Imagine being born $6,750 rich? Well, if activist investor Bill Ackman had his way, that is how every person in this country would be born. The subject of “income inequality” among Americans has been at the forefront of issues for a long while now. As the economy wavers between rebound and recession, the stock market has bounced back feverishly with both the S&P 500 and Nasdaq hitting all-time highs within the past few weeks. Yet many feel the rise in the stock market has only benefited the wealthy, as most Americans have little invested in the market. Ackman has theorized a potential solution.
The chairman of Pershing Square Capital Management recently proposed a solution to “preserve capitalism” and “close the inequality gap” (MarketWatch). This solution consisted of the US Government opening a retirement account of $6,750 for every child born that they would not be able to access until they were 65 or older. This money would be then invested into zero-fee index funds and compounded tax free (Business Insider). Under the assumption that return rates continue to average at around 8% annually, this money would grow to nearly 1 million dollars by the time they reach the age of 65. Ackman adds that this program would cost the US around $26 billion a year assuming the birth rate stays the same (Business Insider). In theory, every American would sign up for this type of proposal.
Having one’s child born with a free $6,750 check would be welcoming for most middle-to-low income families. This would be a great way to get every person in the country more involved in the financial markets and investing. Far too many people in the US do not understand the potential of growing one’s savings by investing in the stock market. The rare stock market crashes often get more news and attention than the continuous daily rises. Ackman’s plan would also essentially eliminate the need for the majority of people to ever invest in the market. Assuming the annual 8% return on their initial investment of $6,750, by the time they turned 40, they would have somewhere around $130,000-$140,000. The average American has about half that amount saved in their 40s, with usually a number closer to $63,000 (Synchrony).
This plan sounds perfect on the surface, but it does have a few remaining questions that could create some holes. First and foremost, the cost is astronomically high at $26 billion a year, and that is assuming the birthrate stays the same and does not increase. The cost could be nulled if this plan were to replace Social Security, but that would be unlikely to be the case.
One glaring issue is that the money made at the end of 65 years relies on the assumption of an average return of 8%. But what happens if that return is not so high? What if it is a more modest 5% annually? Well, that $1,000,000 at the end of 65 years would shrink all the way down to a number close to $150,000. With people growing up already having a retirement account set up by the government, they might not look to invest extra money elsewhere into the market, and when they eventually retire, they might find they have less money than what was proposed to them. The difference between $1,000,000 and $150,000 is enormous.
Even if the return was increased to 6% annually, the number moves closer to only $300,000 at the age of 65. This plan could encourage people to avoid investing money and saving more for retirement because they were already born with a retirement account; yet adding money continuously helps a retirement account grow. Given the previous assumption of an average annual return of 5%, if the investors simply adds $5,000 to his account at ages 20, 30, 40, 50, and 60 (only $25,000 total), his account grows to over $250,000, a $100,000 difference just from an extra $25,000 invested. There will be little incentive for people to create and save in other retirement accounts if they believe that their nest egg at birth is all they will need.
Furthermore, a government-operated retirement account adds questions as to who will invest their money. Would people be able to switch their investment advisors as they age, or would they be designated to Government-sponsored investment advisors? And how will the Government choose who gets to invest this money? How will they choose between the numerous indices and mutual funds that exist within the stock market, especially considering the diverse returns? Nobody would want to grow up knowing they were put in an index that produced solely a 4% average annual return while other options could have netted them an average annual return of 10%.
Ackman’s plan is certainly an interesting starting point for a conversation about how to get people more invested into the stock market. There is much to be gained by entering the market, and these numbers do prove that the earlier one invests in the market, the more their money will have grown by the time they are at an age ready to retire.
In addition, this may prove a powerful incentive for parents. Even if the government is not funding an account, or there is a tax drag, the power of compound interest remains clear in this example. Putting away $6,750 for your child at their birth can put them on the path to retirement security 65 years later.
Whatever the solution may be to bridge the income-inequality gap and lack of low-to-middle class Americans in the stock market, be it starting with $6,750 at birth in a retirement account, conversations should be encouraged and begin to be had both at the government and the personal level.