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Are Low Interest Rates a Hidden Risk to 401(k) Plans?

NEW: Bonus Question

Question: Similar to low bond yields being a blessing and a challenge, is low inflation a similar concept?  If so, why?

Mike Barry:  

Short answer, yes. Long answer: Generally (and nearly axiomatically) –

  • Inflation transfers wealth from lenders to borrowers. And that may be a good thing or a bad thing, depending on conditions.

  • A modest rate of inflation may be a good thing if it allows the renegotiation of some otherwise "sticky" prices -- most significantly, wages. The problem is that these effects depend on either:

    • The inflation being a surprise, or

    • The injured party (the lender or wage earner) not being able to negotiate compensation for anticipated inflation.

  • For instance, in the context of a predictable rate of inflation, lenders will adjust up the interest rate at which they will lend. And wage earners with the power to do so will negotiate inflation-based wage adjustments.

  • Inflation makes economic signals more noisy – you have to decode “real” effects from the merely nominal. This can make decision making problematic.

  • Certainly in our current economy, “inflation” has become a slippery concept and (in my humble opinion) nearly impossible to measure. You can track increasing costs on some basics (like rents or food), but how do you account for changes in technology, new and more powerful gadgets, gains from the sharing economy, or even just the difference between really good shows or bad ones on TV – I find accounting for all that in the overall “level of prices” fundamentally mysterious.

Listen now!

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With Guest:
Michael Barry, 
President & CEO, 
O3 Plan Advisory Services, LLC

Michael P. Barry is a senior consultant at October Three and President of O3 Plan Advisory Services LLC, which provides retirement plan regulatory analysis targeted at plan sponsors and those who provide services to them. Plan Advisory Services publishes analyses of regulatory developments affecting private employer defined benefit and defined contribution plans, focusing on the challenges, opportunities, and consequences for sponsors that regulatory changes present. Mike has had over 40 years’ experience in the benefits field, in law and consulting firms, concentrating on the regulation of private employer DB and DC retirement plans.

Beginning law practice in 1976, the year that the Employee Retirement Income Security Act (ERISA) became effective, Mike has worked with and studied the evolving complexities of regulation in this heavily regulated field. Before founding Plan Advisory Services in 1998, Mike was Managing Director at Bankers Trust and, before that, a New York benefits partner at LeBeouf, Lamb, Greene & McRae. He writes a regular column for PLANSPONSOR magazine (“Barry’s Pickings”). Mike blogs at, and you can follow him on Twitter @PlanAdvisorySvc. His book – Retirement Savings Policy – Past, Present, and Future, published by De|G PRESS is available on Amazon

Recap, Highlights, and Thoughts

Interest rates could be a significant risk to retirement savers that is hiding in plain sight. During my conversation with Mike Barry, President of O3 Advisory Services, we connect a lot of dots on how low interest rates could impact the retirement of current and future retirees.  We also hit on several reasons why interest rates have been trending lower, whether student debt plays into the conversation and why employers who are even considering pursuing a retirement income strategy should think very carefully about all of this prior to making a decision.  Mike and I definitely get into the weeks on a few things but pull everything together in a way that will leave you with a better understand of the impact of interest rates on retirement plans.  

Important Links Discussed:














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Thanks for listening!​​

Sincerely Your Host, 

Rick Unser

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NEW: Episode Transcript

Rick:    Well, Mike. Thanks for taking the time today. Welcome back to the podcast. I'm really looking forward to diving in with you today on some things you're seeing out there that might present some, let's call them, storm clouds for retirement savers.

Mike:    Thank you, Rick. I've very excited to be back here. I think of it... I've been taught to think about these things as challenges.


Rick:    Well said. I will say that I know the last time we had you on the podcast I kind of threw you a curve ball with blockchain, which certainly you did a great job of explaining. I'm looking forward to giving you more of a fast ball down the center of the plate today with some of the stuff we're going to chat about. So thank you.


Mike:    A little bit. I still love blockchain. I think it's not going away.


Rick:    Yeah, I'm with you there. So let's jump in a little bit on... I think thematically there's some things going on right now in the market that seem like they're maybe good on one hand, but could actually be bad on another. I know one thing you wrote about recently was low interest rates and how that could present a challenge, as you said, to retirement savers in the future. I think that's just a very logical thing where I think a lot of people look at interest rates today, and say, "Wow. There's cheap money. This is great." But I think you've done some good work on maybe the other side of that conversation with what that could me for savers or retirees, either today or in the future.


