Social Security Benefits: Poor, Nasty, Brutish and Short

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machinehead's picture
machinehead
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Social Security Benefits: Poor, Nasty, Brutish and Short

The president who campaigned on a platform of 'change' digs in his heels on Social Security:

“I’ll fight with everything I’ve got to stop those who would gamble your Social Security on Wall Street,” Mr. Obama said on Saturday in his weekly national address. “Because you shouldn’t be worried that a sudden downturn in the stock market will put all you’ve worked so hard for — all you’ve earned — at risk.”

“A few years ago, we had a debate about privatizing Social Security,” Mr. Obama said. “And I’d have thought that debate would’ve been put to rest once and for all by the financial crisis we’ve just experienced.”

http://www.nytimes.com/2010/08/15/us/politics/15address.html?hp

Oh my -- all that's missing from this overheated rhetoric are scenarios of impoverished grannies subsisting on cat food.

The old-age component of Social Security is a defined-benefit pension plan. Every other defined-benefit plan in the country that I'm aware of -- corporate, union, government -- invests in a mix of equities and bonds. The reason is simple: over the past century, bonds have returned about 3% annually, while stocks have produced a total compounded annual return of about 8% -- 4% from capital gains, and 4% from dividends.

Currently, stock dividends at 2% yield only about half their historical average. So, conservatively, one might downgrade expected returns on stocks to only 6%, in place of the 8% historical average. Dr. John Hussman has derived a similar expected equity return, using more sophisticated techniques.

The difference between earning a 3% yield on Treasuries and 6% on equities is enormous, when compounded. Even in a single year, the 3% yield difference amounts to $88 billion on Social Security's $2.92 trillion in reserves.

President Obama's scaremongering about 'stock market downturns' reflects a profound misunderstanding about how a long-term investor such as the Social Security Trust Fund operates. Up until now, Social Security has been a net acquirer of assets throughout its existence. Stock market downturns would have been opportunities to buy cheap -- no selling would have taken place at disadvantageous prices.

Indeed, the first two decades of Social Security's existence -- from 1935 to 1955 -- were the best buying opportunity of the century for stocks. Not only did stocks yield a fat 6% or so during this period, but also they went on to rise in price by a factor of 50-fold through today. Meanwhile, Social Security was accumulating Treasury bonds at record low yields. From 1942 to 1951, Treasury yields were pegged at 2.25%, meaning that the Social Security Trust Fund was condemned to paltry returns in a managed market.

Rejecting the judgment of all other pension funds to run a 'Treasury only' portfolio carries enormous costs. Among these costs are the pitiful average Social Security benefit of only $1,069 a month -- a below poverty line income. The higher return which Social Security could have obtained on a conservative mixed portfolio probably would have supported average benefits of over $2,000 a month today.

Obama's remarks reflect a passionately-held ideology that government investments are somehow purer or more trustworthy than private-sector ones. Whether this is true or not, it is an extremely costly indulgence that a nation now in permanent deficit can hardly afford. Pension funds worldwide hold equities; this is standard practice. Social Security remains mired in the Depression mindset of 1935, when it was created. As a result, its hapless participants can look forward to retirement benefits that are poor, nasty, brutish and short. It didn't have to be this way.

V's picture
V
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Re: Social Security Benefits: Poor, Nasty, Brutish and Short

I am with you MH.

I say we turn all those IOU'S over to Goldman Sachs, JP Morgan, Morgan Stanley, Citicorp, Bank of America and let them invest it for us.

V

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Re: Social Security Benefits: Poor, Nasty, Brutish and Short
machinehead wrote:

The reason is simple: over the past century, bonds have returned about 3% annually, while stocks have produced a total compounded annual return of about 8% -- 4% from capital gains, and 4% from dividends.

MH,

I normally have the highest regard for your posts but I will take issue with this contention about equity returns.  While these are the figures commonly promulgated by the Wall Street propaganda machine, I simply don't believe them.  From the cherry picking of the stocks for the various indices to such eminent investors as Jim Rogers disagreeing with these figures when he is making a case for commodities, there is too much shakey ground here for me to want to build the foundation of my financial house on top of it.  For example, one analysis looked at every stock that was ever part of the Dow (including those many stocks that were rotated out of the Dow when they underperformed) and the net return over the years has been flat, zero, nothing, nada, nichts.

