Why Social Security Should Be Privatized

While searching the internet, I found an old article by former New York Governor Eliot Spitzer entitled, “Privatize Social Security?!  Can We Finally Kill this Terrible Idea?”  Interested, I read through the article and was surprised that his analysis showed that the return from the current Social Security system would be about as good as a private account.  Digging into the numbers a little bit, I discovered the reason.  His analysis was plain wrong.

The Governor uses a hypothetical couple making $100-$150,000 per year at retirement.  He states correctly that their Social Security income would be about $3000 per month.  He then looks at what sort of return they could get if they instead saved in a private account – for example, if they had put their Social Security taxes into a 401k-like account during their careers.  He comes up with a return of about $3000 per month if they get out in a good year like 2007, but only $2000 per month if they get out in a bad year, like after a market crash like 2008.

I was surprised that the return was so low when compared to Social Security, and soon discovered why.  He simply states, without any sort of justification, that “With an income of that size, the couple would be able to save about $500,000.”  Really?  Let’s run the numbers.

I looked at average family incomes since the 1950’s and values of the S&P 500 index since that time.  I chose the S&P 500 since it is a good measure of the overall value of the markets.  For income levels, I used a chart from Stanford for the period of 1960-2000 and data from the census bureau for 2005 and 2010.  For the S&P500 values, I used Yahoo.  For simplicity I assumed fixed income for five-year periods and fixed values of the S&P 500 for the same five-year periods.  For each five-year period, I calculated how many shares a family on the median income could purchase of the S&P 500 index (or an index fund tracking it).  To find the values at retirement, I simply multiplied the shares accumulated by the price of the S&P 500 at that time.  Here’s what I calculated:

Year Income Yearly Contribution Share Price Shares Bought Total Shares Value
1960 $5,300.00 $689.00 $55.34 62.25 62.25 $3,445
1965 $7,500.00 $975.00 $84.12 57.95 120.2 $10,112
1970 $8,500.00 $1,105.00 $72.72 75.98 196.18 $14,266
1975 $12,000.00 $1,560.00 $83.36 93.57 289.75 $24,154
1980 $17,500.00 $2,275.00 $102.09 111.42 401.17 $40,956
1985 $24,000.00 $3,120.00 $191.85 81.31 482.49 $92,565
1990 $30,000.00 $3,900.00 $306.05 63.72 546.2 $167,165
1995 $34,000.00 $4,420.00 $500.71 44.14 590.34 $295,588
2000 $42,148.00 $5,479.24 $1,454.60 18.83 609.17 $886,102
2005 $46,326.00 $6,022.38 $1,180.59 25.51 634.68 $749,295
2010 $49,445.00 $6,427.85 $1,030.71 31.18 665.86 $686,308

So, in 2010 our family at the median income level would be making about $50,000 per year – about 1/2 to 1/3 of the amount Governor Spitzer’s theoretical family made.  And yet, the amount they had invested in 2010 was almost $700,000.  This means that the couple he described, which would be upper-middle class and have incomes well above the national median, would have between $1.4 M and $2.1 M saved.  Assuming he calculated his annuity values correctly, this would be a monthly income of about $6000 to $8000 per month – far above the $3000 they would collect from Social Security.

So what if they retired in 2008, the worst possible year, instead of in 2010?  Well, the S&P500 was at $815 that year, so the couple at the median income would have “only” had about $550,000 in savings, receiving about $3200 per month from an annuity – a little more than the Social Security income the wealthier couple would receive.  Spitzer’s upper-middleclass couple would have had two to three times that, or $6400 to $9600 per month.

If they waited five more years, the S&P 500  would have recovered and then some, closing currently at $1771.  Our median couple would have about $1.2 M in savings, or a monthly payout of somewhere like $7,000, and his upper-middleclass couple would have $2.4 M to $3.6 M and receive between $14,000 and $21,000 per month, compared with their Social Security income of $3000 per month.

But wait, it gets worse.  Governor Spitzer says that the couple with the private account who buys an annuity would receive the payout until the death of the older of the two, which is correct.  If the couple were on Social Security instead, the surviving spouse would lose income when his her husband/wife died.  If they made equal incomes, this would cut their income in half to about $1500 per month.  Meanwhile, the surviving spouse with the private account would continue to receive the full income level.

But what if the couple dies at age 65 before receiving Social Security?  Social Security would pay a death benefit of $500 per person, or $1000 for the couple.  All of the rest of the benefits would be gone forever.  If the couple had private accounts, their children/heirs would receive the full value of the accounts, minus any estate taxes and income taxes due.

