Allison's ode to the second moment


Welcome to the sixteenth issue of Allison’s Ode to the Second Moment, a newsletter that knows why you feel so anxious and can't do your daughter's math homework.

Why do we feel so poor?

You might be surprised to learn that, in many respects, Americans never had it better. Wage growth may be flat, but living standards are significantly higher. I reckon risk explains why people are so unhappy. Americans might be living better, but they fear it’s not sustainable---they haven’t saved enough for retirement, they don’t have enough savings to handle economic setbacks, and their labor income may be riskier too. When it comes to a financial asset, all else being equal, more volatility makes that asset less valuable. So similarly, if income is more volatile or pro-cyclical, even stagnant wages are worth less.

There’s mixed evidence about how much wage variability increased. This is an issue that needs more attention and, if there is more risk, better solutions. Most people are fixated on what’s happening with the first moment, average wages—and not the second, wage risk. The story of our lives--am I right?

Even if wage variability hasn’t increased much so far, there’s reason to believe it will in the future--if gig work catches on in a big way. Diane Mulcahy challenges the conventional wisdom that gig work is great for high-paid, skilled people and terrible for everyone else. She agrees gig work in low-skill jobs may not be wonderful—but it is often better than being a low-skill employee. You have more control, set your own hours, and can diversify your income. Sure it takes more hustle, but the upside and flexibility may compensate for the vagueries of gig work. Perhaps we should stop fetishizing traditional employment and restricting the times of day when you can email employees.

Does it matter how you invest your money?

It sounds nuts, but am seriously asking that question. Because it’s becoming fashionable to argue portfolio composition doesn’t matter. If you are investing for retirement--just "diversify" and go into passive funds. That sounds like good advice, but whether it works depends on your goal. Is it a big pile of money when you retire or a secure, comfortable retirement? These are two different things and each requires a different investment strategy.

I’ve spent a lot of time thinking about the retirement problem and worked with some very smart people on it. And I think it’s a hard problem. You must turn income today into predictable income in the future. That’s not a trivial task. It takes more than a low-cost target date fund.

I understand the temptation to keep retirement investment simple. Often complicated products and strategies blow up or rip people off. We are asking everyone, from janitors to venture capitalists, to invest for themselves. We need simple solutions, but converting current income to reliable, future consumption is not a simple problem.

Speaking of the cult of simplicity. Perhaps you saw this story about the Nevada Public Employees' Retirement System fund manager. He eschews active management, invests simply, and barely touches his assets. He is surely saving Nevada tax payers a boatload in management fees.

I was curious about his investments and took a look the Nevada pension’s asset allocation. And while I was impressed his portfolio's elegance, it's not clear what he's doing, if anything, in terms of risk management. His fixed income allocation is short duration, so he’s probably not doing any kind of Liability Driven Investment strategy.

Remember, Pension Geeks, it is not just about returns. The goal should be meeting obligations to pensioners, while exposing tax payers to as little risk as possible. Is he doing that? Maybe. It will work until it doesn’t…

Long-term growth risk

If there is one thing that will determine if our debt and entitlements can be paid, it’s economic growth. And that too is uncertain. Some people promise 4%. Others worry the industrial revolution was a blip, we’re tapped out on new ideas, and growth will be negligible going forward.

One certain headwind is a shrinking, aging population—which means fewer bodies working and more people to support. Both are bad for growth. It’s sort of like modern day Malthusian crisis, except now we worry about too few people instead of too many.

Now I may be prone to optimism, but I think our best days are ahead; even with an older population. Humans have a tendency to innovate and technology might make up for fewer workers and an older population. Technology proved Malthus wrong, maybe it will prove Robert Gordon wrong too.

In many ways, there’s never been a better time for innovation. “But it doesn’t show up in productivity statistics” you might say? Well, neither did the steam engine… at least not for a 100 years after it was invented.

Business cycle risk

The New York Times reassures us a recession isn’t imminent under a Clinton presidency because recessions only come from big external shocks (like the Fed increasing interest rates). So if we just stay on track, economic expansions can go on for decades.

OK, now for some pessimism. I think that argument is only sometimes right. You see, the length of an expansion often depends on what caused it in the first place. If growth is based on weak foundations, (say propping up the stock market and employment, but not fixing structural issues) an expansion can run out of steam. It’s hard to know what's structural and what's cyclical. It may not matter. A recession-causing event often ends an expansion before it reaches a natural end…if it had one.

Good thing we have rational policy markers steering us rubes toward more rational decisions.

And speaking of smart people

We live in an enlightened age. It is considered (at least in polite society) wrong and offensive to suggest men are smarter than women. But, as I woman with a STEM PhD, I’ve noticed there still exists a presumption (especially in polite society) that when it comes to extreme intelligence and talent, men are more able. And, believe or not, there is some data to back this up. More boys score in the top 0.01% of the math SAT.

But girls are gaining on them. In the 1980s there were 14 boys for every girl in the top 0.01%, now there are just 2.5 per girl. The convergence suggests the long-running disparity resulted from social conditioning and not natural ability. Girls get more encouragement these days and are excelling.

Great news! Maybe they'll figure out a simple and efficient retirement investment strategy.

Until next time, Pension Geeks!