Most critics of personal accounts seem unconvinced of their own arguments, and therefore scared to death that many would jump at the chance to put a bit less into Social Security (and take less out), in order to build a retirement account they own and control.
Indeed, the latest Washington Post poll (oddly described as bad news for President Bush) finds that “68 percent of adults 18 to 29 years old said they support investing some Social Security contributions in the stock market. That support falls with the respondents’ age, to 60 percent among those 40 to 49, 53 percent among those 50 to 64, and 37 percent among those 65 and older.” The only age group that doesn’t like the idea is ineligible and unaffected.
The first phase of this debate began with strained efforts to show that those lucky enough to have defined contribution plans, such as a 401k, have not fared so well if you pick a period short enough to be dominated by the market’s decline in 2000-2002. Tom Luricella’s Wall Street Journal piece last December thus cited a study claiming amateur investors earned “only” 6.4 percent a year over the 10 years ending in 2002, while funds managed by experts earned 6.8 percent. That proved nothing, because the figures were not adjusted for risk. Professional investors may have just invested a larger share in risky small-cap stocks and less in cash.
Looking only at 10 years ending in the bear market of 2002 also made investor returns look much worse than usual. The S&P500 index returned 10.9 percent a year over the past 15 years, and several of the largest, most popular managed funds did significantly better. Even if you shave off a few percentage points to compensate for inflation, the real return on stocks over any extended period has been enough to double the real size of a pension fund every 10 years. It might not be that good on the particular year you turn 65 or 67, but it would be absurd to compel people to liquidate or annuitize their account at such a young age. And, contrary to a New York Times report, retirees can buy annuities that leave any leftover money to heirs.
Desperate critics of personal accounts, tired of being caught fibbing about actual investment experience, have switched to hypothetical estimates of future investment returns. To make these hypothetical returns as low as possible, they first assume no more than half is invested in the stock market.
Jonathan Weisman of the Washington Post cites figures from Robert Shiller concerning a “life cycle” account that would have only 15 percent in stocks by age 60. Since Shiller calculates that U.S. stocks have long earned 6.8 percent a year in real terms, after adjusting for inflation, while bonds earn a more-variable 3 percent, any life cycle plan requiring a tiny share in stocks after middle age guarantees a low median return of only 3.4 percent. That is, he notes, “considerably below the 4.6 percent that the Social Security actuaries have assumed,” because the actuaries assumed 50 percent in stocks (which is also much too low most of the time).
Weisman neglected to mention that Shiller found, “Workers could do better, of course, if they eschewed the life cycle accounts and went for 100 percent stocks. In this case … the median net account is … 10 times as large as with the baseline life cycle account. … Workers who choose the 100 percent stocks option lose only 2 percent of the time.”
In 1999, when Bill Clinton was president, Shiller appeared more worried about overtaxing younger people to subsidize retiring baby boomers. “We should do more yet to encourage saving,” he wrote; “The younger people already have their own income concerns and needs without also having to bear the burden of the risks of the retired.”
Shiller’s figures reveal one genuine risk with personal accounts — namely, that Congress might allow people too little choice between stocks and bonds. A 50-50 stock-bond split was originally mandated for 529 college savings plans, which has now been wisely scrapped. The notion that bonds are safer than stocks is a particularly risky illusion. Indeed, Shiller’s study shows, “the outcome of a portfolio of 100 percent bonds is terrible. The final balance is negative 89 percent of the time.” The value of bonds falls when interest rates rise, so investors in “safe” U.S. Treasury bonds have frequently been clobbered by big capital losses.
In the Federal Reserve Bank of St. Louis Review, Thomas Garret and Russell Rhine earned the last word on this topic. They calculate what the return would have been to those who retired in 2003 if they had instead been allowed to invest the money they “contributed” to Social Security in an S&P 500 index fund or 6-month CDs. Then, they compare what retirees’ amortized monthly income would have been if payroll taxes were invested with what it actually is under Social Security. What they found was that “over 99 percent of the U.S. population would have earned a greater return by investing in the S&P 500, and over 95 percent would have earned a greater return by investing in 6-month CDs relative to the current Social Security system.”
Specifically, “A person retiring at age 65 will only benefit more from Social Security relative to a private investment in the S&P 500 if he is a low earner and lives to be at least 96 years old. For those retiring at age 70, the only individuals that benefit more from Social Security are low earners who live to be at least 94 years old and average earners who live to be at least 108 years old.”
In the future, the relative payback from a lifetime of paying Social Security taxes will get much worse: “Since those people retiring in 2003 have not always paid into the system at the current high rate of 12.4 percent, their average tax rate is only 10.7 percent, assuming 40 years of work. This average tax rate will increase in later years, as future retirees have fewer years paid in at lower tax rates and more years paid in at higher rates.”
Whenever economists or journalists pretend that Social Security offers a better or safer return than the stock market, just remember Don Luskin’s apt phrase about “the conspiracy to keep you poor and stupid.”