STOCKS and SOCIAL SECURITY

  Stocks Safe Enough for Social Security?
Retire at 80% of Final Pay--Guaranteed? */


        Stock safety in social security is equal to that of Treasury bonds. This study unequivocally demonstrates the continuous equal safety of stocks compared with Treasury bonds in a social security setting. And it shows that the magnitude of stocks' earnings superiority is 13 times more than bonds in buying power on average. It does not address fiscal-legislative remedies for the present system. But these are not difficult to mandate while maintaining all present commitments.

STOCK PROFITS CAN BE ENORMOUS. So can stock losses. Retired workers want guaranteed, steady income, adjusted yearly for inflation, to replace partially the wages they no longer earn. Current law provides them with this. Is there a fit between these sets of facts?

Older people are terrified of inflation. Younger people are angered at injustice of paying into a system that, as they think, will be empty before they will get anything out of it. None wants benefits cut. All who work chafe at the high and rising mandatory payments into the system, which, they are widely informed by politicians and media as well as by the Office of the Chief Actuary of the Social Security Administration, is headed for bankruptcy around 2038. And many workers resent not being able to direct the investment destiny of the funds which the Federal Government takes from them in the form of taxes to invest on their behalf.

The now emergent proposition is that stocks should be allowed to some extent in private investment accounts as part of the statutory Social Security System in the United States because stocks are more profitable than government bonds.

Despite widespread, prevailing, contrary opinions and the accompanying cloud of misperception and ignorance of the historical relationships of bonds, stocks and inflation, the returns from stocks as a class of investments since 1871 (the earliest reliable data available) have always exceeded the return from government bonds as a class by enormous margins and, more important, have never had a loss with respect to the actuarial structure of a retirement fund. Let us look at this structure which expands returns beyond expectations and reduces to inconsequentiality the probability of any loss.

Demography is Destiny

The typical individual enters the work force at the age of, let us say, 20 (some earlier, some later, but no matter), and contributions to the retirement fund commence on his behalf. Work ends upon retirement at age 60--savor the illustration! (versus the current, statutory 62 or 65, soon to be 67). Mortality occurs 20 years later at age 80. These numbers may be more precisely adjusted by actuaries, but they are exemplary for my purposes.

With this lifespan structure, the appropriate investment horizon is precisely either 40 years (the work span) or 60 years (from work entry into the system until mortality). In the case of the former, the investment-funding vehicle is exchanged into a benefits-payment vehicle upon retirement. The vehicles are different. In the second case, the 60-year span, the initial funding vehicle remains in place, and benefit payments are distributed from it; there is a single vehicle. In either case, stocks are demonstrably as safe as bonds and pay two to three times as much in investment returns at the very least. These two investment horizons are riveted into the exact time line of the wage earner's working and retired life. Other time frames for the retirement investment horizon are entirely without meaning, relevance, or utility. I will here treat comprehensively of the 40-year period. Conclusions regarding it apply a fortiori to the 60-year period.

There are eighty nine 40-year periods from 1871 (the earliest year of reliable data for use here) to the present. Invest $1 each in stocks, bonds, and the rate of inflation ("CPI") each year. Then calculate the cumulative final value (the "Wealth Index") of each dollar for each of the 40-year periods (Table 1 below).

At the end of the worst period for stock returns out of all eighty nine 40-year periods, 1880-1920, $1 intially invested in stocks and held for 40 years is worth $7.50. In U.S. Treasury bonds, $1 is worth $3.40, and the cost of living rose to $2.60. Stock and bond returns are both positive. Neither investment category loses money. The terminal wealth margin of stocks over bonds is better than two to one.

In the best of periods for stocks, 1949-1989, terminal wealth is $109.60 versus $8.20 for bonds, with inflation rising to $5.30. The terminal wealth margin of stocks over bonds is better than 13 to 1. Here is the summary for the last 129 years. The table shows the terminal value of 1 at the end of 40-year periods for each category heading. (The compound annual returns ranged from about 9% for stocks to about 4% for bonds with inflation around 3%. I will come back to these data in another table in a moment.)

Table 1.

