Social Security Reform and Risk
As a lawyer, I have represented clients in disputes involving corporate and public pension funds on numerous occasions, so I guess I know a little bit about how large-scale planning for retirement works, and I think it's applicable to a couple of questions people may have about the President's Social Security reform package.
1. Isn't it risky to permit people to invest their retirement funds in the stock market?
Threshold point -- of course it's "risky" if by risky you mean that stocks can and do go down as well as up. Business ideas fail, business plans run aground, businesses go under, technology makes some businesses obsolete (the buggy whip industry, the electric typewriter industry, etc.). But the same "creative destruction" that makes investing in business enterprises risky also gives them the possibility of rewards. If there wasn't any risk to them, there wouldn't be any upside reward either. So don't let anybody tell you that investing Social Security money in the stock market won't be risky. The fact that it's risky is precisely why you want to do it!
That's why a huge public employee pension fund like the California Public Employees Retirement System (CALPERS) has 60-70% in equities. Its trustees know that, over time, taking that risk will enable them to grow the fund, pay higher benefits, etc. In a given year, they may take a "hit." But, in the long term, they'll be better off by having put their money at risk.
2. How risky is it really?
In the short term it's of course a little risky. If you were retiring next year, you'd want to have less exposure to equities in your overall portfolio, depending on how much you have, how much you want to pass on to your children, how much you need for basic living expenses in retirement, etc. You'd probably still want to have some, to make sure your assets appreciate over the actuarial course of your life to beat inflation.
But, if you're not retiring for 25-45 years (the target audience for President Bush's plan), it's much, much more risky not to be in the stock market. There is no 25 year period over the past century where equities didn't do substantially better than cash, money markets, bonds, T-bills, etc. Again, that's why corporate and public pensions -- which have to consider the probable lifespans of their employees through actuarial modeling -- will invest substantial portions of their assets in equities. (That's also why any investment advisor worth his salt asks a prospective client "What's your time horizon?", i.e., when will you need this money to be liquid for your living expenses? If the answer is never, you can take a lot of risk and reap, over time, commensurate rewards. If the answer is tomorrow, you can't take risk and need to keep your money in risk-free investments like Treasury bills. But if the answer is 10 years, or 20 years, or 30 years, or 40 years, the answer is that you can take on a significant amount of risk, and will end up reaping a significant reward for having done so.)
Moreover, if the stock market somehow doesn't do well over the 25 or 30 or 40 year period prior to your retirement, what makes you think that the economy will have done well enough during that same time to support the Social Security system anyway? The stock market is ultimately tied to corporate profitability and corporate profitability is tied to employment and employment is correlated with government revenues, both in income taxes and payroll taxes for Social Security. If the stock market tanks for an entire generation or more, we'll have a lot more to worry about than whether our Social Security payments are a little less than we thought they'd be.
3. But what about the "transition" costs?
Estimates of what it will "cost" to transition the system to some use of private accounts (the amount of diverted funds that would otherwise have been paid into the system during the transition period) are about $2 trillion. OK, that's a lot of moolah. But what they don't tell anybody is that the long-term liabilities of the system will be cut by something on the order of $10 trillion, because the younger workers now who are diverting those funds into their private accounts will get less in Social Security payments from the government when they retire in 25 or 30 or 40 years. (They'll make up for it by the wealth they will have amassed in their private accounts.)
Pension funds do this all the time. A company (or a county) will offer early retirement incentives like lump sum payouts for the purpose of reducing overall future liability -- they'll pay now so that they won't have to pay as much later. There is literally nothing wrong with this idea, except that no one has adequately explained that the long-term liabilities of the Social Security system will go down, not up, under the President's plan.
Just some thoughts. I've been out of the loop for a few days on business.
Peace, out.
1. Isn't it risky to permit people to invest their retirement funds in the stock market?
Threshold point -- of course it's "risky" if by risky you mean that stocks can and do go down as well as up. Business ideas fail, business plans run aground, businesses go under, technology makes some businesses obsolete (the buggy whip industry, the electric typewriter industry, etc.). But the same "creative destruction" that makes investing in business enterprises risky also gives them the possibility of rewards. If there wasn't any risk to them, there wouldn't be any upside reward either. So don't let anybody tell you that investing Social Security money in the stock market won't be risky. The fact that it's risky is precisely why you want to do it!
That's why a huge public employee pension fund like the California Public Employees Retirement System (CALPERS) has 60-70% in equities. Its trustees know that, over time, taking that risk will enable them to grow the fund, pay higher benefits, etc. In a given year, they may take a "hit." But, in the long term, they'll be better off by having put their money at risk.
2. How risky is it really?
In the short term it's of course a little risky. If you were retiring next year, you'd want to have less exposure to equities in your overall portfolio, depending on how much you have, how much you want to pass on to your children, how much you need for basic living expenses in retirement, etc. You'd probably still want to have some, to make sure your assets appreciate over the actuarial course of your life to beat inflation.
But, if you're not retiring for 25-45 years (the target audience for President Bush's plan), it's much, much more risky not to be in the stock market. There is no 25 year period over the past century where equities didn't do substantially better than cash, money markets, bonds, T-bills, etc. Again, that's why corporate and public pensions -- which have to consider the probable lifespans of their employees through actuarial modeling -- will invest substantial portions of their assets in equities. (That's also why any investment advisor worth his salt asks a prospective client "What's your time horizon?", i.e., when will you need this money to be liquid for your living expenses? If the answer is never, you can take a lot of risk and reap, over time, commensurate rewards. If the answer is tomorrow, you can't take risk and need to keep your money in risk-free investments like Treasury bills. But if the answer is 10 years, or 20 years, or 30 years, or 40 years, the answer is that you can take on a significant amount of risk, and will end up reaping a significant reward for having done so.)
Moreover, if the stock market somehow doesn't do well over the 25 or 30 or 40 year period prior to your retirement, what makes you think that the economy will have done well enough during that same time to support the Social Security system anyway? The stock market is ultimately tied to corporate profitability and corporate profitability is tied to employment and employment is correlated with government revenues, both in income taxes and payroll taxes for Social Security. If the stock market tanks for an entire generation or more, we'll have a lot more to worry about than whether our Social Security payments are a little less than we thought they'd be.
3. But what about the "transition" costs?
Estimates of what it will "cost" to transition the system to some use of private accounts (the amount of diverted funds that would otherwise have been paid into the system during the transition period) are about $2 trillion. OK, that's a lot of moolah. But what they don't tell anybody is that the long-term liabilities of the system will be cut by something on the order of $10 trillion, because the younger workers now who are diverting those funds into their private accounts will get less in Social Security payments from the government when they retire in 25 or 30 or 40 years. (They'll make up for it by the wealth they will have amassed in their private accounts.)
Pension funds do this all the time. A company (or a county) will offer early retirement incentives like lump sum payouts for the purpose of reducing overall future liability -- they'll pay now so that they won't have to pay as much later. There is literally nothing wrong with this idea, except that no one has adequately explained that the long-term liabilities of the Social Security system will go down, not up, under the President's plan.
Just some thoughts. I've been out of the loop for a few days on business.
Peace, out.
posted by PDB at 10:43 AM
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