Briefing Paper No. 74

Personal Accounts in a Down Market: How Recent Stock Market Declines Affect the Social Security Reform Debate

By Andrew G. Biggs
September 10, 2002

Executive Summary

The S&P 500 stock index is down almost 40 percent from its peak value in 2000. Where does that leave the case for personal retirement accounts, which would allow workers to invest their Social Security payroll taxes in stocks and bonds through accounts similar to individual retirement accounts or 401(k)s?

The evidence shows that long-term market investment for Social Security, while hardly risk free, bears little resemblance to the “meltdown” scenarios painted by many account opponents. Opponents of personal accounts implicitly assume that workers with accounts would be short-term investors without any nonstock diversification. In the real world, the combination of asset diversification between stocks and bonds and time diversification over long time horizons reduces the risks that a short-term market drop could substantially affect workers’ retirement incomes. Even in today’s bear market, workers with personal accounts would retire with higher total retirement incomes than the current pay-as-you-go program is able to pay.

Moreover, personal accounts would allow individual workers to take on only as much market risk as they are comfortable with. The public realizes this, and support for personal accounts is higher today than it was at the market’s peak.

If personal accounts would be a good policy even today, and if they retain public support even today, it is hard to imagine a circumstance in which they would not. Today’s stock market declines do not contradict the case for personal accounts. In fact, they confirm it.

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Andrew G. Biggs is a Social Security analyst at the Cato Institute.