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from 16 to 1 in 1950 to only 3.3 to 1 today. The

Table 4

Social Security Administration estimates it will

Worst and Best Average Annual Returns for Various Time Periods

fall to only 2 to 1 by 2030.17

Length of Time

Worst

Worst Interval

Best

Best Interval

At this stage, political risk is no longer mini-

mal; the possibility of increased taxes and

20 years

3.36%

1929­1948

17.32%

1942­1961

decreased benefits looms. In 1950 the OASI tax

25 years

6.00%

1929­1953

15.27%

1943­1967

rate was 3 percent of $3,000 of earnings for a

30 years

8.53%

1928­1957

13.96%

1942­1971

maximum tax of only $90.18 The rate in 1997 is

46 years

7.32%

1929­1974

12.88%

1942­1987

10.70 percent of $65,400. Even adjusting for

63 years

9.72%

1929­1991

12.64%

1933­1995

inflation, this is a jump of about 1,200 percent.

During this same period benefits increased only

about a third as much. As in the past, the debate

spiraling then falling oil prices, war with Iraq,

on how to save Social Security includes further

and the stock market crash on October 19,

tax increases and benefit cuts.19  The risk of

1987--the worst single day since 1926.

higher taxes relative to benefits in a govern-

During shorter intervals, the upward bias in

ment-mandated pay-as-you-go structure is real,

prices is also evident. This is true even during

significant and certain.

troubling times. Table 4 shows the worst and

A privatized system also incurs risk, that is,

best 20, 25, 30, 46 and 63 consecutive years

uncertainty and volatility of returns. At first

from 1926 through 1996. Forty-six years is cho-

glance the stock market appears to be a hodge-

sen for it is the length of a working career start-

podge: a roller coaster of up and down days that

ing at age 21 and ending at 67, the normal retire-

has no form, pattern, or logic. If this is all it is,

ment age for workers born since 1960. At age 65

then investing in the market for one's retirement

life expectancy is age 84. Thus, the period of 63

would be a fool's decision--comparable to

years, from age 21 to 84, is shown.

gambling, to which it has been equated. But

There is no

As will often be the case, lengthening the

gambling and investing are fundamentally

interval is consistent with its return being closer

need for a

different.

to the mean. This is important because the aver-

In gambling--whether horses, roulette, or the

worker who

age market return during one's full working

lottery--total winnings cannot exceed total

chooses the

career determines the accumulated wealth at

wagers. Because the horse track, casino, and the

retirement--not a single year's change, whether

market-based

state incur operating expenses associated with

it be high or low.

their betting games, winnings must be less than

system to

Although average returns in all cases were

the total amount bet by the sum of the operating

know how

positive, there was volatility. Figure 2 shows

expenses. In other words, the bettor should

this for the full period 1926 through 1996. It

markets work

expect to lose. For the bettor this is a negative-

shows the distribution of annual returns of the

sum game.

as long as the

U.S. market as defined above. The average of

Investing, on the other hand, is the owning of

pension

the annual returns is 13 percent. Most years

assets--such as construction equipment, com-

clustered around the average plus or minus 20

system is

puter software, or electrical power plants--that

percent. Only during very few years did the

have the ability to make goods and services to

properly

market do spectacularly well or poorly. This pat-

produce wealth. The value of these assets, as

structured and

tern of clustering around the average is common

represented by the stock market, fluctuates as

and is expressed using standard statistical tech-

sensible

investors change their views on the earning

niques. (See Appendix C.) From this we esti-

power of the assets. But over time, the stock

guidelines are

mate that about two-thirds of the time annual

market reflects economic growth and rising

followed.

stock market returns were between ­8 percent

earnings, resulting in increased stock prices. For

and 34 percent. Returns either side of this range

the investor this is a positive-sum game.

occurred only 16 percent of the time. The pat-

Stock prices, far from a hodgepodge, form

tern of historical returns is a reasonable starting

patterns. The first is that over time, whether dur-

point for estimating the probability that any

ing prosperous periods or not, they tend to rise.

future return will occur (Figure 2). But investors

From 1926 through 1996 the average annual

do not have to subject their retirement savings to

nominal return from U.S. stocks was 10.89 per-

any single market. Investing in many markets at

cent, or 7.56 percent adjusted for inflation.20

the same time is a common way to reduce risk.

During this period we lived through the Great

Figure 3 is one illustration of this.

Depression, World War II, Vietnam, Watergate,

7