New NCPA Study
July 23, 2001
Investing Social Security surplus in the stock market is less risky than doing nothing
WASHINGTON (July 23, 2001) - Investing the Social Security surplus in the stock market is less risky than maintaining the status quo, according to a study released today by the National Center for Policy Analysis (NCPA) and the Private Enterprise Research Center at Texas A&M University.
"Although market returns can fluctuate widely from day-to-day or even year-to-year, the volatility of the market is reduced to a few percentage points over long holding periods," said NCPA President John C. Goodman. For example, over the past 128 years:
- The annual return on stocks ranges from a worst-year drop of 35 percent to a best-year increase of 47 percent. But over investment periods of 35 years, the return ranges between 2.7 and 9.5 percent.
- The return on bonds ranges from a one-year low of 10.8 percent to a one-year high of 18.4 percent. But over investment periods of 35 years, the return ranges between 0.6 and 5.1 percent.
"Stocks are a lot less risky than most people think," said Andrew J. Rettenmaier, one of the authors of the study. Written by three economists at Texas A&M University, the study concludes that over long periods, investing in the stock market is much better than investing in bonds or in mixed portfolios of stocks and bonds.
According to the study, in any 35-year period over the past 128 years:
- The average annual real rate of return for an all-stock portfolio was 6.4 percent, with the lowest being 2.7 percent.
- By contrast, most young people entering the labor market can expect a return on Social Security taxes they pay of less than 2 percent.
The study estimates that if a typical worker contributes 2 percent of earnings to an all-stock portfolio over a 35-year working life:
- During retirement, the average expected return from a private annuity would equal 43 percent of currently promised Social Security benefits.
- However, the actual annuity could range from 85 percent to 17 percent of the currently promised Social Security benefit.
How these potential variations affect the retiree's actual pension benefit depends on the specific Social Security reform adopted. Every serious reform proposal limits the downside risk to the retiree. Under most proposals, retirees would be guaranteed a benefit at least as much as under the current system.
What happens if the surplus is not invested in the market? "When today's 18-year-olds become eligible for retirement in 2050, their children and grandchildren will face a payroll tax of about one-third of their incomes just to pay for Social Security, Medicare and other health benefits currently promised," Goodman said.