For the last several years the stock market rode a wave of expansion. A correction was inevitable. So what? For retirement purposes, year-to-year market fluctuations are irrelevant compared with the long-term trends over the 40 or more years of a person’s working lifetime. And there is no 40-year period in history in which an investor would have come close to losing money in the stock market. In fact, the worst 20-year period in U.S. history, encompassing the 1929 crash and the Great Depression, produced a return of more than 3 percent after inflation. The average 20-year real return has been around 7 percent.
The current bear market is painful. But let’s put it in perspective. A worker retiring at 65 today would have started investing money in his private account in the mid-1950s. At that time, the Dow was in the low 400s. Someone in his 40s today would have started investing when the Dow was around 1,500. It would take a lot more than the recent slump to wipe out the gains those workers have seen. William Shipman and Melissa Heiger of State Street Global Advisors estimate that the market would have to drop 65 percent for an average worker retiring this year to end up with personal account benefits lower than those Social Security could provide.
Indeed, even with recent declines, it is hard to overstate how much better a deal private investment remains. If an average-wage earner retiring today had invested his payroll taxes he would have a retirement nest egg, even after the recent plunge, of more than $460,000. Sure, that’s less than at the market’s peak, but it would provide for an annuity of nearly $4,000 per month. In contrast, Social Security promises benefits of barely $1,000 per month. Worse, Social Security can’t guarantee its promised benefits. The program will begin running deficits in 15 years and will be more than $22 trillion in debt over the next 75 years. Unless payroll taxes are raised, benefits will have to be slashed by a third. Now that’s a bear market.
Of course, the above examples assume that workers invest exclusively in stocks. But if workers thought that stocks were too risky, they would be free to invest in bonds, money market funds, annuity contracts, and other conservative investments—and still earn a higher return than under the current system. Many workers would do better stuffing the money under a mattress.
In practice, most workers would invest in a balanced portfolio that included both stocks and bonds. Given a portfolio of 60 percent stocks and 40 percent bonds, the stock market would practically have to be wiped out to make individual accounts a worse deal than Social Security. Even if the stock market went out of business on the day of a worker’s retirement, the bonds alone remaining in his account could in most cases pay higher benefits than Social Security.
Where then lies the risk? Is it riskier to rely on markets that have never failed to produce positive long-term results, or on a politically dependent intergenerational transfer—a welfare program—that is financially insolvent and guaranteed to produce below-market returns for most workers? Given the choice, we know where most young workers would rather put their money.