Cumulative Wealth Indices and CPI 1871-1999
Selected 40-year Periods
Value of $1 at End of Period

Best & Worst

Trsy

Corp

Cum

Ratio

Periods

start

end

Stcks

Bnds

Bnds

Bills

CPI

St/Tb

Stocks best period

1949

1989

109.6

8.2

9.9

8.2

5.3

13.3

Stocks worst period

1880

1920

7.5

3.4

5.6

5.9

2.6

2.2

TreasuryBnds best

1958

1998

92.4

17.4

20.5

10.8

5.7

5.3

TreasuryBnds worst

1929

1969

26.7

2.5

3.5

2.2

2.2

10.6

CPI highest inflation

1940

1980

74.3

2.9

3.4

4.0

6.1

25.6

CPI lowest inflation

1871

1911

12.1

4.7

9.5

6.5

1.1

2.6

Avg All Periods

1871

1999

40.2

5.0

6.8

4.9

3.1

8.1

Columns 4 through 7 show the ending values of $1 held for 40 years.
Column 8 shows the ending price of $1 over the same period.

Sources and notes: end of the article

Next we must take account of the fact that the employee-employer contributions in the form of taxes occur every year of the employee's 40-year work span. Therefore a more comprehensive measure of final wealth is needed. Table 1 dealt with terminal wealth for only single 40-year periods for each investment category. There are 39 additional years in each work span, each year with its own compounded terminal value whose term decreases one year at a time as the wage earner moves toward retirement. Summing the total terminal wealth indices for all the periods in the 40-year span gives us a "Final Wealth Index" for each wage earner upon retirement. */

The final wealth indices (Table 2 below) appear surprisingly large and shockingly wide ranged. They are not. Their annual compound rates of return fall into acceptable ranges. They are easily actuarialized into requisite stability by appropriate smoothings. The important thing is that in no period did stocks show a loss (nor did bonds), demonstrating the equality of safety of stocks with bonds despite single-year negative total returns in stocks (there were 35 loss years out of 128, averaging one year per every three or four), the largest, of course, being the cluster ending in 1932 which produced a maximum four-year drawdown of 65%.

There were 15 single-year loss years in Treasury bonds (total-return basis, wherein the change in the market value of the bond is added to its income yield), with the worst negative cluster ending in 1959 with a -3.5% drawdown and a single-year bond negative return of -7.3% in 1994.

The final columns show the stock-bond and stock-inflation ratios of relative final terminal wealth under a variety of conditions. Average compound returns for all periods were 9.7% for stocks and 4.1% for bonds. CPI averaged 3.1%.

(In Table 2, I have omitted the Table 1 columns "Corporate Bonds" and "Bills" for the sake of simplicity. Note that Corporate bonds offer significantly superior wealth accumulation vs. Treasuries. These matters, however, lie beyond the scope and intent of this article. They are touched upon in the Notes which follow at the end of the article as are the magnitudes of absolute final real wealth of stocks which average 60 times more than the final real wealth of Treasury bonds in Table 3. Table 3 also shows the failure of bonds to keep up with inflation, often by shocking margins, in 21 out of 89 periods.)

Table 2.

Cumulative Final Wealth Indices and Related CPI 1871-1999
Selected 40-year Multiple-Year Periods
Value of $1 at End of Period

Best & Worst

Trsy

Cum

Ratio

Ratio

Periods

start

end

Stcks

Bnds

CPI

St/Tb

St/CPI

Stocks best period

1959

1999

1272

283

115

4.5

11

Stocks worst period

1901

1941

133

94

51

1.4

2.6

TreasuryBnds best

1958

1998

1142

321

116

3.6

10

TreasuryBnds worst

1948

1988

671

176

122

3.8

5.5

CPI highest inflation

1950

1990

627

210

127

3

5

CPI lowest inflation

1948

1988

671

176

47

3.8

14

Avg All Periods

465

109

80

4

6

Sources and notes: end of the article


Some Indisputable Conclusions

Four telling conclusions emerge from this summary table. First, Stocks equal bonds in safety. There are no losses (Lines 2 and 4). Second, Stocks far exceed bonds in wealth accumulation in all periods (Columns 4, 5, and 7). Third, Stocks offer substantial potential increases in benefits or reduced taxes ¹/ or both. Finally, the gross demographics ratio of worker/retiree population need no longer apply because each worker's entitlement can be a separate, private account owned by the worker. Sufficient unto each worker's benefit needs are the specific assets thereto.

