The Changing American Workforce: Can They Still Retire?

The Wall Street Journal recently published the article, “What’s Wrong with America’s Job Engine?” which talks about the changing relationships between employers and workers in the wake of the recession. The article suggests that companies have not ramped up their hiring in the ways that many expected.

The first thing that really jumped out at me was that over the past ten years, the U.S. economy’s output of goods and services increased by 19% —but the number of private sector jobs —declined by almost 2 million. Sure, part of the decline in jobs can be blamed on the recession, but David Wessel, the article’s author, notes that much of the shift is due to long-term changes in the U.S. job market—meaning that American business is looking to do more with less.

I thought that the following quote provided the key take-away:

“Corporate employers, their eyes firmly fixed on stock prices and the bottom line, prize flexibility over stability more than ever. The recession showed them they could do more with fewer workers than many of them previously realized.

In a survey of 2,000 companies earlier this year, McKinsey Global Institute, the think tank arm of the big consulting firm, found 58% of employers expect to have more part-time, temporary or contract workers over the next five years and 21.5% more “outsourced or offshored” workers.

“Technology,” McKinsey says, “makes it possible for companies to manage labor as a variable input.”

Trending Away from Full Time Employment

While the trend from lifetime employment (or even full-time) employment to part-time/employment have been underway for many years, there’s been surprisingly little discussion of how this affects the ways that people plan, save, and invest.

Elizabeth Warren, has been a thought leader in promoting the notion that there has been a dramatic increase in the risks to middle class families from income dislocations which she refers to as income vulnerability. Robert Hacker, Yale professor and author of “The Great Risk Shift,” is another key voice in explaining the origins and implications of the shifting role of the worker in American society.

Hacker’s research provides the following striking conclusions:

  • The size of swings of pre-tax family income from year to year has doubled since the early 1970s.
  • The chance that a person with average demographic characteristics will experience a 50% or larger drop in income over a two-year period has risen from 3-4% in the early 1970s to nearly 10% in 2004.
  • Income instability has risen just as quickly among the well-educated as among the less educated. As a result, college-educated workers today experience instability as great as workers without a high-school degree experienced in the 1970s.

Dr. Hacker, working with the Rockefeller Foundation, developed a national metric of economic security: The Economic Security Index (ESI). The ESI website shows the fairly startling trends in the likelihood that an American will lose one quarter of their income in a year (18% did in 2009), or even half of their income (5% did in 2009).

The Variable Income/Fixed Cost Factor

I get that employers want to move from having high fixed costs associated with full time employees for whom they may have varying use. Particularly as the life cycles of products change rapidly, flexibility to respond to market forces is of utmost importance to a firm.

This evolution towards having a larger fraction of the workforce operating on part-time, temporary, or on a contract basis has substantial societal implications, not least for the ways that individuals invest.

Contractors, temps, and part-timers have incomes that are likely to vary far more than the incomes of people who work full-time for one company. The challenge, of course, is that most people and families have certain fixed costs that they need to cover including housing, food, transportation, and insurance. We have moved from a world in which people could match their fixed income to their fixed costs, to one in which many Americans have variable incomes and fixed costs. The variability of income is a new source of uncertainty. Many people have had a hard time balancing their checkbooks with known income. How will they adapt in an environment in which income varies from month to month?

The Great Retirement Shift

The evolution from full-time to part-time/contract employment has corresponded to a shift away from traditional pension plans, in which an employer promises to provide a certain amount of income for retirement, based on salary and years of service. The new model, known as Defined Contribution (DC) Plans, places the responsibility for saving properly and investing effectively on the shoulders of the individual worker.

While full-time employees have seen their lives change as their employers moved from traditional pensions to DC plans, this shift is even more dramatic for temporary/contract workers who can no longer count on receiving any additional tax benefit or matching contributions from their employer, and are now responsible for setting up (and more importantly, funding) their own retirement accounts. This means that part-time workers need to be far more proactive and educated in their retirement savings.

There is a Silver Lining: The Self-Directed Retirement Plan

Are new-era contract workers getting a raw deal? Yes and no.

There are some distinct advantages for the part-time/contract worker. Here are three that come to mind:

1) Retaining control over your investments.

The first and foremost is that you alone retain control over your retirement. You and you alone decide where you invest your money and can shop around for the most cost effective solution that fits for your needs.

While the promise of traditional pensions sound great, they are just that: Promises. Many traditional pension plans are massively under-funded. If your employer goes bankrupt, you will most likely receive a substantially reduced benefit from what you were originally promised. Will the current and future retirees actually get paid what they were promised? We can only wait and see.

2. More investment options to choose from.

A second distinct advantage for the part-time worker is that they can select a retirement plan that allows them to invest the way they want. My research suggests that the best option for the vast majority of Americans would be to invest in a well-diversified, low-cost portfolio of index mutual funds or ETFs. Full-time employees investing in a 401(k) or other self-directed plan, like a 403(b), don’t always have this option. In fact,they are typically given a limited selection of mutual funds to choose from—and ETFs are almost never listed as an option. Current research shows that some self-directed DC plans offer such a limited selection of funds that it’s essentially impossible to build a well-diversified portfolio.

On this same front, there may also be certain asset classes that you simply don’t have access to in your employer’s retirement plan—like TIPS (inflation-protected bonds) or commodities, or even precious metals like Gold or Silver. A range of research suggests that commodities play an important role in building a full-diversified portfolio.

3. You can control costs.

A third advantage is cost. I recently wrote a post on the all-in costs of 401(k) plans that explores the implications of analysis from research firm, BrightScope. The article found that the average all-in cost of 401(k) plans amount to 1.9%, (on average) for plans with less than $10 million in total assets and 1.36% for plans with assets from $10 million to $100 Million. As a rule of thumb, every additional 1% you pay in annual expenses for your retirement savings equates to about 30% of your total wealth accumulation over a working lifetime.

A self-employed individual or owner of a business where employees are the owners can set up self-directed retirement plans that cost far less. SmartMoney Magazine recently gave an overview of the various accounts that are available to the self-employed. I haven’t seen a survey of the average annual costs that they will incur with these plans,and there may be a combination of fund and ETF expenses, brokerage commissions, and annual fees for the plan. However, IRA’s can be set up very cheaply and typically, there are no additional expenses (beyond brokerage costs and any expense ratios for funds held in the plan) for the investor. While the actual costs depends on the size of the account, how often they trade in the account and the types of funds that they buy—it’s still possible for a self-employed person to build a self-directed retirement plan with an all-in cost of around 0.5%. (An investor at Folio Investing, for example, can pay $290 per year for an account and hold Target Date Folios in an IRA and have a total all-in cost of 0.56% for an account with a $100,000 balance.)

Take Control of What You Can Control

While there has been a shift towards increasing uncertainty on many fronts for American workers, there are also new options that allow people to still save for retirement. Yes, our society has become one in which income stability and traditional pensions are quite rare. However, we all must face the fact that the larger economic and political trends that have caused these changes are here to stay.

With the changes, workers who are not full-time traditional employees have some advantages.  They can save for retirement more cheaply, maintain more control, and have access to a wider universe of investment choices.  The real challenge, of course, is that people need to save before they can invest and they need to become educated consumers of financial products and services.  

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7 thoughts on “The Changing American Workforce: Can They Still Retire?

  1. Pingback: Social Security and Retirement: The Reality « Portfolio Investing Blog: Portfolioist

  2. Pingback: The Hidden Risk in Target Date Funds « Portfolio Investing Blog: Portfolioist

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  4. Pingback: Saving and Investing for Retirement: Part Five « Portfolio Investing Blog: Portfolioist

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