Social Security vs. stock returns: no contest

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One of the strangest arguments against voluntary personal accounts is that those who choose such accounts will earn a lower return than those who do not. This argument is not odd because I disagree with it but because if it were persuasive, young people could easily be convinced to shun personal accounts. If personal accounts were really an inferior choice, few would choose them and Social Security would remain pretty much the way it is now -- a bunch of empty promises dependent on the generosity of future taxpayers.

Most personal accounts critics seem unconvinced of their own arguments, and therefore afraid many would jump at the chance to put a bit less into Social Security (and take less out), to build a retirement account they own and control.

Indeed, the latest poll by The Washington Post (oddly described as bad news for President Bush) finds "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 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 expert-managed funds earned 6.8 percent. The data weren't adjusted for risk, and so proved nothing. Professional investors may have just put more 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 last 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 force 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 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 about a "life cycle" account with only 15 percent in stocks by age 60. Since Mr. Shiller calculates 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 it assumed 50 percent in stocks (also much too low most of the time).

Mr. Weisman neglected to mention Mr. 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, Mr. Shiller seemed 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."

Mr. Shiller's figures reveal one genuine risk with personal accounts -- namely, 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 bonds are safer than stocks is a particularly risky illusion. Indeed, Mr. 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 often 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 been allowed to invest the money they "contributed" to Social Security in an S&P 500 index fund or six-month CDs. Then, they compare what retirees' amortized monthly income would have been were payroll taxes invested with what it actually is under Social Security. They found: "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 six-month CDs relative to the current Social Security system.

"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."

The future 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 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."

Alan Reynolds is a senior fellow with the Cato Institute and a nationally syndicated columnist.