Morningstar Magazine - October/November 2017 - 10

Dispatches

Triple-Down Economics
Americans bet on
markets to pay for
retirement, education,
and healthcare.
PHILLIPS CURVE

Don Phillips

Common inflation numbers don't tell the full story.
While technology has brought the cost of many
services such as communication, transportation,
and entertainment down significantly over the past
few decades, the costs of three of the biggest
concerns of American adults have skyrocketed.
Retirement has grown substantially more
expensive as people live longer. Educational costs
have risen dramatically as college campuses
have made their sticker prices affordable to only
a handful, forcing most families to rely on
scholarships or loans to afford a level of education
that has become the entry price to a decent job.
Finally, healthcare costs have spiraled upward,
well beyond the rate of inflation. While
these costs get magically scaled back by insurance
discounts, the list price has become absurdly
expensive, making some form of insurance
coverage an absolute necessity.
We are at the point where hard work and diligent
saving alone will not allow the vast majority
of citizens to secure these basic needs of
education, healthcare, and retirement security.
As such, we increasingly turn to the financial
markets to solve these predicaments. By investing
our savings, the hope goes, we can turbocharge
our savings and, thus, be able to still afford
those necessities we used to be able to pay for just
through work and savings. While this approach
is logical, it is hardly without risk. Financial
markets offer few guarantees, and time horizons
do not always align in practice as nicely as
they may in theory. At the very least, the massive
inflation in the price of these core needs has

10

Morningstar October/November 2017

forced American savers to play the game at
a much higher level of risk than did our grandparents. The days of the Bailey Building and
Loan providing sufficient security to our families
are long gone.
The first of our new breed of solutions is the 401(k)
or similar retirement plan. Here, we take
a long-term goal-saving for retirement-and
match it sensibly to an activity with potential
long-term benefits-investing in equities.
The financial-services industry has done a good job
in providing and improving these services,
especially in the big-plan market. These plans
today are generally well diversified; company stock
is now the exception, not the rule. They make
enrollment easy, encourage step-ups in saving,
and offer streamlined choices such as targetdate funds that guide the investor toward
a reasonable portfolio that takes on less risk as the
goal nears. While these plans lack the security
of a government or corporate pension, they can
be a valuable tool in offsetting the rising challenge
of retirements that are growing more costly.
If the stock market can rescue retirement, perhaps
it can also solve the problem of the outrageous
increases in academia. That's the thinking behind
529 plans in the United States. The problem
here is that the investor is not starting with
a 45- to 50-year horizon, as with retirement, but
instead just 18 years at best. That's still a
reasonable horizon for equities, but the investor
must be ready to start downshifting pretty
quickly, and the opportunity to recover from a bear
market is sharply reduced. The prospect of the
financial markets saving the day is far more limited.
For parents who start these plans late, their
utility is even more restricted. Still, these plans are
a useful tool to counteract the almost unconscionable rise in tuition costs at our universities.
If the financial markets can address the problems
of the rising costs of retirement and education,
why not apply this magical elixir to the
soaring cost of healthcare? Such is the thinking
behind health savings accounts, or HSAs,
which are beginning to attract more attention from
investors, corporations, and politicians. Here,
savers can set aside money from their paychecks
that can be invested in financial markets and then

used later to pay for healthcare. If the investor
is fortunate enough to save more than is needed
to cover health costs, the surplus can be added
to retirement savings, thus solving two problems at
once. The problem, of course, is that health
costs are far less predictable than college and
retirement costs, and the time horizon until
the costs come due may be far shorter than the
time horizon necessary for successful equity
investing. That isn't a reason not to try to grow the
pot of earnings that need be directed to healthcare,
but guarantees are far less sure here.
All of these are reasonable solutions to problems
the financial-services industry did not create. The
problem is that they all rely on the same engine.
Moreover, they rely on the financial markets
at a time when stocks are not cheap by historical
measures and when bonds offer very limited yields.
It's a big bet with a weak hand. And if the
bet fails, it will be the financial-services industry
that takes the fall-not the Congressmen
who failed to clamp down on health and education
costs, not the price-gouging pharmaceutical
companies, and not the self-aggrandizing college
deans who caused the problem. Instead, the
financial advisor who suggested the 529 plan or
the corporation that offered the HSA or the 401(k)
plan provider will take the blame.
The financial markets are great and powerful
things, but they are not easily harnessed. You can't
just ask for x units of performance over y number
of years. You get a range of returns that may
exceed your needs or fall well short of them. The
higher the valuation and the lower the yield
at the point of embarkation, the greater is the
probability of shortfall. And if you make essentially
the same wager to address all three problems-
retirement, education, and health care-you run
the risk of catastrophic failure, meaning you
could lose on all three bets at the same time.
That's not the type of diversification wise planners
seek, but this triple-down risk is one many
Americans feel pressure to take. Now more than
ever, the well-being of Americans rests in the
hands of the financial markets. K
Don Phillips is a managing director with Morningstar.
He is also a member of the editorial board
of Morningstar magazine.



Table of Contents for the Digital Edition of Morningstar Magazine - October/November 2017

Contents
Morningstar Magazine - October/November 2017 - Cover1
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Morningstar Magazine - October/November 2017 - Contents
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