Wednesday, December 29, 2004

Day-Trader Nation 

Our distinguished colleague Susan Madrak of Suburban Guerrilla flagged the following item about former defense-industry analyst Stanley Logue of San Diego, who has been collecting Social Security since his retirement in 1994. The ongoing debate over privatization inspired him to wonder whether his nest egg would have been larger had he managed his own money instead of leaving the job to the government, so he pulled out his calculator and got to work:
He recorded all the payroll taxes he paid into the system (including the matching amount from his employer), tracked down the return the Social Security Trust Fund earned for each of the 45 years, and then compared the result with what he would have gotten had he been able to invest the same amount of payroll tax money over the same period in the Dow Jones Industrial Average (including dividends).

To his surprise, the Social Security investment won out: $261,372 versus $255,499, a difference of $5,873.

It's an astonishing finding. The DJIA represents blue-chip stocks. Social Security invests in US Treasury bonds. Over long periods of time, stocks have consistently outperformed bonds. So, you would think that Logue's theoretical stock investments from 1950 to 1994 would have surely outpaced the return on government bonds.

The fact that they didn't illustrates one of the hard truths about stock investing: Timing matters.
The article points out that Logue's imaginary portfolio suffered because he would have been lightly invested during the stock boom of the mid 50's-early 60's, near the beginning of his career, and he retired before he could benefit from the late-90's orgy. However:
The debate hinges considerably on what people want their retirement system to be. Social Security has always been an insurance program. It was never intended as an investment scheme. So everyone - retirees, the disabled, widows, and orphans - receive guaranteed monthly income. The "return" on their Social Security contributions depends largely on how long they live. Those in their 90s have enjoyed superb returns. Those who don't live as long benefit less.

Private accounts, by contrast, involve far more variability, both sides agree. Individuals who enter and exit the market at the right times would undoubtedly do better under privatization.

But under Britain's privatized pension system, so many retirees are doing so poorly at this moment that a commission warned this fall that widespread poverty among the elderly may be returning, which could require massive new government spending . . . .

"Because financial asset returns are volatile, benefits under a personal account system would fluctuate," notes Bill Dudley, an economist at Goldman, Sachs & Co., a New York investment bank. "On a risk-adjusted basis, the privatized account ... becomes much less compelling."

There are other problems with private accounts. Administration expenses of the present Social Security system are minuscule compared with the size of the benefits provided. The Bush administration so far has provided no details on its private accounts plan. But if these are handled by Wall Street, the fees could be sizable, dissipating some of the return from investing in stocks. Logue takes no account of such expenses in his analysis.
We may be certain, however, that our friends on Wall Street have taken account of those "expenses" and found their prospect pleasing in the extreme.

Meanwhile, if you have not yet read "Social Security Is Simple" by our venerated colleague Max B. Sawicky, kindly do so now. After you finish, hurry back, because you will also want to read this.

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