Social Security is Better
Published March 2002
by Paul D. Van Ness
If I had not heard it with my own ears I would not have believed
it. Mr. Bush said, in the State of the Union Address: 'We must allow
personal retirement accounts for younger workers who choose them.'
This proposal amounts to recommending that some workers be allowed
to retire in destitution. Mr. Bush should be thinking of ways to
improve retirement for everybody, not of ways to degrade it.
Why would the proposal work out like that?
In 2002, the employer and the employee each contributes 6.2% of
wages for a total of 12.4%. It is proposed to transfer two percentage
points, or about 1/6 of the joint contribution, to these 'personal
retirement accounts.'
The Social Security System is a defined benefit plan. If one qualifies
to receive benefits, one receives a specified monthly amount depending
on one's contributions to the system over one's working life. Since
one would contribute less, Mr. Bush's proposal would reduce Social
Security benefits 'for younger workers.'
It would also cause a huge reduction in the amount of money flowing
into the Social Security trust fund, which would then lack the resources
to fulfill its obligations to older workers who do not have a 'personal
retirement account.' This shortfall of billions of dollars would
have to be made up either by raising social security taxes, or by
appropriating money from the government's general revenues, or by
reducing the benefits for older workers.
Mr. Bush's proposal would be fearfully expensive.
Workers would have to manage their 'personal retirement accounts.'
They would have to choose whether to put the money into savings
accounts, or CD's, or money market accounts, or mutual funds (of
which there are thousands), or common stocks (of which there are
thousands), or preferred stocks, or corporate bonds, or government
bonds or other little-known financial instruments.
At this point, workers will encounter an expense which they avoid
in the Social Security system: they will have to pay brokers' commissions
and fees.
Of the items listed above, only the first two may be insured by
the Federal Deposit Insurance Corporation. Money market accounts
are not insured, but are generally quite stable. The rest are not
insured and are subject to the up and down fluctuations of the stock
markets.
Can the individual investor make more money in his 'personal retirement
account' than s/he can in the Social Security System? It is not
likely.
You have heard the reassuring statistics. For example, the National
Center for Policy Analysis estimates at least a 7% average annual
return in the stock market for any recent 20-year period. Obviously
this beats a 2% return (which is about the current figure) on a
money market account But the pertinent question is: can the individual
investor actually do as well or better than the 7%?
Such success is unlikely, for a couple of reasons. In the first
place, for any short period of time, returns may be negative, as
they have been for the last two years. In 2000 the Dow Jones Industrial
Average dropped 6.18%; in 2001 it dropped 7.10%. On the very day
that Mr. Bush put forward this idea, the Dow Jones Industrial Average
dropped 247 points. If you want to realize 7%, you will have to
track your investments. You will have to get out of your losers
and find winners. These tasks are laborious and time consuming and
fraught with uncertainty. Not the least benefit of the Social Security
System is that the benefits are defined and guaranteed.
Speaking of returns, you may have heard the widely disseminated
report that the returns on the Social Security Trust fund only amount
to about 2% per year. This report is false! The Trust
Fund contains government bonds which pay varying rates of interest
since they were issued at different times. The rates vary between
about 5% and 13% per annum, which is not too shabby, even compared
to the stock market.
In the second place, a large body of academic research on the performance
of market professionals, such as mutual fund managers and authors
of stock market newsletters, shows that the experts seldom beat
the market
Does Mr. Bush mean to imply that amateur investors can beat the
pros? Can they do a better job of picking investments out of the
universe of thousands of stocks and mutual funds? One study has
shown that the portfolios of average Americans and of investment
clubs underperform the stock market by about 4% annually. Most people
with 'personal retirement accounts' will not achieve the well-publicized
7% figure for stock market returns.
Why is the idea popular with some people? A CNN poll reported 62%
in favor of something like the Bush plan. I call it 'the Lake Woebegon
Effect.' You know Lake Woebegon, where 'all of the women are beautiful
and all the children are above average.' Everybody likes to think
that s/he is above average and can beat the odds. The odds against
the individual investor are very real and you probably can't beat
them.
Your 'personal retirement account' will be a defined contribution
account. You will deposit a certain amount into it every payday.
It is not a defined benefit account; there is no guarantee as to
the benefits you will receive when you retire. 'Young workers' will
give up some part of the security of defined benefits with Social
Security for a gamble, against the odds, that they will do better
than Social Security in the stock market, which is a very dangerous
place, indeed.
How dangerous?
Your 'personal retirement account' will bear certain similarities
to a 401(k) account. You and your employer put money into it. The
money may be invested in some stock; commonly much of it is invested
in the employer's stock. This fall, everybody learned that the company
could collapse.
The employees of Enron Corporation (thousands of them) who had their
401(k) money invested in Enron Stock lost it when Enron went bankrupt.
Nor is this an isolated occurrence. On the very day of the State
of Union address, the newspapers carried the story of the bankruptcy
of Global Crossing, Ltd., which also wiped out the retirement savings
of thousands of employees.
When 'younger workers' manage their 'personal retirement accounts,'
they may learn the harsh truth that although the stock market may
go up, the companies they invest in may crash. At one time Enron
stock was trading over $80 per share. It has been delisted from
the New York Stock Exchange, and its last trade was for $0.67. Global
Crossing, Ltd. once traded above $50.00; the last trade before bankruptcy
was for $0.30.
The Enron and Global Crossing employees (and anyone else who invested
in these companies) saw their retirement savings evaporate and their
retirement plans disintegrate as the stock prices collapsed and
depleted their defined contribution accounts. Such disasters cannot
happen in the Social Security System with its defined benefits.
Don't fall for Mr. Bush's bad idea