October 27, 2010

YOU CAN'T AVOID THE THIRD WAY, ONLY DELAY ITS IMPLEMENTATION:

Private Social Security Accounts: Still a Good Idea: A couple who worked from 1965 to 2009 would have beat the government payout by 75%. (WILLIAM G. SHIPMAN AND PETER FERRARA , 10/26/10, WSJ)

Suppose a senior citizen—let's call him "Joe the Plumber"—who retired at the end of 2009, at age 66, had been able to set up a personal account when he entered the work force in 1965, at the age of 21. Suppose that, paying into his personal account what he and his employer would have paid into Social Security, Joe was foolish enough to invest his entire portfolio in the stock market for all 45 years of his working career. How would he have fared in the recent financial crisis?

While working, Joe had earned the average income for full-time male workers. His wife Mary, also age 66, had earned the average income for full-time female workers. They invested together in an indexed portfolio of 90% large-cap stocks and 10% small-cap stocks, which earned the returns reported each year since 1965.

By the time of their retirement in 2009, Joe and Mary would have accumulated account funds, after administrative costs, of $855,175. Indeed, they would have been millionaires a few years earlier, but the financial crisis lost them 37% in 2008. They were unfortunate to retire just one year after the worst 10-year stock market performance since 1926. Yet their account, having earned a 6.75% return annually from 1965 to 2009, would still pay them about 75% more than Social Security would have.

What's more, this model assumes that in retirement Joe and Mary switch to a lower-risk, conservative portfolio that averages a return of just 3%. Of course for young workers today, Social Security promises even lower returns of only 1.5% or less, given the actuarial value of all promised benefits. For many, the promised returns are zero or negative. And if Congress raises taxes or cuts benefits in order to close financial gaps—as everyone who rejects personal accounts effectively advocates—the eventual returns for young workers will be even lower.

It is a mathematical fact that the least expensive way to provide for an almost certain future liability is to save and invest in capital markets prior to the onset of the liability. That's why state and local pension funds, corporate pension plans, federal employee retirement plans and Chile's successful Social Security personal accounts (since copied by other countries) do so. It is sound practice.

Posted by Orrin Judd at October 27, 2010 5:15 AM
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