How The Debt Deal Impacts Your Retirement
We finally have a deal on the debt limit, and it means you're going to have to save more for retirement. Why, because the US economy will likely be stuck in slow growth mode for quite some time. With slow growth, stock and bond market returns will likely be modest. You'll probably have gains, but not gains big enough to bail you out if you aren't saving enough.
Why are we in for slow growth? Well, the debt deal simply means that we will continue to add more debt, but at a slightly slower pace. As we add more debt, the interest payments begin to consume more of our national finances. And there is some pretty good research out there indicating that counties with high debt loads ultimately sacrifice growth. Economists Carmen Reinhart and Kenneth Rogoff wrote a terrific book on sovereign debt called This Time Is Different. If you want to learn more, read the book. Japan looks like this and so does much of Europe. Economies grow, but just very slowly, which means that corporate profits and financial market returns are generally pretty modest.
- Don't get me wrong. It was important that we did the debt deal. We have to pay our bills, and if we hadn't, things could be much worse. But when you look at the budget numbers and demographics in the US, both factors are pushing us toward more debt. We aren't at a point yet where we're willing to make the hard choices.
You might be wondering how we could change things. Well, we have to start bringing down the total debt, which means we would have to run not just a balanced budget each year, but a sustainable surplus. We could then use the surplus to pay down the debt. But if there's no surplus, there's no money to pay down any of the debt. I don't think we'll see sustainable surpluses any time soon. What we'll likely see are more annual deficits in the $500 billion to $1 trillion range, and those just get added to our total debt. Now Congress could surprise me and figure out a way to run surpluses, which would be great, but the odds of that are small. So you have to plan for the more likely scenario.
So if more debt is what we're likely facing, then you need to understand how it might impact your retirement plans. If stock and bond market returns run below their long term averages for a while, the only way to make up for the lower returns is to save more. There's no magic formula for this.
How much more should you be saving? That all depends on how old you are and how much you already have saved. But if you're going to do some retirement projections, I'd run a few using 5% and 6% returns to see how things look. There are lots of sites with savings calculators, but one I like is www.dinkytown.net
- For example, if you get a 6% return over 20 years as opposed to an 8% return, you need to start with about 45% more money to end up in the same place.
Bottom line. High debt and slow growth means you'll have to save more to meet your retirement goals.
Above material does not constitute investment advice and does not represent a complete discussion of the issues. Consult your individual financial advisor prior to making any financial decisions. Past performance is no guarantee of future returns.
Learn More: Want to learn about a simple way to manage your personal finances and prepare for retirement, investigate my new book Your Money Ratios: 8 Simple Tools For Financial Security, available in bookstores and at amazon.com The Wall Street Journal called the book "one of the best finance books to cross our desks this year." WSJ 12/19/09.
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