Social Security and Market Risk
Tuesday, July 31, 2001
by Liqun Liu, Andrew J. Rettenmaier, and Zijun Wang
Table of Contents
"In the long run, investing Social Security taxes on the financial markets involves very little risk."
Members of both political parties have come out in favor of personal retirement accounts as a means of prepaying some of Social Security's looming liabilities. A persistent criticism of such a move has been that the accounts would expose future retirees to too much investment risk. But as we have seen, this criticism is invalid for several reasons. First, the rates of return are less volatile than they are usually made out to be. Fundamentally, realized rates of returns from long-term stock market investments show less variation than annual swings. Second, using conservative assumptions about the annuitization of personal retirement account balances at retirement, we find that returns from portfolios with at least 60 percent stock holdings are higher 98 percent of the time than the return today's young workers can expect from the Social Security taxes they pay.
Finally, prepayment plans of the sort that allow workers to invest part of their payroll taxes in personal retirement accounts will partially, but not entirely, replace Social Security. With a mixed system, the redistribution inherent in the benefit formula may be maintained if desired, and taxpayers can continue to serve as the insurer of last resort, paying the portion of scheduled benefits that are not paid for by the personal retirement account annuities.
NOTE: Nothing written here should be construed as necessarily reflecting the views of the National Center for Policy Analysis or as an attempt to aid or hinder the passage of any bill before Congress.