Yesterday we discussed the genesis of modern financial planning. It all stems from the Employee Retirement Income Security Act (ERISA) that passed in 1974.
ERISA was more than just legislation. It sparked a transformative wave in financial planning. In fact, it created the entire “retirement” industry.
That being the case, we need to ask ourselves an important question. How did this single act shift our perspectives and practices?
Before ERISA, employees didn’t have to spend much time planning for retirement. That’s because they could count on receiving payments from both Social Security and a corporate pension plan after they retired. These programs guaranteed a steady stream of income for life.
Many people supplemented these items with personal savings. That became known as the “three-legged stool” concept. As long as all three legs were in place, retirement planning was simple.
However, as we moved into the 1970s and 80s, it became very clear that corporate pensions just weren’t sustainable. That leg of the stool was starting to teeter.
That’s why ERISA created 401(k)s and IRAs. They were to be a replacement for guaranteed pension plans.
With this shift, employees suddenly were responsible for their own retirement investments. Financial planning was no longer a distant concern. It quickly became a pressing necessity.
And that’s when the floodgates opened.
As we discussed yesterday, Wall Street very rapidly gained millions of new captive customers. They responded by creating all kinds of funds designed to go into 401(k) plans. These funds were laced with hidden fees. That made them quite lucrative for the funds’ creators.
Of course, these fees ate into the funds’ performance. Many 401(k) plans consistently underperformed the market year after year. Fees were one reason for that.
In addition, many of these funds chose their investments based on “optics”. That is to say, the fund managers moved in and out of positions based on what they thought looked the best to the companies they were pitching their funds to. In other words, the fund managers had incentives that weren’t always aligned with those of normal investors.
Still, this approach to personal finance worked reasonably well during The Age of Paper Wealth. From 1982 to 2022, interest rates consistently fell and U.S. stocks consistently went up… taking even the most mediocre of 401(k) funds up with them.
But as we’ve been discussing, that age is over. Rates are now on the rise… and investors are still grappling with what that means for the stock market.
That’s why we’ve seen so much volatility of late – big swings down followed by big swings up. Nobody under the age of 70 has been an adult in a world where rates didn’t constantly fall and stocks constantly rise.
Yet, personal finance 101 has refused to change. The retirement industry is still peddling the same advice as it has for forty years now. And that’s led to some unexpected reverberations. We’ll talk about those tomorrow…
-Joe Withrow
P.S. Personal finance 101 may not want to change… but it will have to. Sooner or later the world will realize that it’s broken. And that means it’s time to rethink our thinking.
Are you ready to create financial independence outside the broken system? Well my friend, it’s time to go Beyond the Nest Egg.