Mike:    Yeah. So I find all of this really interesting and it never occurred to me that it would be when I started doing this. But it can be just very deep, and there are a lot of profound things going on here. But there's some simple things to say and let's start with the very simplest. Because of the accounting regime that corporate-defined benefit plans have to live under, decreases in interest rates translate, subject to some buffering, into liabilities on the balance sheet and losses on the income statement. So it's for someone dealing with the DB plan, the consequences of low interest rates or decreasing interest rates are intuitive. I mean we live with them every day.


Mike:    But when we moved broadly from a DB system to a DC system, largely because of the effects of low interest rates... and interest rates have, been over the long run, declining, basically since the early 1980s. That move away from defined benefits plans to defined contribution plans was provoked for corporations and see that plans that aren't subject to that [inaudible 00:03:01] gap reporting regime are not moving away from defined benefit plans as quickly, but corporations are. The reason for that is declines in interest rates.


Mike:    In that transaction where you move from a DB plan to a DC plan, the risks that used to sit with the employer moved to the participant, that those risks are, first of all, interest rates. Second of all, asset performance and third of all, mortality. The asset performance risk is very intuitive to everybody. The stock market goes up. The stock market goes down, and the participant realizes that in the old days, with the DB plan, if the stock market went down, that was bad news for the employer.


Mike:    Now with the DC plan, if the stock market goes down, that's bad news for the participant. In the old days if interest rates went down, that was bad news for the employer, because decreases in interest rates, as I said just a bit ago, basically get translated into the financial disclosures and show up as increased abilities, and in effect, increased expenses.


Mike:    It's not intuitive in the DC world, when that risk has been transferred to the participant, what happens to that risk? Should participants be as worried about a decrease in interest rates as a DB plan sponsor is? I would say kind of generally, "Yes," but it's a lot more complicated for a participant to think about this, because participants aren't subject to this [Gasby 00:04:50] gap reporting regime, so they don't have to write up the value of their liability. They don't even have a liability.


Mike:    They just have a target that they're trying to save to. They don't have to increase that target just because interest rates went down. They can just keep thinking about that target the way that they've always thought about it. But in the long run the consequences of these lower interest rates do, in effect, translate into DC participants should think about either saving more or what their plan B is. The most obvious ones being live on less or work longer. I think it's useful to go through the sort of complex way that you get from low interest rates to higher savings cost, or higher cost of funding retirement in a DC plan. But that's a complicated discussion.


Rick:    I think that's where I'd love for you to go is, again if I think about the typical conversation that goes along with the 401K committee, or retirement plan committee where people are looking at maybe their individual account balances. They're looking at their plan balances, as we sit here in September of 2019, man, things look pretty good. My individual 401K balance has never been this high. My plan balance as a whole has never been this high and, yeah, yeah, yeah, we hear some scuttlebutt about interest rates, and things like that, but we're not feeling any pain, participants aren't complaining, so let's file this into the interesting but not relevant category of things that are floating around, whether it's our company or whether it's me as an individual in my own kind of personal financial thoughts. So I guess, maybe help connect some of those dots for me. So if committees are thinking about retirement outcomes, if committees are thinking about the long-term health of their employees and their ability to retire, why do low interest rates present a challenge?


Mike:    So I want walk through six kind of different ways of looking at interest rates. This is going to make..., I just may give everybody a headache at some point. My objective at the end is to say what I said at the beginning, very straightforwardly. Declines in interest rates, meaning for current employees that are saving for retirement, that to hit their targeted retirement objective, it's now going to cost them more. They're going to have to save more to get the same objective.


Mike:    All right, so I want to walk through these. So six different ways of looking at interest rates, and I want to make a promise, which is at the end of it, we're going to land on a very straight forward way to think about them. But you have to understand this phenomenon, the interest rates go down, the stock market goes up. That's got to be good news, right? Whereas in fact long run, it's in my opinion, not good news. Short run, it does trigger a write up in the value of assets. So let's go through these one by one.


Mike:    These are just basically six different things to think about when you're thinking about interest rates as a saver with an account, where you're trying to save towards a target. The first thing is that in one way, interest rates are just another type of return. It's like just another asset class, almost. It's just the rate of return that's the farthest to the left on the efficient investment frontier, they're, more or less, the least risky "investment" that you can have. So that's a little confusing, because they function as if they were just an investment but they have all these other functions also.


