We only dimly perceive how the prevalence of broad economic trends may lull us into a financial trap of our own making. Such a phenomenon is afflicting the current set of pre-retirees, according to a newish study from the University of Pennsylvania's Wharton School called "Debt and Financial Vulnerability on the Verge of Retirement."
The working paper's authors Annamaria Lusardi, Olivia S. Mitchell, and Noemi Oggero examined individuals aged 56 to 61 at three different time periods - 1992, 2004, and 2010 - with a focus on changes in debt over time. They find that recent cohorts are less financially secure than the pre-retirees of 1992, largely because they have purchased more expensive homes with smaller down payments. The authors write:
"Table 1 shows that the percentage of people age 62- 66 with debt rose from 52% in the HRS baseline to 64% among Early Boomers; and the median debt increased from $580 in the HRS baseline to $8,800 (fifteen times) among War Babies and $12,000 (twenty-one times) among Early Boomers...
The diminished financial stability in retirement due to greater amounts of debt is likely to continue as younger cohorts are nearing retirement age with more debt than previous cohorts. The fact that indebtedness decreases as people age most likely means that debt continues to be repaid in old age. It may also indicate that older people today were more conservative about taking on debt near retirement than today's younger generation is."
The above excerpt conveys something of the gist of the 43-page paper. To me, however, the authors' findings are truly a sign of the times. We live in a period of historically low interest rates, and similarly in a time when spending on credit has become the cultural norm. Pre-retirees are not unaffected by these trends.
(Okay, one more excerpt that hits both these themes: "The NFCS data also show that down payments have been decreasing over time; those who recently bought homes had put down only 5 or 10 percent. Moreover, the 2009 NFCS shows that many older respondents pay the minimum only on their credit cards…")
In short, pre-retirees are not only underfunded but overleveraged. And therein lies the significance of the point I started with - about our tendency to be influenced by prevailing trends. With interest rates so low for so long, even Grandma has gotten into the act. The Wharton study points out an increase in variable-rate loans. Not so long ago, I myself took out an ARM and admit I was salivating when signing the loan docs. I got a rate of just 2%! But my situation totally justified the risk. I knew I would be selling the home in a couple of years. But when a pre-retiree takes out a variable-rate loan and especially on a home with a large unpaid balance, that's another story. As finance prof. Moshe Milevsky aptly put it in a recent article comparing variable and fixed-rate mortgages, "You're not a bond trader."
Rates are now slowly but surely creeping up, and many are those who will find themselves in a trap of their own making, since retirees especially cannot generally increase their income in response to costs, like variable mortgage payments, that suddenly shoot up.
There is a time for everything, including a time for taking appropriate risks, but the pre-retirement phase was formerly understood as a time to dial down the leverage. (Remember the quaint concept of paying down your mortgage?)
Despite the exhortations of pious financial-responsibility types (ahem), most people do what they see others doing. That is why cultural influences matter so much. In the meantime, though, we can help those within our own sphere of influence. But neither logical proofs, nor nagging, will much avail. It's the signals we send through our deeds that do the trick.
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