RSS Feed MenuWith the stock market crash, many have pointed to the safety and security of Social Security relative to 401(k) plans and the idea of adding personal accounts to Social Security. There is certainly merit to these arguments, and having a diversified portfolio of safe and risky investments makes sense.
At the same time, it’s worth checking into how Social Security’s investments have done over time. Surplus taxes paid into Social Security are invested in the Old Age, Survivors and Disability Trust Funds (OASDI), which hold special-issue government bonds whose interest rates are based on average Treasury bond interest rates at the time. The idea here is investments which provide safe, if modest, returns for the long-term.
But not many people have considered how modest. Effective annual interest rates on the trust funds are available through the Social Security actuaries’ web site (see here). To calculate real returns I subtracted the annual rate of growth of the consumer price index (CPI), available here. A couple charts tell an interesting story. First is a fairly conventional comparison: how did the trust funds’ returns compare to a mixed portfolio of 50 percent stocks and 50 percent bonds? The first chart shows average annual returns by decade and shows a couple interesting things. First, the mixed portfolio returns exceeded the trust fund’s returns in all decades except for the truncated 2000-2008 period, by an average of around 2.9 percent. Second, both the stock-bond portfolio and the trust funds lost money in two decades, although only the trust funds had a truly terrible decade, losing 3.5 percent annually during the 1940s.
The second chart shows a running average return on the trust funds, beginning in 1940. The return value for each year represents the average of returns from 1940 through that years. Here’s something I found pretty interesting: from the program’s inception through 1986, the average annual return on the trust funds was negative. To repeat, through the first four and one half decades, the trust fund’s investments lost money on average each year. Following 1986 the running average of annual returns was positive, but barely so: even extending through 2008, the average annual return on trust fund investments, adjusted for inflation, was only 1.38 percent above inflation. These returns are safe, to be sure, but far lower than the 4.4 percent real annual return on the stock-bond portfolio.
So here’s a question: if the trust fund’s returns have been so low, how did Social Security manage to pay such high benefit returns to early retirees? (The benefit return is a function of taxes paid and benefits received, with the trust fund’s investment return having an only indirect effect on benefits.) We’ve talked here several times about the high returns paid to early retirees; here’s a chart showing average annual returns paid to beneficiaries. The answer is that while a sustainable Social Security program would have built up a significant trust fund balance over time to help pay future benefits, the trust fund balance was kept very low and the extra funds paid out as benefits. When Social Security was begun, the idea was for it to become a “funded program” carrying a large trust fund balance. Congress soon acted to delay scheduled tax increases and move up the payment of benefits, in addition to making benefits more generous. (Lesson: past Congresses were pretty much like present ones in terms of catering to current voters over future ones.) High benefits were paid, at the expense of the trust fund balance that could help the system fund itself in perpetuity. This was, in effect, like eating your seed corn: things look good in the short-term, but you don’t have the means necessary to keep things going for the long run.
sinz54 // Feb 16, 2009 at 9:13 am
Social Security was never intended as an investment program like a 401(k). It was intended as an insurance program with a guaranteed return. That’s more like a fixed-income annuity than a 401(k). Social Security isn’t just for retirees. It also pays out benefits in the event of death or disability of the contributor. (One of my friends was supported in his childhood by Social Security, after his working father died suddenly long before retirement.)
sinz54 // Feb 16, 2009 at 9:18 am
And so, given that SS resembles a fixed-income annuity, the reasonable thing to do is add on a variable annuity component. That is, enable the worker to direct additional income (beyond the payroll tax) to a separate account which is invested in, say, S&P 500 index mutual funds. This will build up a pool of money that is invested in the stock market and managed by some Government Sponsored Enterprise (GSE). But do *NOT* lose the insurance guarantee. If the stock market collapses just as the worker retires, he will continue to get regular payouts from the pool. Or his beneficiaries will, if he dies or is disabled. That’s how a variable annuity works.
Paulie Carbone // Feb 16, 2009 at 12:59 pm
Social security is SO cash
JJWFromME // Feb 16, 2009 at 5:36 pm
What sinz54 said about SS not being an investment program. And speaking of which, I *wish* my 401k got the rate of return that SS got for me last year.
HLMencken // Feb 17, 2009 at 1:32 pm
Please, Republicans, oh please keep reminding the public that you want to destroy Social Security! Thank you!
WmLarsen // Feb 18, 2009 at 1:22 pm
Myth 3
Social Security is not an Investment, but insurance Individuals seek value for their money. No one likes paying more for an item such as gas, food or travel than they have too. The value one receives from Social Security depends on when you were born. If you were born prior to 1930, you got great value. If you were born after 1930 your value decreases on an increasing basis.
Insurance normally is a signed agreement for a defined coverage in return for a defined payment; Social Security has no such signed agreement as well as no defined payment and coverage. Social security is not guaranteed.
The Cost of Money is generally the highest rate of interest you are paying. Applying the
Social Security tax to reduce the number of loan payments would be an excellent way to
create wealth.
The average worker applying the Social Security tax each month to a mortgage reduces a 30-year mortgage to less than 14-1/2 years. Now make the very same payment of principal, interest and Social Security tax into 5% US Savings bonds for the remaining payments of the original term. At the end of 30 years the worker would have a home plus $370,646. This $370,646 is the value attributed to the Social Security tax being used to pay off the mortgage early.
The Social Security Administration has stated they can pay but 73% of benefits. This means the effective interest rate paid on our Social Security taxes is close to zero if not negative. Assuming a 1% return the value at the end of 30 years for the Social Security benefit is $177,807. The mortgage application method improved the net-worth of the worker by $192,839.
Myth 4
Increased Economic Growth will save Social Security The initial Social Security benefit is based on average lifetime-indexed wages. Wage growth is used to adjust past wages of future retires; similar to inflation being used to adjust social security benefits for current retires. When rate of economic growth, and its resulting increase in wages, exceeds the rate of return on the social security trust fund, then social security is actually disadvantaged due to economic growth.
For example if wages were to rise 5% this year, the initial social security benefit for future retires would also be 5% greater. If the trust fund investment returns did not match or exceed the 5% rate of growth then the trust fund would be falling behind on its ability to meet the pay out commitment.
In simple terms economic growth will not save Social Security and in technical terms, increased economic growth makes funding social security worse. [3]
Myth 5
Productivity growth is what is needed to save Social Security Social Security revenues are based on wages earned by the worker. Productivity can contribute to real wage growth (see myth 4) and/or the displacement of workers. Both of these conditions reduce social security revenues. Productivity growth will not help at all.
More myths http://www.justsayno.50megs.com/pdf/political-myths.pdf