Mike:    Interest rates are also what the market says it's prepared to pay for certainty. I think later, after we get done trying to understand how the interest rates affect the saver, I think we should talk about this phenomenon that we're living through, and frankly we've lived through since the early '80s, which is basically that the cost of certainty has gone up. That as interest rates go down, you get less and less return on an investment that provides you with certainty.


Mike:    So that's the second thing as a way of talking about interest rates is that it's the cost of certainty. In effect, when interest rates go down, the cost of certainty has gone up. Because you have to pay more to get an asset in the future. Someone's going to pay you less to give you back your money in the future. That's, in effect, what happens when interest rates go down.


Mike:    The third thing is, and this is interesting and it's probably the most obvious thing although people don't think about this, is that interest rates have a direct effect on equity valuations in the exact same way that they have an effect in DB liability valuations. That if you're holding an asset and interest rates go down, the value of that asset, all other things being equal, that is assuming, for instance that if it's an equity security that earnings expectations are the same, that earnings expectations haven't gone down at the same time interest rates have gone down. If interest rates go down and everything else is the same, the value of that security is going to go up.


Rick:    Yeah, let's dive into that one for a second, because I've heard that from others as a reason for why we're seeing the stock market maintain some strength and some high valuations is, I guess in my words, it's "Hey if we've got the 10 year treasury at 1.6, 1.7%, I'll pay a little more for equities, and I'll pay a higher valuation, or I'll pay a higher multiple on earnings, because I don't know if locking money up for 10 years at 1.6 or 1.7% makes a ton of sense."


Mike:    I actually think it's more mathematical than that. So I'm going to say this two different ways. The first way is I'm not going to talk about equities, let's just talk about a bond. If you have a bond that's paying 2% and interest rates go to 1.6%, the value of that bond goes up. But that's relatively intuitive. Certainly anybody who's worked with bonds knows that. So that's talking about it in the fixed income world.


Mike:    Now if you think of an equity security as a claim on future earnings and you assume future earnings are unchanged by a change in interest rates, it's in effect the same kind of transaction. That is, you're getting a stream of income relative to what used to be a 2% return, and now it's relative to a 1.6% return. So that stream of income, which hasn't changed, is now more valued.


Rick:    No. That's a good way to explain it and I think good food for thought for people as they're thinking about..., and again, please correct me if you feel differently, or if I'm not saying this in a way that makes sense, how those lower interest rates kind of relate to, maybe a little bit about what I started with, "Hey, we have low interest rates, really high 401K balances right now. Really high stock market right now, etc." Okay.


Mike:    So you're going to see it. That's a little confusing for people, right? Now the point that I'm making about it costing more to save for retirement is that it costs more to save for retirement in the future. People that already have a lot of money banked, those assets get written up in value and that looks like a good deal. Actually they're just being kept whole against the ultimate cost of certainty when they go, for instance, to buy an annuity. That is what happens is the value of their 401K balance went up, but the cost of buying an annuity went up also.


Rick:    To tie it back to one of your statements earlier and please correct me again if this is not a great tie, but an annuity is certainty in terms of income.


Mike:    Right.


Rick:    So that cost of certainty, if I have a hundred thousand dollars that I'd like to turn into a guaranteed stream of income in retirement, I'm going to get more income if rates are around 3%. I'm going to get less income for that same hundred thousand dollars with rates at 1.6, 1.7%.


Mike:    Yes. Exactly. The cost of annuity is directly and inversely related to interest rates. Mortality is also in there. We can go back to the simple version of this. It's just a phenomenon. Interest rates go down, the value of assets already on the books goes up. Or interest rates, fundamentally, and this, it took me a while to get my head around this, I used to believe in something called the time value of money. That basically any saver was entitled to be paid some kind of compensation because she was not consuming her income now, someone else was. That person, in effect, would pay her to use her money to consume and then pay her back with something extra because they were using the money currently, and she didn't need it currently. She needed it in the future.


Mike:    So this fourth factor is that interest rates fundamentally reflect the relative supply of lenders and the demand for credit. As the demand for credit goes down, which I believe is a function most profoundly of demographics. You have fewer new people that are trying to form families, get themselves educated and buy homes. When that demand goes down, and the supply of lenders goes up, that is, when your population starts to age and the group of people that need certainty increases, and as they get older they want more and more certainty, this is a function of your time horizon and your tolerance for risk. It's not a function of the fact that you're just old. It just correlates with being old.


Mike:    So as your population ages, the amount that you're going to get paid to defer consumption is going to go down. That is the return to savers is going to go down. In my view, it can go below zero. That is your need to have money in the future when you retire can exceed the borrower's need to have money now to consume or to invest in some way. When it does you're, in effect, going to be paying the borrower to take your money, so long as he's making a reliable promise to give it back to you when you need it.


