There is a lot of hand-wringing going on around the financial blogosphere regarding financial education, or rather the lack of it, in American schools. The theory is that if we teach kids in high school about budgeting, the basics of investing, and how to prepare for retirement that they will be able to avoid the excessive student loans, consumer debt, and underfunded retirement accounts of the generations that preceded them.
On the one hand I can get behind this. All a school has to do is make a one-semester course on basic finances a mandatory elective and the deed is done. The worst that could result is a couple kids might not be able to fit an easy A from Eastern Religions into their schedule (hand to the sky this was one of the most popular electives at my high school). Best case, realistically, maybe a few students per class take the lessons to heart. That is better than nothing…and with any luck the student loan bubble will burst soon and the price of a college education will come back in line to something approaching its value.
On the other hand I can’t help but think that it would be a potential exercise in futility. Other than learning to read (a skill I developed on my own well past the level school by itself would have gotten me to) and a smattering of math and science I don’t remember much of what I was taught in high school. I knew more history by fifth grade than my peers did by graduation simply by reading the books on my dad and grandpa’s shelves.
One high-school level class will not fix this nation’s dysfunctional approach to money management. What is needed instead is a wholesale cultural shift. Americans are consumers, its part of who we are. That being said we generally suck at it. Somewhere along the line in most people’s development spending money took precedence over simple mathematics (spend less than you earn otherwise you’ll go broke). In others’ (okay, there is probably a lot of overlap) a little concept called compound interest, which they learned about in junior-high school, just went in one ear and out the other.
Compound interest is a very simple mathematical concept (there is a reason why it is taught in junior-high). Yet if you let it slip your mind for a few decades I guarantee it will come back to bite you when you start planning for retirement as it did for the subjects of this Wall Street Journal article. Too many people who are approaching retirement have under-prepared for it and too few among them recognize their error in time to make a difference.
In looking for solutions to the lack of stamina for many retirement accounts the author misses the most powerful one of all: saving more and saving it earlier (saving in this case including investing). Below he talks about alternatives to adjusting asset allocation:
Far more significant are other levers. For couples in their 50s, the tendency may be to spend more after the kids are done with college or when the mortgage is paid off. But cutting spending by 5% meant 40% would fall short of their income goal in retirement, down from 46%. Reduced spending has a dual benefit of building savings and effectively lowering the level of income needed to be replaced.
Working longer also has a significant multiplier effect. It allows more time to save, shortens the length of time savings are needed, and enables the retiree to claim higher monthly Social Security benefits. Waiting until age 70 took the number of those falling short down to 28%.
The suggestion to work longer of course makes sense as it ensures more cash can be added to your retirement fund. The flip side of that is that with every year that you continue to work you bring in dollars that will have correspondingly less time to grow before the time comes for you to spend them. You would be better off entering the workforce earlier in life, saving as much of your income as possible, and then investing it so you can maximize the power of compound interest. The older you are the less effective compound interest will be for you.
Ready for the dividend stock tie-in? Here it is, short and sweet: dividend-growth stocks are called that because in addition to sending you a steady income stream they also increase that income stream by a certain percentage every year. As long as that increase stays ahead of inflation your income will continue to rise. Now remember how the beauty of compound interest is that it builds on the principal and the accumulated interest instead of just the principal itself? Well with a dividend-growth stock you can take that income stream and re-invest it by buying more shares of the company or companies that sent it to you in the first place. This increases your income stream by taking advantage of owning additional income-generating shares on top of the dividend increases each year. Its the snowball effect, similar to the “Debt Snowball”, except that it makes mathematical sense.
This post was included in the Carnival of Financial Planning-Edition #239 at Intelligent Speculator.