This fulfills my purpose in this study to show the feasibility and desirability of adding stocks to the Social Security System's reservoir of investments for its participants, especially for new entrants. The feasibility rests on the demonstrated safety and superior returns of stocks relative to bonds. The desirability rests on the magnitude of the superiority of the returns--as major corporations in the U.S. have long recognized. ²/

Income on retirement from social security could conceivably be raised to levels much closer to the level of wages paid during the last year of work. ³/   Statutory taxes could be reduced considerably below their current levels. And consideration can be given to fully replacing bonds in favor of stocks in the system for selected age cohorts. The specific actuarial details of accomplishing these desiderata are beyond the purpose and scope of the present article. They are touched briefly in the Notes below.

What can go wrong? Three things (not to mention the Law of Unintended Effects--LUE). Poor stock management; overconcentration in index funds; fundamental alteration of the 'capitalist' system in the West. There are also further substantive issues which would need to be, or could be, addressed--alternative funding vehicles upon retirement; and the alternative use of AAA corporate bonds versus U.S. Treasuries dependent upon assessment of the validity of the historical data, current and projected levels of issuances and magnitudes outstanding, and liquidity impacts; also, the inherent variances to be expected in 40-year Final Wealth Indexes will need appropriate smoothings in the benefits calculations. I leave these matters to the Office of the Chief Actuary and others.

Stock-portfolio management. The questions arise: who will manage these stock funds? Individuals, professionals, or the Government? Will individual stocks (or mutual funds) be allowed or only broad index funds? My preliminary answers would be: professionals and index funds, both to be selected by the individual covered workers within broad but protective requirements. If only index funds, then the next possible problem arises:

Overconcentration in index funds. Thoughtful people have advocated the exclusive use of indexed investments in retirement funds. When ERISA was signed by the U.S. president on Labor Day in the Rose Garden in 1974, the whole new profession of ERISA law and lawyering was spawned. Some early attorneys took the position that using anything else except index funds in the stock portion of private-sector pension funds would be a fiduciary breach under the law. Robert A.G. Monks, Pension Administrator in the first Bush administration, held that, in general--not just with respect to retirement funds--investment by large institutional portfolio managers was best accomplished by index-fund investing when it came to stocks. To be sure, the more dollars which are invested in index funds, the greater will be the volatility of prices of both the indexes and their component stocks. What happens when the last dollar goes into the last, giant index fund? That will not happen. There will always be distinctly investment dollars and speculative dollars--with enough speculative dollars worldwide to game the market, resulting in continual oscillation in the transaction characteristics of the market. (But it is here, in this overconcentration, that LUE would most likely to emerge.)

Fundamental alteration of the 'capitalist' system in the West. It is hard to imagine that a time may come when the concept and fact of capital disappears from the Great Tripartite Basis of Economic Theory which--like 'All Gaul'--is divided into three parts. Capital, Labor, and Tools. Social, economic, and political history are replete with temporary milestones of events, eras, developments, and artifacts which were considered impossible or unimaginable prior to their actual arrival on the scene of human history. (See in the Notes below "Bond Safety: Sovereign Power vs. Corporate Resilience.") 4/

Conclusion

Stock returns are always larger than bonds'. Stocks are just as safe as bonds for actuarial purposes. Stocks beat inflation in all instances. It is prudent and appropriate to use them in selected private accounts in the U.S. Social Security System.

*

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Sources. Global Financial Data, Inc. supplied the raw data upon which the calculations in my three tables were made. The Office of the Chief Actuary of the Social Security Administration supplied some of the data appearing in the Notes.

Table 3.