Mike:    In all of human history, we've never really existed in a world like that, but given the demographic trajectory we're on right now, we may be headed to a world like that. I don't want to oh my gosh panic, I think it's just a thing. Savings may have just gotten a lot more expensive. When you think that between December and today, at the end of December, 2018, and today, interest rates have gone down 100 basis points. From November, it's like 140, 150 basis points. That's a big drop. That's a big increase in the cost of saving.


Rick:    And something I think that has largely been invisible to the average investor, the average consumer because certainly I'm just speaking from my experience and what I see, based on conversations with people, I think people are really focused on the stock market, the S&P 500, the Nasdaq, whatever it might be. Whatever they look at as the broader indication of how the stock market is doing, I think most people are also kind of measuring success again based on 401K balances, etc. Again, a lot of 401K balances are pretty highly tied to the stock market.


Rick:    So that movement... I mean I've had these conversations with committees and it's like some people are smiling and nodding, "You're absolutely right, we're seeing the same thing." While others are like, "Wow, I had no idea. I had no idea that there was such a big move in the bond market."


Mike:    It's an irony that everything that I'm talking about is actually intuitive to anybody who's managing a defined benefit plan. They're living with this every day. That is, in many respects, a function of the accounting regime, which forces them to book the cost of decreasing interest rates. If you look at... the charts on this, you look at them and you just think, "Gosh, what happened?" That from 1950 to about 1982, interest rates went up. From 1982 to today, they've gone down. They've kept going down. T


Mike:    hat phenomenon has fundamentally changed the way we think about savings. It's way more than a canary in a coal mine. The part of the world that got shot by this arrow first was the defined benefit system because as interest rates went down, the cost of providing a dollar in DB benefits went up and up and up. Basically the rule of thumb that I use and this is probably even higher now, but since the year 2000, the cost of providing a dollar of defined benefit benefits has doubled or tripled. That's pretty amazing.


Mike:    Any CFO that has a DB plan knows this because his income statement and his balance sheet force him to understand what's going on here. For a DC participant you see your account balance increasing in value and it's not when you go to retire that you think, "You know I had a million dollars saved, you would think I was rich. Now, I went to buy an annuity and it was like 50,000 a year, which is not a lot more than what Social Security pays."


Rick:    Yeah, it's an interesting dichotomy. That's kind of why, as I was thinking about this, I was phrasing it in the way that I did which is, "Hey it might seem good that interest rates are low, but there's challenges that come along with that."


Mike:    This challenge asks a question. That question has kind of three different rows. I'm very much mixing my metaphors here. There are three alternative answers. The question is lower interest rates means retirement costs more, the question is what are you going to do about it? Your choices are to save more, to work longer, or to live on less. By the way, they're not exclusive, you can do all three, if you want.


Mike:    I've always felt this is the greatest virtue in the 401K system is that it allows each participant to decide which combination of strategies he or she is going to pursue. Some will say, "I never want to retire. I don't really see my position being eliminated. I can realistically work meaningfully, maybe not full-time after I hit 65 or 68, so that's my strategy." Others will say, "You know I used to want to live on the beach, but you know I think about it, maybe I can live a couple miles from the beach." Others will say, "I have enough extra income here that I can simply save more to buy myself the kind of retirement that I want."


Mike:    So I want to hit this fifth element. I want to apologize because I said there were six at the beginning, and there are only five. Fifth element and I want insights, I think this is primarily a distraction is that interest rates may reflect, they may artificially reflect, central banking monetary policy in the United States, the Fed. So if the Fed says, "We're going to lower interest rates," I think when they do within my lifetime, only one exception, Operation Twist, the Fed's effect on interest rates has generally been with respect to short-term interest rates, whereas the interest rates that we're most concerned about are medium to long-term interest rates.


Mike:    You'll often see a phenomenon that a drop in short-term rates will have no effect on long run interest rates. Or there are even situations where a drop in interest rates will increase long-term interest rates. Right now I haven't looked at the yield curve in two or three weeks, we had an inverted yield curve. It was sort of partly inverted, where short-term interest rates were higher than medium term interest rates. That's generally by economists regarded as backwards, that the shorter term interest rates are naturally lower because you're tying up your money for a shorter period of time. The long-term interest rates still remained higher than short-term interest rates.


