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The Point of No Returns
By
Libby Perl, The Century Foundation
March
30, 2005
When discussing the purported benefits of Social Security private
accounts, proponents invariably claim that they will produce higher
returns for workers than traditional Social Security. But a new paper by Yale
University
economist Robert Shiller shows that many retirees would actually be worse
off under privatization.
Shiller analyzes prospective investment returns by looking at a "life
cycle portfolio" of stocks and bonds to predict how Social Security
private accounts might perform. This portfolio is the recommended default
option under the President's proposal for private accounts. With this
portfolio, funds are invested more aggressively in risky equities when
workers are young, and then, as they approach retirement age, the assets
are shifted to bonds and other lower-risk investments.
In his first set of calculations, Shiller assumes that stocks will grow at
the same rate in the future as they have in the past. This is a generous
assumption in light of the Social Security Trustees' forecasts that the
economy will perform considerably below historical levels in coming
decades. In spite of the rosy assumptions about stock returns, nearly a
third of workers would be worse off with private accounts. This is because
private account holders need a good rate of return just to break even.
Under the president's proposal, those who invest in private accounts would
only keep returns in excess of 3 percent above the rate of inflation. The
government would take the first 3 percent. In essence, the private
accounts would consist of government loans, at an interest rate 3 percent
above the rate of inflation, to individuals during their working years,
with the repayment deducted from their retirement benefits. After
subtracting the 3 percent, the life cycle portfolio, even using the very
optimistic historical average return to stocks, would still lose money 32
percent of the time.
Using a more realistic rate of return on stocks, the results are much more
grim. Shiller's second set of calculations uses the median 20th century
stock market return in 15 countries. Although this rate is below the
return in the
United States
in the 20th century, it still is slightly above the rate of return that 10
leading
US
financial economists expect, according to a recent Wall
Street Journal survey. Under this less optimistic, more realistic
scenario, the life cycle portfolio would lose money 71 percent of the
time. Nearly three quarters of private investment accounts would leave
retirees worse off than if they had never gambled with their retirement
income.
Making predictions about future investments is a tricky business, and far
from an exact science. We can almost guarantee that some workers will win
and some will lose if they choose to invest in private accounts. What
Shiller's numbers tell us is that somewhere between many and most workers
would be worse off with the private accounts the president is advocating
than they would be if they took no risks with their Social Security
benefits.
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