We’re all told in some way or another that retirement savings goes hand in hand with our first job. My colleagues and I always stress: If you have a 401(k) at your place of employment, contribute the max to make the match. But what if you could start saving earlier than the day you deposit your first paycheck? I talked to Tony Stenning, BlackRock’s Head of Retirement in EMEA, who insists that retirement savings should start at birth. Of course, right off the bat, it sounds a bit crazy—saving for retirement for newborn babies?! But he may be onto something.
Stenning: It only sounds crazy because of the way we have always saved for retirement in the past; in actuality, what is crazy, is perpetuating an unfunded pay-as-you-go system. There’s no doubt that it goes against the grain of so much received wisdom. But it makes sense for a number of reasons—and three that really stand out. The first is, it takes maximum advantage of the “time value of money.” Second, such a scheme would be vastly less expensive than the way we fund retirement now. And third, this could show the way to significant, and greatly needed, infrastructure investment.
Let’s take these in turn. What do you mean about the time value of money?
Stenning: It’s an investment truism that the longer money stays invested, the more it grows. BlackRock’s President Rob Kapito puts it this way: It’s not about timing the market—that is, trying to guess the highs and lows, which even professionals can’t do very well. It’s about time in the market—staying invested continuously for as long as possible. For the average person who starts saving a portion of their paychecks, that means saving doesn’t start until work starts—late teens at the earliest or early to mid-20s for those who go on to higher education. And that’s assuming that people start saving at the first moment they can, which very few people do.
So what you’re talking about is giving everyone an extra 20 or more years of time in the markets.
Stenning: Exactly. Einstein himself highlighted that the eighth wonder of the world is compound interest: “He who understands it, earns it…he who doesn’t, pays it.” In the financial world over the long-term this can have a profound impact. For instance, just £2,000 (that’s almost $2,900) invested at birth would be worth—using conservative assumptions, which you can review in my longer write-up—nearly £300,000 at age 65. And more than £435,000 at age 70. Think Einstein may have been onto something!
That sounds great—but where are all these initial lump sums going to come from?
Stenning: Well, in principle the money could come from a lot of sources, including parents and grandparents. But my idea is that it should come from the government.
Government budgets are stretched thin as it is. How could governments possibly afford to give new pots of money to every single baby born? What would that cost?
Stenning: Taking just the UK, where I live, there are about 800,000 babies born every year. So the annual cost would be £1.6 billion—or about $2.3 billion. That sounds like a lot. But keep in mind that the cost of our current pay-as-you-go pension system is more than £100 billion per year! Even better: those sums I just cited generate an annual income for retires that is well above, at a fraction of the cost, what the current system can provide. Clearly, there would have to be a phase-in of the new system coupled with a phase-out of the old, so that in the short- and medium term, costs would rise marginally. But the long-term savings would be enormous and would vastly outweigh the near-term costs.
Occasionally proposals are floated in the U.S. to allow people to invest part of their Social Security—our version of your government’s pensions—in the markets. And the typical objection is that markets are too volatile and insecure, while the whole point of a government pension is that it’s secure. Your plan seems like it’s exposed to that same objection. How do you respond?
Stenning: Sure, that’s a real concern. But there are a number of points to make here. The first is that government pensions are secure only so long as government balance sheets are solvent, and these pension systems are putting enormous stress on government finances—especially in aging societies in which the ratio of workers to retirees continues to narrow. Reform is going to have to happen one way or another. Second, recall the point about time in the market. Time, in effect, heals all wounds. The long time horizon insulates investors from volatility. Third—and this is really the most important point—the suggestion is not to put this money into risky, volatile assets. Rather, my idea is to pool it into a sovereign wealth fund that could invest in infrastructure projects. The need is of course tremendous. The fact that domestic savings rather than international capital could now be used to finance domestic infrastructure would strengthen this plan politically—which is not an incidental point, as this would have to be approved legislatively. And the long time horizon of infrastructure investments—something that makes them a difficult “sell” in a market that prizes liquidity and daily pricing—makes them ideal for retirement investing. These people won’t need to touch their money for decades and could earn an attractive return (securing the illiquidity premiums on offer) without worrying about the daily ups and downs of financial markets.
Sounds like you’ve outdone the old proverb and killed not just two but three birds with one stone.
Stenning: That’s for others to judge. However, I do think it is possible to secure better retirements, while lowering the cost to society and providing much needed financing for infrastructure. It’s win-win-win.
Chip Castille, Managing Director, is head of the BlackRock Global Retirement Strategy Group and a regular contributor to The Blog.