Mike:    So anyway, there's this element of central banking policy. So now interest rates are, among other things, just another asset class, in effect. They are also a proxy for certainty. They are... the market return for individuals who prefer certainty to risk, changes in rates, typically result in an increase in asset values, all other things being equal. They reflect the relative supply of lenders and borrowers. As the supply of lenders goes up and borrowers goes down, interest rates goes down. To some extent, they reflect monetary policy. All of this stuff creates a lot of noise around interest rates went down, what does that mean for me? The answer you get is kind of a noisy answer. It's not always clear. The value of your account goes up, the cost of annuity has gone up also.


Mike:    I would say that, as a general matter, a drop in interest rates, in the long run, is going to be associated one) with a write up in the value of assets on the books, and lowering of future earnings expectations and liability growth. So on the one hand, whatever you've got in your pocket now becomes more valuable. On the other hand, what you're going to be able to earn in the future goes down. So bottom line what that means, at its simplest is, if you've got a big hunk of money and interest rates go down and you're going to have to buy an annuity, it's going to cost more than before they went down.


Rick:    So one other thing, I guess, that I know a lot of people think about when they're running some of these numbers about do I have enough to retire, am I going to have enough to retire, is a 4% withdrawal rate, a 5% withdrawal rate, you know..., so I guess tying back to this conversation, hey, I'll use your million dollars example. I've got a million dollars, I'm going to forecast a 5% withdrawal rate and historically I should be doing great because I'll be able to take money out, but I'll replenish that with earnings and growth. I'll be able to meet whatever my income needs are in retirement for a certain number of years.


Mike:    What you need to do is [inaudible 00:26:08] earnings assumption in that calculation. I think it's generally accepted that if interest rates go down, say by 200 basis points, that's probably an underestimate of what's happened since that 4% withdrawal rate rubric was developed, it probably means that 4% is too much. I want to make a disclaimer though, which is I'm not comfortable with a withdrawal rate as a solution to the retirement income puzzle.


Mike:    In my experience, annuities look like very good deals in any situation where you're not trying to preserve a legacy. If you're trying to preserve a legacy self-insuring, which is, in effect, what doing a 4% withdrawal rate does, then annuities are a bad deal. If all you're concerned about is retirement income, annuities are still the best deal around. For most people, there are problems. The biggest one is uncertainty. Something could happen to you where you need a lot of money now, but if it's tied up in an annuity, you can't get your hands on it, unless it's a very complicated annuity, which it probably is, is probably pretty expensive, if it gives you substantial withdrawal rights.


Mike:    So if all you care about is retirement income an annuity looks like the best deal going, there are problems in the annuity market also, but just an annuity in the abstract is probably the best deal. If you care about how much money you get out of your account and don't care whether you get to spend it all before you die, and that's just a complicated way of saying, if you care about a legacy or if a legacy has some value to you, and you don't just care about retirement income, then an annuity may not be the perfect solution. But the result is going to be that you're going to live on less.


Mike:    The reason you're going to live on less, whether it's a 4% withdrawal rate or a 3% withdrawal rate... There are people who have pushed back recently against the 4% rate. I don't consider myself an expert in this, and I'm not going to tell people what rate they should be retiring at. But if you're going to take this withdrawal rate strategy, you're going to wind up, generally, with less retirement income than you would get from an annuity. But the tradeoff is that your heirs are more likely to get something. The total of what is paid to you and your heirs will be more than the total of what an annuity will pay you.


Rick:    Well said, and that I'm tracking with you on that one.


Mike:    By the way, don't take my word for this. You know, sit down with a serious and competent financial planner and think this through. You know, especially if you have a balance of any size, you've got to think hard about these issues. I will say one other thing you've got Social Security there. Depending on how big that is for you, that's, in effect, a DB benefit. That may provide you with the ability to take some risk, with respect to your 401K balance and maybe not put all your money in annuity and leave it in the stock market.


Mike:    Generally while stock market returns are..., I believe if interest rates go down and stay down, stock market returns will follow. They still generally will be higher, subject to the amount of risk that you're taking, with respect to them.


Rick:    That's a good transition point there because that was actually kind of a question I wanted to just take your pulse on, as well, is as we sit here, 10 plus years into a very strong bull market, five year returns look great. 10 year returns look great. 15 year returns look really good, but as you and others can probably understand or appreciate, obviously that has all happened in the past. If we look forward to maybe what the next five or ten years look like several guests have come through the podcast and one common theme I've heard and you just kind of hit on it is, well for many reasons and depending on people's areas of specialty or whatever, they'll kind of cite different reasons why, but a lot of people are stating that the next five to ten years are probably not going to look like the last five to ten years, in terms of the returns on various asset classes.


