NCPA - National Center for Policy Analysis

Investing Suplus In Stocks Less Risky Than Doing Nothing

July 23, 2001

Based on the historic long-run behavior of the stock market, investing the Social Security surplus in stocks via personal retirement accounts would be less risky than maintaining the status quo, according to a study released today by the NCPA and the Private Enterprise Research Center at Texas A&M University.

Social Security uses a worker's highest 35 earning years to calculate benefits. In even the worst 35-year period in the stock market, the return has been greater than the return a young worker today can expect on Social Security taxes paid.

In fact, the study found, 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.
  • The average annual real rate of return for a portfolio of 60 percent stocks and 40 percent bonds was 5.1 percent, with the lowest being 2.0 percent.
  • By contrast, nearly all young people entering the labor market can expect a return on the Social Security taxes they pay of less than 2 percent.

To provide insurance against outliving one's savings, a retirement system based on individual retirement accounts must convert the funds into annuities upon retirement. The study estimates that if a typical worker contributes 2 percent to an all-stock portfolio over 35 years:

  • During retirement, a private annuity would be expected to equal 43 percent of currently promised Social Security benefits, on average.
  • The annuity could equal anywhere from 85 percent in a best-case scenario to 17 percent in a worst-case scenario -- however, every serious proposal limits the downside risk to the retiree.

And if the surplus isn't 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 just to pay for Social Security, Medicare and other health benefits now promised.

Source: Liqun Liu, Andrew J. Rettenmaier and Zijun Wang, "Social Security and Stock Market Risk," NCPA Policy Report No. 244, National Center for Policy Analysis, July 23, 2001.

 

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