Americans have been talking a lot lately about needing to save more money, both individually and governmentally. Without getting into the national deficit questions, it is worth thinking about how tricky the process of individual savings can be and how widely results can vary, even with the best of intentions. If we look at the past, we see that sometimes making the best choice entails being knowledgeable, but other times it is just being lucky.
Let me give you an example of Alex and Pat, who were 28 in 1974, which was the year the government provided us with a tax-free way to save by creating Individual Retirement Accounts (IRAs).
Both Alex and Pat planned to work for 38 years and then retire. Both decided to put $1,000 in their IRA each year and they stuck to the plan.
In the beginning Pat believed the stock market was the best investment and put the annual contributions in an index S&P stock fund that reinvested any dividends received. Alex, on the other hand, bought a gold fund. Both continued their strategy for seven years until 1980.
When they compared notes that year, Pat's IRA was $9,580, while Alex's had grown to $29,600. Pat then sold the stock fund and bought the gold fund, while Alex dumped the gold fund and bought the stock fund Pat just got out of.
For 20 years they stayed with this investment strategy. In 2000 they got together again. Pat's IRA was worth $19,860, a good bit less than the $27,000 they both had sequestered over the years. Alex had holdings of $696,200.
Pat then gave up on gold and moved all the funds to the index stock fund. Alex took the opposite course and jumped back into gold.
In 2009, Pat was totally burned by the stock market and converted what is now worth $21,810 into a money market account and left it there for the last two years. When 2011 arrives and after contributing a $1,000 a year for 38 years, Pat has an IRA worth $23,860. It is not hard to see why Pat is looking for a job to keep working and can think of a modest retirement years in the future -- with the help of Social Security.
For the eleven years leading up to 2011, Alex stayed in gold and on the first of January had an IRA worth $3,479,000. Following a different but perhaps no more logical investment strategy than Pat's, Alex is ready to retire in style, buy a condo at a ski resort and a yacht to cruise the Caribbean.
First moral: It is sometimes better to be lucky than to be smart.
Second moral: Individual savings are good, but Social Security is necessary.
If you want to make your own comparisons, tryout The Time Traveler's Investment Calculator.