Mike:    So this is funny. I'll tell you a story. I wrote this book Retirement Saving Policy, available on Amazon. I kept saying throughout the book that expectations for returns in the future are low and are in single digits. My editor said, "What are you talking about? The stock market is doing fabulous." So I wound up putting a call out, a one side bar explaining that pretty much everyone, like all the major economists, expect returns to be lower in the future. You know, these people have been wrong before, but without interest rates going back up, I don't understand a world in which interest rates are at 2% and returns on equities are at 12% for a long period of time.


Mike:    At some point everybody is just going to take their money out of fixed income and put it in the stock market, if that's true. That can't go on forever. At some point, those two things have to converge. This may be an appropriate time to discuss why is that we're living in this world of low interest rates? Why is it that since 1982, interest rates have just gone down, down and down? How does that relate to retirement savings? How is that, in effect, correlated with this change to individual saving and this increasing cost of individual saving.


Mike:    So I have a chart and I'm hoping you'll be able to post this, that tracks the growth and the size of the working age population, which is roughly age 15 to age 64. The change in the size of the working age population, over time, from 1950 to when the book was published, end of 2018. It looks at that metric, which is the key metric. So there's something that's relatively intuitive, which is the change in the size of the working age population, more or less reflects the change in the size of total population, 14 years earlier. Because the new baby is born and 14 years later, under this metric, and this is just the way it gets measured, becomes working age. These are world-wide numbers.


Mike:    Those world-wide numbers, and this, of course, is in the context of globalization, those world-wide numbers uncannily track the trajectory of interest rates. The rate of increase in world-wide population goes up, up, up and up, working age to early 1980s, then it goes down, down, down, down and down, and the same thing happens with interest rates. That demographic change is correlated with a move away from social retirement systems, like Social Security, where in effect, the next generation pays for the retirement of the preceding generation. That approach worked and worked really well during that period when the size of the population was going up.


Mike:    It reflected a situation in which it was always cheaper to have the next generation pay for the prior generation's retirement because there was going to be so many more in the next generation than there was in the prior generation. When that reversed, and now there's less in the next generation than there was in the prior generation or at least there's less growth then what happens is it, in effect, becomes more expensive to have the future generation pay for the retirement of the prior generation than it is to have that generation pay for itself.


Mike:    This is why I call my book, The Retirement Savings Policy, this is the revolution that we went through through the second half of the 20th century and here in the first 10 to 20 years of the 21st century. It's we went from a world in which one generation paid for the prior generation to a world in which each generation is expected to save for itself.


Mike:    We went through a world where I would guess that retirement savings made up less than 1% of the capital markets to this world today where retirement savings make up a third to half of the capital markets. This change that we went through is at the same time correlated with, first of all, the increase and then the decline in interest rates. Which again, reflects this aging population with an increased demand for certainty, which in the market, translates to something like an annuity. Or maybe just bonds that match when you're going to need the money. An increasing demand for certainty and a kind of decreasing supply of borrowers who want to start new businesses, young people. Fewer young people, more old people equals higher interest rates. It's also correlated with every generation needing to save for its own retirement.


Mike:    There's an even deeper point about all this, this may be slightly off topic, but let's just note it, because it's kind of the business that we're all in. It's the kind of business that participants are in is that savings is not enough. Just putting the money away and then getting it back in the future is not going to buy you more retirement, if there's fewer people around. It's just going to increase the cost of providing nursing care, for instance.


Mike:    What you have to do with this money that you're setting aside is invest it, and invest in a way that increases productivity in the future. If you do that, then retirees will have a better retirement, the kind of retirement that they want because either they saved money and then whoever borrowed it went and invested in creating more productivity or they just invested in a company that increased productivity. That whole mechanism, that's a meta thing, that's not really about our business. That's about our economy. Does our economy accomplish that? That's a profound thing. I think so far we're kind of doing a pretty good job of it. Kind of the future remains to be seen. We'll see how it works out.


Rick:    On that note, I think this kind of ties in well with a lot of what you've been talking about, student loans have been a big topic of conversation, certainly as we head into the next presidential cycle, with loans sitting at about 1.6 trillion or plus, in total outstanding loan balances. But that number alone is a big number and a troubling number in one way, but one thing I've heard from others that I think ties into what you were just talking about is the bigger impact of student loans, potentially, is not necessarily just the raw number or the risk of, "Oh my gosh, everyone's going to default and what does that mean to the economy?" Like the mortgage crisis or whatever. But the bigger impact of student loans is, as you were saying I think, you've got a lot of older Baby Boomers that are exiting the work force that are moving into retirement, their consumption is being replaced in the economy with the younger workers, the Millennials.


