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Who Really Wants to Be a MILLIONAIRE?

"Game shows and lotteries are dreams come true for only a few people. Saving and investing can be a reality for all Americans."

GAME SHOWS have made a comeback. Traditional stalwarts "Jeopardy!" and "Wheel of Fortune" enjoy steady popularity, but "Who Wants to Be a Millionaire," with its $1,000-000 prize for the person who correctly answers 15 multiple-choice questions, has rekindled excitement, garnered top ratings, and spawned numerous imitators. Meanwhile, lotteries are a national obsession, as nine-digit jackpots entice players from nearby states. Clearly, the chances of winning a lottery or becoming a game show "returning champion" are astronomically small, so why are so many people entranced by the allure of big bucks at incredibly long odds?

A Consumer Federation of America/Primerica poll in October, 1999, showed that a majority of Americans are under the belief that it is easier to get rich by winning a lottery or sweepstakes than by saving and investing modest sums of money. It seems inconceivable that the little bit of money you could invest would ever rum into the millions a lottery jackpot offers, so you might as well try to get lucky, right?

Many people seem to think so. Millions of viewers tuned in on Nov. 19, 1999, to watch John Carpenter walk away from "Millionaire" with $1,000,000 (before taxes, of course), the largest prize ever won on a television game show until then. How long would it have taken him to accumulate that much wealth by investing'? According to a Cato Institute study, if he put $2 a day into a stock fund that has the historical average return of 11% per year, it would take him 50 years--the career span of an average American--to amass just over $1,000,000.

Other game shows don't offer the big prize that "Millionaire" does, but viewers often feel that the contestants an those shows are rich or enviable because of the amounts they win. Yet, looking at how modest their winnings truly are makes one wonder just why people should be impressed.

The biggest all-time winner on "Jeopardy!," Bruce Seymour, won $305,989 in 1990. If someone were to undertake a $2-a-day savings plan and build up equity in a mutual fund, he or she would have the same amount after about 36 years. Moreover, the odds of achieving that would be far greater than the odds of winning on "Jeopardy!"

The biggest winners on "Wheel of Fortune," Peter Agryropoulos and Deborah Cohen, won $146,529 in cash and prizes during Sweetheart's Week in 1996. Saving $2 a day in a mutual fund that tracks the market would yield that amount in about 29 years.

You don't even have to be a financial genius to make such substantial investment returns. All of this is possible thanks to what Albert Einstein called the "most powerful force in the universe"--compound interest. No matter how much you save, the key to wealth accumulation is simple: Start early, be patient, and let the investment grow and accumulate. In tact, of the $1,000,000 accumulated over 50 years in the $2-a-day savings plan, just $37,230 of it derives from the contributions made to the investment. The remainder ($962,770) comes entirely from the momentum of compounding interest.

Remember, too, that $2 a day for 50 years is simply a starting point. The older a worker becomes, the more money he or she usually makes, and the more can be devoted to investing. If you can become a millionaire in 50 years on simply $2 a day, imagine the exponential growth the investment would yield if you increased that amount. Let's say you save $6 a day. The power of compound interest combined with the historical return on stocks would make you a millionaire in 37 years.

An "out of sight, out of mind" approach to saving is also very effective over long periods of time. Consider this: If your grandparents had put $100 into a similar mutual-fund stock account in 1928 and never touched it again, today they would have a "grand prize" in excess of $200,000. The "Jeopardy!" winner could have had a total prize that matched his game show winnings if his grandparents would have invested $100 in 1927.

The old-fashioned view that investing is done only by brokers in three-piece suits who have just stepped off their yacht and that savings are best placed under a mattress is giving way to a rise of a "new investor class"-Americans who are contributing to the longevity of the robust economy and their personal financial health. Over 40% of American households own stocks or stock mutual funds. More than 60% of the money in the stock market comes from those households. A majority of the equity in the stock market is owned by working Americans. Day traders may be a flash in the pan, but the wealth-building American family signals a new, important, stable, and optimistic trend.

Despite these truths, people still have aversions to saving. One standard refrain is that stocks are too risky. Yet, when you look at the returns in the stock market since 1926, a mutual fund that tracks the market yields around 11% per annum. In fact, short-term volatility in the market is a greater incentive to hold your investment over long periods of time as a way to ride out the market's bumps. It certainly should not be seen as a disincentive to start saving.

