FRANCO Modigliani is not a name most Malaysians recognise. Nonetheless, the groundbreaking research carried out by this illustrious economist forms the bedrock of retirement funding mechanics for all of us.
Modigliani was born in Italy in 1918, emigrated to America in 1939, and died there in 2003 as a naturalised citizen. In 1985 he won the Nobel Memorial Prize in Economics for work he began in the 1950s on a savings-consumption model called the Life-Cycle Hypothesis, or LCH.
In essence, the LCH is based on the logical assumption that (on aggregate) consumers tend to aim for a roughly stable level of real consumption, adjusted for inflation, throughout their lives by setting aside surpluses during their active working years to sustain themselves when they retire.
Think about squirrels setting aside (literally squirrelling away) acorns in the warmer months — in regions far away from our own perennially balmy equator — to feed on when the weather grows cold and food scarce.
Even though Modigliani's insight seems obvious to us today from our financially stressed 21st century vantage point, his erudite research pointed to a real-world behavioural departure from the assumptions laid out by the most famous economist of the first half of the 20th century, John Maynard Keynes.
A British economist, Keynes is most famous for being the author of a seminal economics book entitled The General Theory of Employment, Interest and Money, first published in 1936.
Keynes (pronounced 'canes') investigated the missteps leading to the Great Depression, which began in October 1929 and that lasted a decade. His work remains crucial in helping governments step in to help national economies when businesses and households fare badly in a recession. But just like all of us, Keynes was not always right.
Now, regarding Modigliani, here is a standout example of another genius recognising his contributions to usable economic theory. The heavyweight economist and fellow Nobel laureate Paul Samuelson once said of his Italian-American friend, who died in September 2003:
"Franco Modigliani could have been a multiple Nobel winner. When he died, he was the greatest living macroeconomist. He revised Keynesian economics from its Model-T, Neanderthal, Great Depression model to its modern-day form."
LESSONS FROM MODIGLIANI
At the smallest end of the scale, the individual — what does Modigliani's research tell us?
It explains why each of us should accumulate unspent money during our high-productivity working decades to sustain us during our later non-working season — remember our diligent squirrel and its nuts.
As longevity risk — running out of money before we run out of life (!) — is the greatest challenge faced by retirees today, we should all extract key lessons from Modigliani's LCH.
As we do so, I believe it is essential we choose to look upon our work not merely as something we do to make a living. If, instead, we craft our career and adjust its trajectory to permit us to extract ever-increasing levels of satisfaction and joy from it, then our work can help us sculpt our life into a masterpiece that we — and, frankly, others — find pleasing, productive, and proactive instead of just reactive.
When we enjoy our work, we are more likely to continually work harder and smarter for increasing levels of income. If we also then exercise some restraint upon our appetites, we won't spend all our money all the time. And that's the key to financial success.
You see, if we accumulate our unspent money during our typical three to five decades of active work by spending less than we earn, saving and investing the difference, and doing so for a long, long time, we will succeed financially — a major life goal for most of us.
Economists refer to such cash flow-generated surpluses, collectively, as "savings". But from the perspective of a financial planner, I draw a clear distinction between those two activities:
True saving and targeted investing.
DELAYED GRATIFICATION
This bears repeating. Although most economists lump both what we save and what we invest as generic "savings", there is a difference.
Allow me to help you understand that difference:
We save money for two reasons, and we invest money for two other reasons. All four reasons are important. Specifically, we save money for financial stability and, less obviously, for emotional stability.
And we invest money to try to grow some of our generic "savings" faster than inflation erodes its purchasing power, and faster than the ever-growing quanta of taxes loaded upon us do the same.
In the Malaysian context, I have long maintained that our official retirement age of 60 is too low. There are growing numbers of Malaysians with lifespans extending from 70 to 80 years until 80 to 90 years, and beyond.
Also, Malaysians boast the world's highest incidence of centenarians per capita (for elaboration, refer to an earlier 2023 Money Thoughts column: www.nst.com.my/lifestyle/sunday-vibes/2023/06/921376/money-thoughts-live...).
So, do everything possible to exercise delayed gratification during most of the first three decades of your working career, say throughout your 20s, 30s, and 40s, to build separate savings and investment bases to improve your quality of life throughout your 50s to your 80s and, quite possibly, beyond.
© 2024 Rajen Devadason
Rajen Devadason, CFP, is a securities commission-licensed Financial Planner, professional speaker and author. Read his free articles at www.FreeCoolArticles.com; he may be connected with on LinkedIn at www.linkedin.com/in/rajendevadason, or via rajen@RajenDevadason.com. You may also follow him on Twitter @Rajen Devadason and on YouTube (Rajen Devadason).