To: "homestead AT lists.ibiblio.org" <homestead AT lists.ibiblio.org>
Subject: [Homestead] Social Security 2005: Personal Accounts Already Work
Date: Thu, 30 Dec 2004 07:15:22 -0700
December 27, 2004, 10:05 a.m.
The Lesson of Thrift
Personal accounts already work (which might be why the critics are so scared).
Critics of the Bush administration plan to reform Social Security with
personal accounts have a seemingly endless supply of reasons why it cant
possibly work. You know the litany: Its too risky. Its too expensive.
Its too complicated.
The critics never mention that theres already a government-administered
retirement system that has shown for over 15 years that personal accounts
are prudent, inexpensive, and simple. Its the Thrift Savings Plan of the
United States federal government, currently serving 3.3 million government
employees.
The years since Thrift was first offered in 1987 couldnt make for a better
laboratory to crash-test a personal-account system. During this period
there have been both bull and bear markets that were among the most severe
in history. Through year-end 2003, investments in Thrift personal accounts
have earned $44.4 billion in profits for system participants an average
of more than $13,000 per participant.
Over time and on average, 65 percent of the value of Thrift participant
accounts has been invested in a special money-market account operated by
the U.S. Treasury. Thats been responsible for about $20.3 billion of the
total investment gains. But almost as much $19.8 billion came from an
S&P 500 Index fund. Thats remarkable because, on average, only 30 percent
of the value of participant accounts has been invested in the S&P 500 fund.
This is a textbook lesson in why it makes sense to invest in equities. Even
though they are riskier in the short-term, they have a higher expected
return in the long-term. Thats why the S&P 500 fund has earned just about
as much for Thrift participants as the plans money-market account, with
only half the money invested.
Yes, after the bubble burst there were three difficult years for stocks
2000, 2001, and 2002. In those bear-market years, Thrift participants
overall lost money in their accounts, with losses in the S&P 500 fund
overcoming gains in the money-market account (as well as the third fund
tracking the Lehman). But the non-stock funds did well in those years, and
2003 was a great comeback year for stocks. (This year has been okay, too).
So the least-lucky participants, those who started right at the top of the
market in 2000, have already gotten back to even on average and those
who started even a little earlier or a little later are solidly ahead.
How did Thrift participants react to the bear market? Not a bit like the
scared rabbits that critics pretend the non-professional investors are.
They didnt dump right at the bottom; there were net redemptions from the
S&P 500 fund in only 1 year 2001. And when the market finally hit true
bottom in the early spring of 2003, there were the biggest net
contributions to the S&P 500 fund in Thrifts history. Today, 43 percent of
participant investments are in the S&P 500 fund (with another 10 percent in
the other two stock funds).
And what about Enron? Dont the critics always carp that gullible investors
will lose their retirement fortunes in stocks, like Enron, that suddenly
implode? Amazingly enough, any Thrift participant who invested in the S&P
500 Index fund did indeed invest in Enron, because Enron was a member of
the S&P 500 Index until it was removed in late November, 2001 (after all
the damage had been done). But Enron was only 1 of 500 stocks, so its risk
was diversified away, just like the textbooks say.
The use of index funds has other advantages too advantages that perfectly
answer the critics of personal accounts. For one thing, index funds are
simple to understand. Thrift started with one for stocks and one for bonds
about as simple as you can get. Two years ago Thrift added two more funds
one for smaller company stocks and another for non-U.S. stocks. Still,
its so simple that even the most inexperienced investor can get it.
And index funds are cheap to operate. As I discussed in detail in my column
last week, investment management fees for index funds are ruinously small
for the managers. And speaking of cheap, Thrift is a model of efficiency.
Its administrative costs are only about six one-hundredths of 1 percent of
invested assets. That compares especially favorably to Social Security,
which has administrative costs that are more than five-times greater, even
though youd think its vast scale would lead to significant economies.
Index funds also have the advantage of being very resistant to meddling by
government bureaucrats. Critics of personal accounts complain that any
government-sponsored retirement system creates an irresistible temptation
for politicians to guide participant dollars toward favored investments, or
for politicians to grandstand by interfering with corporate governance.
Indeed, all those things have happened in large pension plans sponsored by
state governments. But theres never been a whiff of it at Thrift. Thats
because investment in simple index funds is clearly mandated in the
legislation that created it it would take an act of congress to permit a
bureaucrat to funnel Thrift money into some pet investment.
Ironically, the Thrift Savings Plan a perfect model of the future of
Social Security reform with personal accounts was created as part of the
last round of Social Security reform. Legislation passed in 1983 as part of
the reforms recommended by the Greenspan Commission mandated for the first
time that federal employees participate in the Social Security system. The
idea was to force millions of new young participants to move back the day
when the demographic time bomb threatening Social Security will inevitably
explode. As you can imagine, federal employees werent thrilled, and Thrift
was part of a complex package of adjustments designed to make them feel
better about it.
The Thrift Savings Plan proves that theres nothing too risky, too
expensive, or too complicated about personal accounts for Social Security.
So what are the critics really worried about? I think theyre afraid that
personal accounts are too empowering. Once a nation of voters becomes a
nation of empowered investors theres just no telling what kind of
empowerment theyll want next.
Donald Luskin is chief investment officer of Trend Macrolytics LLC, an
independent economics and investment-research firm. He welcomes your
comments at don AT trendmacro.com.