Final Wealth Indices, Annual Returns, and Related CPI
All 40-year Periods 1871-1999
Ending Value of $1 Contributed Annually


Updated through 2005 available
here

Period

Wealth Index

Cum

Real Wealth

Annual % Return*

Ending

Stocks

Bonds

CPI

Stocks

Bonds

Stocks

Bonds

CPI

1911

203

86

49

154

36

6.8

3.0

1.1

1912

207

85

51

157

34

7.0

3.0

1.1

1913

178

84

52

126

32

5.2

3.0

1.2

1914

161

83

52

109

31

4.4

3.0

1.2

1915

206

83

53

153

30

7.7

3.1

1.3

1916

211

82

59

153

23

7.5

3.0

1.5

1917

146

81

69

78

12

3.4

3.0

1.9

1918

169

76

82

88

-6

5.9

2.3

2.4

1919

187

74

92

95

-18

7.2

2.2

2.6

1920

143

75

93

50

-17

3.9

2.6

2.6

1921

157

82

81

75

1

5.3

3.6

2.2

1922

190

82

78

112

4

7.5

3.5

2.2

1923

186

84

79

107

5

6.7

3.6

2.3

1924

223

87

78

145

9

8.6

3.8

2.4

1925

269

89

79

190

10

10.4

4.0

2.5

1926

289

91

77

212

15

10.3

4.1

2.5

1927

372

92

73

299

19

12.7

4.1

2.4

1928

509

89

71

438

18

15.5

3.6

2.3

1929

437

91

70

366

21

11.9

3.9

2.4

1930

307

92

65

243

27

7.5

3.9

2.2

1931

161

89

58

103

32

1.5

3.5

2.0

1932

139

91

51

88

40

1.2

3.7

1.8

1933

201

93

50

151

43

6.3

3.9

1.8

1934

182

95

50

132

45

4.9

4.1

1.9

1935

246

95

51

195

44

8.9

4.0

2.0

1936

299

94

51

248

43

10.7

3.7

2.0

1937

175

94

51

124

43

4.1

3.8

2.1

1938

213

96

49

164

47

7.2

3.9

2.0

1939

194

94

48

146

46

6.0

3.7

1.9

1940

162

95

47

114

48

4.2

3.8

1.9

1941

133

94

51

82

43

2.7

3.5

2.0

1942

152

92

55

98

38

4.8

3.4

2.2

1943

181

91

55

126

36

6.8

3.3

2.2

1944

201

90

55

146

35

7.8

3.2

2.2

1945

258

92

55

203

37

10.4

3.4

2.2

1946

224

89

63

160

26

7.6

3.1

2.5

1947

223

85

67

156

18

7.4

2.7

2.7

1948

216

84

68

148

17

7.1

2.7

2.7

1949

240

85

64

175

21

8.3

2.9

2.5

1950

296

81

67

229

15

10.4

2.5

2.7

1951

345

78

69

276

10

11.4

2.3

2.8

1952

384

78

67

316

10

11.8

2.3

2.7

1953

357

77

66

291

11

10.1

2.3

2.7

1954

505

76

64

441

12

14.3

2.4

2.6

1955

612

73

63

549

11

15.5

2.0

2.6

1956

612

70

63

549

7

14.1

1.7

2.4

1957

513

72

63

450

8

11.1

2.2

2.1

1958

671

68

64

608

5

14.6

1.8

1.8

1959

692

65

64

628

0

14.0

1.4

1.6

1960

645

69

65

581

4

12.4

2.4

1.5

1961

740

68

64

676

4

14.0

2.3

1.7

1962

613

70

64

548

5

11.3

2.6

1.8

1963

692

68

65

627

4

12.7

2.4

1.8

1964

737

69

65

672

4

13.1

2.5

1.8

1965

767

67

65

702

2

13.0

2.3

1.8

1966

647

69

67

581

2

10.4

2.5

1.9

1967

757

65

68

689

-3

12.2

2.0

2.0

1968

803

64

70

733

-5

12.1

2.0

2.1

1969

712

60

73

639

-13

9.8

1.2

2.2

1970

713

69

76

638

-7

9.6

3.0

2.5

1971

774

74

77

698

-2

10.3

3.7

2.8

1972

833

74

77

755

-3

11.3

3.4

3.2

1973

627

74

82

545

-7

8.1

3.3

3.5

1974

421

75

89

332

-14

4.4

3.3