Rick:    Those younger workers are not consuming and they don't have the same buying habits as Baby Boomers in a lot of ways. They're not buying houses, they're not starting families at the same rate. They're not doing a lot of things at the same rate the Baby Boomers were doing maybe at their age. So does that also tie into some of what you're talking about in the grander scheme of things and maybe even relate to where rates are or where rates could be down the road? Or am I trying to connect too many dots here?


Mike:    I haven't thought of student loans that way, just responding if you're competing for people to lend money to and all these schools or the federal government, in cooperation with the schools, have already lent money to these people, that's going to make them even more reluctant to borrow more. That's going to reduce the supply of borrowers. That's profoundly true. It's also going to reduce consumption.


Mike:    I think I want to make an abstract point. First of all, if you borrow one dollar and save one dollar, you haven't saved anything, okay? Borrowing is like the anti-matter of saving. The amount you owe is equal to the amount you have saved, you haven't saved anything. So my first reaction when I heard about financial wellness was it sounded like kind of a marketing concept. But very quickly I started to re-think that. I actually think we need a richer way to think about the challenges.


Mike:    I mean I have three kids. They're all on the threshold of adulthood. We have to come up with a richer way for them to think about what they should be doing with their financial assets, with their financial leverage on our economy. In that regard, I think their biggest problem right now is debt. There are a lot of people that don't go to college and have debt and that's a problem. But for a lot of them, their biggest problem is student debt. I wrote an editorial about this for Prime Sponsor.


Mike:    It's kind of crazy to tell somebody to save for retirement when they haven't paid down their student debt yet. Or for that matter, they haven't paid down any other debt. You're not really saving, in that situation. All you're kind of doing is you're taking some debt from the financial services industry and then you're also giving back some money to the financial services industry that supposedly are earmarked for retirement. But it would frankly be better if that money was used to pay down your debt.


Mike:    The first thing we need is a better way of thinking about this challenge that these generations of kids are facing, and I think in that regard, the debt challenge is more important than a retirement savings challenge, thankfully. But at some point, they are going to have to start saving for retirement. You kind of want them to get to that point, relatively early. To do that, I think the first thing you got to do is get their debt paid off.


Mike:    You also, I just want to note this, because this is very far afield at this point, you have a problem if people aren't forming families, a correlative of forming families typically is some kind of home ownership. So if you're not getting that out of your new generations, you're going to get even less people in the next generation than we've got in this generation. I know different people have different views on this but I kind of think that's a problem, for what it's worth. We should be addressing that issue in a positive way.


Mike:    By the way, if we can get that dynamic earned positive, in my opinion, that's going to be good for the economy. That's going to solve a lot of the problems that we're sort of winding ourselves into with decreasing interest rates are going to unwind, if we can change that relative relationship between people who want to lend money and people who want to borrow it. We can get more people that are prepared to borrow to take risks, go out into the adventure that life is and use whatever leverage, financial leverage, they can put together to participate in, that's going to be good.


Rick:    Yeah and I think in my mind of minds, as you were kind of describing all that, that's where I saw a lot of those themes coming together with the whole student loan conversation and the way that, again, some people looked into it, you're exactly right, because of debt, what a lot of people are observing is Millennials are putting off, or those with student debt, are basically just kicking the can five years down the road, starting families, buying houses, making large purchases.


Rick:    As you were talking just a lot of that, to me, all kind of tied together with yeah I get it. Then I guess the other thing that started to come to mind is we're in a low interest rate environment right now. We've had some fluctuation in that, but still we seem to be kind of in this environment again. I don't know if you have any forward looking thoughts on is this low interest rate environment something that sticks around for a while and becomes the "new normal", or do you see this reversing? Or maybe do you see this getting even worse, in terms of heading closer to zero, as time goes on?


Mike:    I see it as the new normal. I disavow any utility to any speculation I may give about where interest rates are headed, okay? But that's, as far as I can see into the future, I think interest rates are going to stay low. The only question is are they going to go up 150 or 200 basis points or are they going to go down further? I think, to some extent, the answer to that question is kind of baked in the cake. But if it's baked in the cake, I don't know why the market doesn't already understand it. So I'm kind of assuming the market already understands it.