Social Security is not a pension fund or a retirement fund.  It is a system by which money from one generation is paid to the previous generation with the government taking any excess and spending it however they desire.  Because the money is not invested, the returns are terrible.  And even with the terrible returns, the system is still running out of money since there are more people retiring than entering the workforce and because the government continues to spend more than it takes in and eventually it will need to make cuts somewhere.

The best thing we could do is create a real national retirement system where Social Security taxes were directed into private accounts that would stay with the individual.  These accounts would provide better returns, could be left to heirs if the retiree dies early, and would not be subject to the uncertainty caused by political policy and deficit spending by the government.  Elliot Spitzer’s “guaranteed” returns aren’t all that guaranteed, and are lousy besides.

Contact me at vtsioriginal@yahoo.com, or leave a comment.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Three Reasons Wall Street is Booming; Three Reasons Main Street is Dragging

Investors on Wall Street have been doing very well over the last few years.  Even over the last few weeks, as the government shutdown took effect and various commentators warned of a “default on the economy” if the debt ceiling were not lifted, the market held up relatively well.  The average worker on Main Street has been doing less well.  This clearly shows that the stock market and the economy are not always correlated.  In fact, they often act independently of each other, or even are negatively correlated – one goes down when the other goes up.

The stock market looks at corporate earnings, future values, and factors such as inflation.  Consumers and workers look at job stability, the level of spending or business, and how valuable they feel to the company for which they work when judging their confidence in the economy.   The markets are also often concerned with predictability, so the markets may rally after taxes are raised. for example, because there would no longer be a question of whether taxes would be raised.  The consumer, on the other hand, may feel poorer when taxes rise and reduce his take-home pay.

To understand the current economy and markets, let’s look at three factors affecting the stock market and three factors affecting the consumer markets.

Factors Affecting the Stock Market:

1.  Federal reserve Policy is inflationary and stimulative.  There is an old saying to “never fight the Fed.”  This means when the Federal Reserve is keeping interest rates low to encourage borrowing and growth of the economy, it is good to be long stocks.  Likewise, when it is raising interest rates and taking money out of the economy, it is wise to take some profits and raise cash, or even go short stocks.  Low interest rates can also have the effect of causing inflation, which will eventually lift stock prices in dollar terms as dollars become less valuable.  The Federal Reserve has been keeping interest rates low and, with the economy going nowhere fast, is unlikely to be raising them anytime soon.  This has helped drive the market boom.

2.  Corporations have become more efficient, raising profits.  Because business dropped off during the last recession, businesses laid off all but their best workers.  Unable to hire workers back due to the slow economy, they have purchased technology and improved their processes to allow them to get by with fewer workers.  As the economy has come back somewhat, they have been able to produce more profit per worker, thereby increasing their profits.  Higher profits per share has caused share prices to advance.

3.  Low interest rates have forced savers into stocks.  Normally savers and people in need of current income (like retirees) would be invested mainly in CDs and Treasury bonds.  The very low interest rates, however, have forced these savers to take on more risk, buying dividend paying stocks, large cap funds, and the likes.  This has caused the price of equities to rise.

Factors affecting main street:

1.  Businesses have been slow to expand and hire more workers because of low growth rates.  The economy has been growing at a very anemic rate, causing businesses to delay expansion and hiring until the economy appears to be picking up.  In addition, the efficiency improvements and technology investments which have helped corporate profits have allowed companies to get by with fewer workers, reducing the employment rate.  Note that while the employment rate has been declining, the labor participation rate has been dropping as well.  This means that individuals are simply giving up, rather than that people are finding jobs.

2.  Regulations in the healthcare law and elsewhere are discouraging hiring.  The Affordable Care Act requires that companies that have 50 or more full-time workers provide health insurance or pay a fine.  Employees working 30 hours or more per week are considered full-time.  This has caused businesses to either not hire or convert workers to 29 hour per week schedules or less to avoid the jump in costs, which in some cases would make the workers cost more than the amount of money they produce for the company.  

Beyond the healthcare law the government has been far more activist than it has ever been.  With new environmental regulations being enacted that regulate CO2 production, new wage limits being discussed, government voiding of contracts (for example, during the auto bailout) companies are leery of hiring and expanding.  They have instead taken a wait-and-see attitude, waiting for the dust to settle so they can pick the best path in  the new regulatory environment or perhaps simply waiting for the next Administration.