Another reason people may decide not to save is the current income tax's bias that encourages consumption today over saving for the future. All income is consumed eventually, of course. Savings and investment are, by definition, deferred consumption. Because the current tax code taxes interest gains on savings at the same rate as income earned in the present, it is logical to want to take a smaller tax hit now by consuming wealth. Moreover, as people get older and make more money, they slowly creep into higher income brackets where their earnings and savings may be taxed at 30% or more.

Here's an example: Someone in the 15% tax bracket (for instance, a single person making roughly $30,000 a year) who saves $1,000 annually for 20 years would lose 30% of the potential gains from saving because of interest taxation. Saving for longer--say, 50 years-brings the tax loss to 50%, and that is assuming the saver never steps upward from the 15% tax bracket.

To put it another way, under the current income tax code, it will take that person at least 56 years to save the same amount he or she could save in 50 years if the income tax code didn't tax savings accumulation. The government could give back to an average citizen the fruit of six years of hard work and patience just by changing the income tax code to favor wealth building.

One way this tax bias against saving can be remedied is by lowering or eliminating the taxes on interest income. Investing in accounts that allow contributions to accumulate tax-free until withdrawal, like individual retirement accounts (IRAs) or 401(k)s, is one method to avoid taxes on the interest. It is this realization that has fueled the popularity of such accounts. Enrollment in 401(k)s has doubled over the past 10 years.

IRAs are popular as well, but it seems that fewer people are opening these accounts because of Federal regulations that make it more difficult to save. For example, the Tax Reform Act of 1986 lowered the allowable tax-deferred contributions workers could make to IRAs if they were participants in a 401(k) or other defined-contribution retirement plans. That policy obviously discourages workers who may want to invest in more than one type of account. The lower limits on contributions also restrict the amount those workers can save.

IRAs and 401k)s are primarily vehicles for accumulating savings for retirement. While recent law has allowed withdrawals for preretirement purposes (for instance, the purchase of a first home), the government still won't allow this tax-free accumulated wealth to be withdrawn for other purposes, such as an unexpected illness or paying for your offspring's education. The government shouldn't be in the position of telling people they may accumulate tax-free interest if they save for retirement, then hit every other saver with a tax. There are many different motivations for saving money, and the government should treat them all equally.

This bias in favor of retirement savings hurts the poor, too. After all, those who are wealthier can afford to save for retirement and other things, like buying a house, for example, simultaneously. Lower-income families often cannot. That's because much of their income is taken away by the payroll tax to support the Social Security System. The Social Security payroll tax, which takes 12.4% of every worker's wages (up to $76,200) to support a government pension system that is careening toward insolvency in 2037, falls most heavily on poorer Americans, who derive most of their income from wages.

A better policy would be to help the poor accumulate real wealth by allowing them to devote all or a portion of the Social Security payroll tax to a personal retirement account to which they have ownership rights. These accounts have a number of benefits. First, they allow all workers to invest a significant portion of their lifetime income. That lets them take advantage of the market rate of return, which is much higher than what the Social Security System offers (especially for younger workers, who will likely receive a negative return on their payroll contributions). Second, since those accounts contain real assets owned by the workers, they can pass on the wealth to their heirs, while Social Security merely passes on debt to future generations. Third, workers will be safe from the political whims of Congress, which has the power to set benefits, change the retirement age, and even deny retirement benefits whenever it wishes.

With personal retirement accounts, almost everyone would be guaranteed a nest egg that would make today's jackpots on "Who Wants to Be a Millionaire" seem less than impressive. After all, if $2 a day over 50 years can make you a millionaire, think what 10% of your income over your entire working career would net. By our math, you could be a millionaire at least twice over.

Game shows and lotteries are dreams come tree for only a few people. Saving and investing can be a reality for all Americans. The government should encourage the accumulation of real wealth by turning Social Security into a personal savings plan and scrapping an income tax code that punishes saving. With a little discipline and some long-term planning, almost anyone can be a winner in wealth. You don't even have to know which U.S. president appeared on "Laugh In."

James N. Markels is assistant director of public affairs, Cato Institute, Washington, D.C. Stephen A. Slivinski is a Cato fiscal policy analyst.
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Article Details
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Title Annotation:savings and investments
Publication:USA Today (Magazine)
Geographic Code:1USA
Date:Nov 1, 2000
Previous Article:Media Silence Is Not Golden.

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