Granted, one can make good money in stocks ... I've done so.  But the cards are rigged and the deck is stacked and I for one, no longer wish to play their game nor do I wish to have my SS money put at risk in the game (even though I'm certainly aware it's being put at risk in other ways). 

Plus, to consider investing SS in equities while still in a secular cycle favoring commodities is, to me, unwise.  For example, I would have hated to see SS money go into equities in 1929 and have to wait until the early 50s before it started generating some positive returns.  Count me out on this one.  YMMV.

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Re: Social Security Benefits: Poor, Nasty, Brutish and Short

 

Machinehead:

I don't mean disrespect, but the other big problem with your analysis (aside from ignoring the survivorship bias in the market indices or the fact that 60% of all publicly traded stocks' values eventually go to zero due to companies failing, or how a HUGE trillions-worth WHALE moving into the market waters will mean buying at inflated prices or how the 3Es point to a bleak growth future) is the assumption that there is actually money in the Social Security "trust fund" to invest.

In reality, all of the "surplus" each year is counted as current revenue - invested in special U.S. Treasury bonds - that are immediately spent. All those years until now (where we actually gave out more in benefits that paid in) where we even had a little bit of a surplus, the surplus was spent by the Federal government already. The extra money is now going to have to come out of other Federal government revenues (taxes, fees,etc.) There is no giant pool of money to be moved into something else - even if those special U.S. Treasury debt obligations owned by the Social Security Fund could be sold, who would buy them, at what price and for how much longer?

It doesn't matter what what Obama has said on this. I'd rather not see you singling him out for special attacks - pretty much all politicians on both sides of the aisle won't touch this third rail of American politics. The last major change in 1983 took a MASSIVE bipartisan effort (unlikely now with both at major odds and the vitriol dialed up)  to raised the retirement age to 67 on a graduated basis. I doubt it will happen again and even if it does, more and more people are taking half benefits at age 62 because of poor health and a bad jobs market.

Poet

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agitating prop
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Re: Social Security Benefits: Poor, Nasty, Brutish and Short

Regardless of  past stats, what does the future hold? I have zero invested in the stock market, so I can argue for large cap stocks from a detached perspective.  In a world that is controlled by  transnational oligarchics, subsidized by tax payers of nation states,  who benefits, who survives?

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DrKrbyLuv
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Re: Social Security Benefits: Poor, Nasty, Brutish and Short

Social Security doesn't have any money to invest, the government spent it all.

The government should monetize our SS IOUs then we would have something to invest.

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Re: Social Security Benefits: Poor, Nasty, Brutish and Short
DrKrbyLuv wrote:

The government should monetize our SS IOUs then we would have something to invest.

Larry,

Wouldn't this idea constitute an outlet through the 'money trap' as we've recently discussed ?

Just thinkin'.

 

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Re: Social Security Benefits: Poor, Nasty, Brutish and Short
Poet wrote:

I don't mean disrespect, but the other big problem with your analysis (aside from ignoring the survivorship bias in the market indices or the fact that 60% of all publicly traded stocks' values eventually go to zero due to companies failing, or how a HUGE trillions-worth WHALE moving into the market waters will mean buying at inflated prices or how the 3Es point to a bleak growth future) is the assumption that there is actually money in the Social Security "trust fund" to invest.

There is no giant pool of money to be moved into something else - even if those special U.S. Treasury debt obligations owned by the Social Security Fund could be sold, who would buy them, at what price and for how much longer?

It doesn't matter what what Obama has said on this. I'd rather not see you singling him out for special attacks - pretty much all politicians on both sides of the aisle won't touch this third rail of American politics. 