3.  Fewer people are working, meaning that there is less being produced to go around and people feel poorer.  During his speech at the Democratic National Convention, President Clinton spoke of how employment rates dropped significantly during his second term after Newt Gingrich and the Republican Congress passed welfare reform which he signed into law.  This caused people who had never worked before to enter the labor market.  Because there were more people working, there were more goods and services being produced, which in turn could be traded, causing the economy to grow.  This lead to consumer confidence, resulting in more spending and a more rapid expansion of the economy.

We have seen the opposite effect since the 2008 crash with welfare rolls expanding and fewer people working.  Because a large number of people are not producing anything, there is less wealth to trade even though they are receiving benefits from the government.  This means that businesses expand slower and there are fewer jobs created.  This all leads to a weakened outlook from the consumer and, consequently, less spending.

Contact me at vtsioriginal@yahoo.com, or leave a comment.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

The Land of Opportunity

The United States has long been known as the Land of Opportunity.  Unlike other parts of the world where you might be doomed to a life of poverty unless you were born into the right family, anyone could go from poverty to middle class or even wealth in one generation in the US.  This is because there were schools (traditional and trade schools) where individuals could learn skill regardless of their backgrounds, there were jobs where people were paid in relationship to the value they produced, there were opportunities for individuals to grow in their jobs and increase their skills and salaries, or even create their own job if desired, and there was the ability to invest and save so that wealth could grow over time.  Sadly, the US has reached the tipping point where this may no longer be possible.

The large amount of wealth that exists in the US exists because most people in the past were productive.  While there were a small number of people (percentage wise) who were physically or mentally unable to be productive, the large majority of people did something during the day that was useful to other people.  (Note in a capitalist society, people receive income when they do something that someone else wants or needs, and therefore is willing to pay for.  If people were receiving a paycheck, they must therefore have been doing something beneficial to others.)  This has started to change, with more and more people not working and instead receiving welfare from the government.

It certainly is tempting to choose welfare over work.  In many states the total amount of benefits available approaches the income one would receive from an entry-level or even mid-level job.  Many would question the wisdom of getting up early, getting dressed, driving through rush-hour traffic, working at a job all day, and then fighting the commute home when you could make the same amount by simply walking to your mail box and pulling out a check.

The issue, however, is that as more and more people are getting a check (or an EBT card, home heating aid, disability aid, etc…) it means that fewer are actually producing things.  Think about a situation where two families have farms in isolation.  If both families are growing crops and raising animals, harvesting, going through the work of canning vegetables and smoking or salting meat, and doing what is needed to keep their farm implements and buildings in repair, it is very likely that both families will have more than enough food, clothing, and other necessities.  If there are several families farming, it is also likely that they will be able to help a family who cannot support themselves – for example, one in which the husband died when he had four young children.

If one of the two families decides not to farm (or half of the families in a set of farms decide not to farm), however, and instead use the force of the government to take food and supplies from the families who are farming, there will be half as much food, clothing, and other items available for everyone.  Items that might once have been in high supply, like corn, bacon, and flour, might suddenly be very scarce.  The society has lost the output of the labor from those who were once working, and therefore there is less to go around.

The situation in the case of the two farming families would be very obvious.  One could go and see that there was half as much grain as there was before the one family decided to stop farming.  In a big society like the US, however, it will be less obvious.  Things will  just start to be in short supply.  Prices will increase and many will likely blame the merchants or producers of price gouging and other practices,  The fact is, however, that one cannot raise prices when there is an abundance.  If someone tries to gouge there will be others who undercut him and prices will fall back down so long as there is a lot of production.

This situation can be reversed, but it will take individuals going against their instincts.  People must work for what they need even though they can get it with no effort.  People may need to take what they see as a pay cut when they return to work (or start working for the first time in their lives), getting less initially from working than they were getting on welfare, but knowing things will be better in the long run.  Those who are working must no longer be blind to those who can work but who choose to sponge off of the system.  While it should not be shameful to take help when you truly need it, those taking welfare who can produce for themselves should be embarrassed for doing so.

If you are on welfare and not taking a job because you’ll get less than you are receiving now, consider what your children think.  It would be better for them to see their parents out doing something during the day instead of being paid for doing nothing when they are physically and mentally able to do better.  After the welfare reform of the late 1990’s, many lifelong welfare recipients spoke about how they had pride for the first time int heir lives once they were forced to find a job and provide for society.  We can become the land of opportunity again, but to do so we must bring back pride in work.

Contact me at vtsioriginal@yahoo.com, or leave a comment.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.