Today the words “pension,” “retirement,” and “Social Security” are universally understood and many Americans even refer to them as “rights.”  It wasn’t always so. In a fascinating post last week on bigthink.com, Joseph Coughlin discusses how the modern day social security and pension system arose largely from the Union Army pension offered to veterans of the Civil War.

The Union Army pension originally covered those injured in battle, but the program was gradually expanded and soon covered veterans who became disabled off the battlefield and allowed veterans as young as 62 to make a claim of “disability” simply as the result of old age.

Prior to the Union Army pension, the ability to “retire” was not a standard concept among American workers.  Your average Joe worked until no longer physically capable and then relied on his children for care until he died.  This was accepted practice and so the ability of Union veterans to claim benefits in old age was an incredibly novel and welcome concept.

The Union Army pension’s features made the program wildly popular and, as Coughlin writes, “By 1900, the Union Army pension was the most widespread form of assistance to older adults in the United States, paying out to a quarter of the population 65 and over and accounting for almost 30 percent of the federal budget.”

Sound familar?

Today Social Security is a household word and its expenditures reached $768 billion in 2012, 20% of the federal budget.  The size of these numbers shows just how firmly “retirement” is enshrined in the modern day political system.  Yet the concept of retirement is evolving today almost as much as it was when the Union Army pension was first introduced.

Retirement = Right?

Workers are living longer than ever and demographics means that ever fewer workers are supporting ever more retirees.  The recent financial crisis decimated many Americans’ savings and companys are switching in droves from defined-benefit to defined-contribution pension plans.

In short, the responsiblity of planning and saving for retirement is falling increasingly on the individual.  We would do well to remember how new a concept retirement really is and be realistic in thinking that of it as a “right”.  It can only be guaranteed where the resources exist to guarantee it and, in a world where governments or corporations live beyond their means, pensions and social security systems can and will be cut.

Risk: A Quick Quiz

Which of the following investments do you consider to be less risky?

1. An investment in stocks of a single company.
2. An investment in a mutual fund.
3. Don’t know/ no answer.

You may recall from our earlier posts that this was the third and final question of a financial literacy survey done throughout the OECD (a club of the world’s wealthiest nations). The answer is option two, “an investment in a mutual fund”, and today’s post will explain why.  To do so, let’s first look at what the words “stock” and “mutual fund” actually mean and then address why each represents a different level of risk.

What is stock?

Stock represents ownership in a company.  Simply put, if you owned 100% of the stock of a company, you would own the company outright and benefit 100% from any profit the company made.  Likewise, if the company went bankrupt, you would lose your whole investment.

Modern corporations that are traded on stock exchanges often have millions of shares of stock, which means that each individual stock represents only a tiny fraction of ownership in the company.  For example, if you buy 1 share of Apple, which has a total of 939 million shares outstanding, you would own 1 nine-hundred-and-thirty-nine-millionth of Apple.

Owning such an infinitesimally small amount of company might sound ridiciculous, but such a structure allows you to own part of a company, which you could never buy outright yourself (unless you have 410 billion dollars lying around, which is Apple’s current market valuation).

Stock therefore gives you, the investor, the ability to own parts of businesses that do all sorts of things from selling drinks (Coke) to producing iPhones (Apple) to lending money (Bank of America).  Generally speaking, if the businesses whose stock you own do well, you will make money on their stock.  And if they do poorly, you will lose money on it.

Option 2: What is a mutual fund?

A mutual fund is a investment vehicule that buys stock in many different companies.  Some funds might own 50 stocks, others 500.  You as an investor can buy a share of the mutual fund and thereby own a small part of all the companies that the mutual fund owns.

Listen to Grandma: “Don’t put all your eggs in one basket”

When you own a small part of many companies via a mutual fund, the chances that all of the fund’s companies do poorly is quite low.  Some might do poorly, but their poor performance will likely be offset by others doing well. If you only own one stock, however, and the company it represents does badly, then there is no other company to balance it out with a positive performance.

To put it as grandma might: owning a single stock is putting all of your eggs into one basket.  If it drops you have a problem.

Discussion over gold while equities keep rising.  

What’s happening with gold?

A brief look at what is happening in different market sectors for the 9^th week of 2013.

U.S. Stocks

It was a good week for the US indexes with the S&P, Dow and Nasdaq finishing higher than the week open. Meanwhile, Berkshire Hathaway underperformed the S&P last year, raising its share value by only 14.4%, compared to 16% for the Index.  Home Depot announced a $17bn share buyback and a 34% quarterly dividend hike, to 39 cents a share.

Foreign Stocks

European stocks had another great month, ending February with a ninth consecutive monthly gain although the Italian vote lead to a slump at the beginning of the week. It was also a positive week for the FTSE 100 index, with a 5-day change of 0.68%.  Meanwhile RBS announced that it plans to float part of its US division to raise capital for privatization.

Emerging Markets

The Vanguard FTSE Emerging Markets ETF held steady this week, while the iShares MSCI EAFE, PowerShares QQQ and SPDR Gold Shares indexes made modest gains.

Real Estate

Mortgage rates, from 30-year fixed-rate to 1-year treasury indexed mortgages, were down from last week as well as year over year.  Home prices were relatively unchanged.

Commodities

Amongst much debate, gold jumped early in the week to a high of $1,596 an ounce in electronic trading, restoring faith in the precious metal after recent declines.  However, week-end statistics showed a fall to both gold and oil price, possibly as a result of US spending cuts and weak Chinese manufacturing data. Base metals were generally lower with Platinum hitting an 8 week low though Nickel did manage a US$50 rise.

Bonds

A very slight rise for bonds this week with the US Treasury set to sell $90bn in debt next week.  Meanwhile the Italian elections lead to a huge rise in Italian government bond yields.

Where do we go next?

Can money games teach practical money skills?  Many researchers think so and a new wave of financial education is emerging around how people think (and play) with money.

Financial education has been around for decades.   Specifically in countries like America and the UK evidence suggests that financial education and counseling in schools, at the workplace and in third party social programs can increase financial literacy and change behavior toward money.

But if financial education correlates to more knowledge of money, why have there been such extreme financial crisis and rising debt levels worldwide in the past decade.  Research suggests that what people do learn about responsible behavior toward money is forgotten relatively quickly after the learning period.  Addressing this issue is much of what modern money games have a chance to solve.

The latest money games take the form of interactive video games designed to demonstrate and encourage awareness and thought patterns useful in making financial decisions.  Games such as The Cure, developed by Vienna based ThreeCoins and Mind Blown Life by Mind Blown Labs engage young players through interactive play that expose them to the pitfalls of finance and demonstrate how better financial decisions can lead to success.

One major benefit of these games is their ability to continually engage users around a topic that is typically boring at best and embarrassing or scary at worst.  In theory users who frequently play money games will be less likely to spend frivolously, stay out of debt and most importantly save for the future.

But what about banks, the institutions who profit from selling products and services?  Despite their lackluster reputation, banks hold significant power in the financial ecosystem and would very likely work to keep it that way.  After all if a banking customer has more knowledge of money they are less likely to buy products that award high fees to their bank.  

Money games and the new financial education are off to a great start.  But only if a motivator for change can be found within the financial system can there truly be a groundswell of change.