper.
What do you think? Are we in a period of secular stagnation? Are we doomed to decades of economic stagnation like Japan?