Mike:    Whatever we know about demographics and how many people, 14 years from now, are going to join the work force? What demand is going to look like if somebody's buying a 20 or 30 year bond, what demand is going to look like over the next 10, or 20 or 30 years, I'm assuming that's all the market already. The only question is which way is it going to go? This is in the Prime Sponsor editorial when we look at interest rates from 1982 to now, we sort of boxed out a kind of stairway down.


Mike:    There are periods of interest rates stability. Then there's a drop and then a new period of stability is established. It only goes down. It doesn't go up. There are years when interest rates are higher than they were the year before, but this general trend only goes down and these boxes of stability, these windows of stability, each successive one is always lower than the prior one.


Mike:    I said this in the editorial that we published in Prime Sponsor, the question right now with interest rates really testing our lows, is we've been in since, I don't know, about 2012 to today, an area where interest rates are bouncing around between 3 and 5%, this is long-term corporate. The question is are we moving out of that window to a lower window? I emphatically say I do not know, but I'm saying like watch the space.


Mike:    I think what's going to happen over the next three or four months is probably going to tell the story on that. Do interest rates go back up and we're still bouncing around between 3 and 5, or do they drop down to some lower rate where it's 2 to 4 or 2 1/2 to 4 1/2? They could go back up to 5, they're not going back up to 10, in my humble opinion. Please don't use that to make a bet on the market, okay?


Rick:    All right, one more question on this topic, and then I'm going to let you run. One thing that I think as you've been talking through all of this, one thing that I've kind of thought about or one of the narratives that is emerging in the 401K market space, again, kind of ties back to some of your defined benefits stuff, is this idea that defined contribution or 401K or 403B plans are going to get in the business of providing retirement income options to employees.


Rick:    So the DB-ization of 401K or 403B providing some type of option that sits within your investment line-up where a participant can take some or all of their account balance and use that within their retirement plan to create a steady stream of income. I guess what just strikes me as ironic is the timing of all that in light of what you just talked about in terms of the increased cost of certainty. That increased cost that goes along with low interest rates.


Rick:    So I guess one thing, I don't know if you've given any thought to this concept of retirement income in that more defined contribution 401K world. If you have, certainly if there's any thoughts you have for employers as they might be considering some of these different options in the near or maybe a little farther down the road.


Mike:    So I have some thoughts about it. It's something that I am intensely... look you go to any conference, this is all anybody wants to talk about is how do we crack the retirement income problem? The suite of solutions is relatively limited and basically starts with annuities. I think, in that regard, the big problem there annuities, there are problems that are just historical with the efficiency of the annuity market. There are problems that are kind of structural. Both of these problems are going to be hard to solve, but the structural ones are maybe harder to solve than just historical ones.


Mike:    I think that sponsors would do very well to think very hard about alternatives and what that alternative would look like. Whether there's an efficient way to do that. I really don't have any more to say about it, at this point. I am sitting and thinking. In my book I said this when we went from DB to DC, we had three adequacy problems. We had to get enough money in these plans. We had to get it invested efficiently, and we had to come up with an efficient way of paying it out.


Mike:    I believe with defaults like auto-enrollment, we've solved the first one. When I say "solved", I mean there are a lot of problems with the margin and this issue of covering the uncovered and getting contribution rates at the right level. But we kind of know the direction to head in. With respect to investment efficiency, I think the very same thing, the development of default target date funds, we're getting towards a relatively efficient asset allocation strategy for the 401K system as a whole. But nobody, nobody has come up with a solution. I think they've... other than somebody's got a product they want to sell you, nobody's come up with a solution that they think solves the retirement income challenge. It's just one challenge that is still sitting there, waiting.


Rick:    Yeah and I think that it is something that is going to get a lot more conversation and a lot more discussion. I think it's an interesting thought, as we kind of wrap up here, around a lot of this where I think interest rates today and in the future will be something that hopefully maybe people pay a little more attention to, that are running retirement plans and have a little bit better understanding of what the impact could be on their overall account balances and their overall plan balances, but also on that other part of the conversation which is how does that impact people's ability to generate income and retirement, exit the work force?


Mike:   I could not possibly agree with you more.


Rick:    Well there we go. Mike, it's been a ton of fun to have you [crosstalk 00:52:19] back on the podcast again. I really appreciate your thoughts and comments. It really got me thinking a lot. Hopefully everyone that listened also is leaving the conversation with a better understanding of where low interest rates might take us and where some challenges might come. So thanks for making us think and certainly would love to have you back sometime down the road.


Mike:    It was my pleasure, Rick. I look forward to it.

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