Poet, you're right that the Social Security Trust Fund consists of non-marketable IOUs. Moreover, it isn't as large as it should be to meet Social Security's future obligations. The Financial Report of the United States, page 147, estimates that Social Security has a $7.677 trillion funding shortfall, in terms of net present value. So the Social Security Trust Fund actually should be more than triple its present size, for Social Security to be fully funded.

Nevertheless, I used the amount of the Trust Fund simply to put a number on how much annual income is potentially being sacrificed by accepting below-market returns. If it were triple the size, as it should be, it would be sacrificing $260 billion a year in potential earnings.

The equity returns I cited include survivorship bias. Over the years, companies have been dropped from stock indexes such as the DJIA and S&P and replaced with others. A few were dropped because they failed, or turned from large caps into small caps, or canceled their dividends (a requirement to be in the DJIA). Others were replaced because of mergers and takeovers. But the 8% long-term total return from equities includes these dropouts and replacements.

If you don't believe this, you can assemble the individual index components from the published Standard & Poor's daily stock price records available at your public library. These volumes were published quarterly since 1962. Before that, microfilmed newspapers such the New York Times  provide stock price and dividend data going back to the late 1800s. I have spent hundreds of hours going through these old archives, from the 1920s forward, and have yet to find any glaring errors in the calculation of index returns.

The DJIA index divisor is available from 1896 on, so you can enter the security prices and dividends into a spreadsheet and recalculate the total return for yourself. But Ibbotson & Sinquefield already did this, for T-bills, T-bonds and stocks. Sinquefield established one of the original S&P 500 index funds in 1973. In looking back to 1926, Ibbotson and Sinquefield had no interest in deceiving themselves. If they had, they would have been caught out. But no 'survivorship bias' critic has ever successfully challenged their numbers. Ibbotson's total return research is still sold by Morningstar:

http://corporate.morningstar.com/ib/asp/subject.aspx?xmlfile=1383.xml&ad=07Cat

Although the first S&P 500 index funds weren't established until 1973, a blue-chip investor could have mirrored the DJIA and other indexes prior to that time. The S&P 500 index in its present form began in 1957; an S&P 90-stock index began in 1923; while the Dow Jones index began in 1896. All of these indexes weeded out non-survivors. You can verify their performance from then until now, including the replacement of corporate failures. Their compounded annual total return, depending somewhat on which year you begin, is around 8%. The Ibbotson-Sinquefield indexes, a bible of the finance industry, commence in 1926, when the 1920s bull market was already well underway (thus depressing average returns slightly, as compared to cherry-picking a crisis-year starting point such as 1920).

The 'equity risk premium' is one of the most fundamental, universally-accepted assertions of finance. Every defined benefit pension plan, other than Social Security, incorporates equities -- because they can't afford not to. But the equity risk premium was unknown in 1935, and Social Security remains mired in the pre-Modern Portfolio Theory darkness. By 'modern,' I'm talking about the 1950s -- Modigliani-Miller and all that. Dozens of Nobel Prizes in Economics have been awarded since then. But Social Security soldiers on -- blind, uncaring and impervious -- in its flat-earth, 1935-stopped-clock universe.

Since government is the last entity in society which ever gets a clue, we can at least be thankful that they didn't invest the entire Social Security Trust Fund into stocks in 2007. Believe it or not, a non-profit on whose board I served considered doing exactly that in 2007, after receiving a financial windfall. I argued passionately against this, and saved them from going over the waterfall. But long-term, I will assert with equal ferocity that shunning the superior returns of equities is a Luddite, head-in-the-sand stance. Not a single sovereign wealth fund on the planet invests on that basis. We in the US don't have a sovereign wealth fund, as our government's net worth is negative. Wake up, America.

p.s. -- Disrespect? If you object to my ideas, whack them as hard as you can -- no offense taken! Smile

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Re: Social Security Benefits: Poor, Nasty, Brutish and Short

Machinehead:

Thank you for the well-thought out reply to my comments. I'm no stock Luddite either - but I just don't think what you're advocating will be feasible. No amount of healthy persuasion of the benefits to the public will cause the government to part with current established policy of investing solely in these special U.S. Treasury bonds. If anything, the government needs them to be purchased.

Poet

 

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