Social Security Reform: The Risk Factor

by Matt Moore

Is the stock market too risky for retirement savings? Only if you believe the opponents of President Bush's proposal to reform Social Security with personal retirement accounts. Fortunately, history is not on their side.

President Bush launched the public debate when his bipartisan Social Security reform commission released its final report in 2001, which called for the integration of personal retirement accounts into the current Social Security system. These accounts would allow younger workers to set some money aside to be invested in real assets, earn a market rate of return over the worker's life and pay a portion of the worker's Social Security benefit at retirement.

Senate Minority Leader Tom Daschle (D-S.D.), one of many leading the charge against personal retirement accounts, said recently that "a lot of us thought that idea was a bad idea two years ago, when the Dow was going up every week. After what's happened to the stock market ... we think it's a terrible idea!" As evidence, Sen. Daschle and his fellow opponents quickly note that the S&P 500 stock index is down more than 40 percent from its high in 2000.

But just how risky would a personal retirement account invested in the market be? Here are the facts. Workers will not be asked to rush home after work and trade stocks on the Internet. In fact, they won't be able to pick and choose individual stocks at all. Workers would be able to choose between a limited number of pre-constructed, diversified portfolios at varying levels of risk, each of which would be sponsored by a professional money manager operating under government oversight.

In addition, workers will not be investing for just one or two years; they will hold their investment for their entire working life - 35 to 40 years or more. This is why arguments about short-term market losses don't hold much water.

While the market may go up and down sharply from day to day and even year to year, over the long haul it always grows in value. In fact, throughout the 20th century, diversified investments that tracked the entire market have been profitable. For example, according to an analysis of investments in an S&P 500 Index by economists at the Private Enterprise Research Center, over any 35-year period within the last 128 years the market has provided an average annual return of 6.4 percent after inflation. Even the lowest 35-year period provided a return of 2.7 percent.

That means a worker who maintains a broad, diversified portfolio or index fund can earn money, even if the stock market experiences returns equal to the worst since 1907.

What about today's market? Since hitting a peak in 2000, the S&P 500 Index has fallen more than 40 percent. If we had implemented personal retirement accounts 35 years ago, and the first retirees who had held accounts all their lives were retiring, these workers would still have earned an average annual rate of return of 7.3 percent.

Of course, if workers still think the market is too risky - or don't trust Wall Street with their retirement money - they will likely have the option to invest their money in government and municipal bonds instead. Albeit, their returns will be lower over time.

Ah, opponents say, despite all this, personal accounts can never compete with a bedrock program as safe and secure as Social Security. But remember the current system faces a $25 trillion long-term debt that it cannot pay. That's why we're having this conversation about reform to begin with - we can't afford to keep the current system.

In fact, a recent analysis by the Social Security Administration's independent Office of the Chief Actuary found that in most cases, a system with personal retirement accounts would provide future retirees greater benefits than the current system can afford to pay. Low-wage workers in particular would earn substantially higher benefits than the current system promises, and much more than the current system can afford to pay - as much as 25 percent more.

That sounds like a risk worth taking.