New paper: “Social Insecurity: Personal Accounts and the Stock Market Collapse”

I have a new paper out today through AEI called "Social Insecurity: Personal Accounts and the Stock Market Collapse." The paper is the first in AEI's new Retirement Policy Outlook series and builds on previous work on how personal accounts would have fared given the stock market conditions of the past year or so. Here's the summary, followed by a few comments:

The recent financial crisis and ensuing stock market gyrations have drawn renewed attention to Social Security reform, in particular proposals to establish personal retirement accounts that invest in stocks and bonds. As Barack Obama asked a campaign audience, "Imagine if you had some of your Social Security money in the stock market right now. How would you be feeling about the prospects for your retirement?" But despite the recent market downturn, individuals investing four percentage points of the 12.4 percent payroll tax in a personal account holding a "life-cycle" portfolio and retiring today would have increased their total Social Security benefits by more than 15 percent. Moreover, a simulation of ninety-five cohorts of individuals retiring from 1915 through 2008 found that all of them would have increased their total Social Security benefits by holding personal accounts. These results are not intended to understate the risks of equity investment, but rather put them in perspective. Some analysis has overstated the importance of returns over a short period of time relative to those over the full course of a working lifetime by looking at declines in stock returns over only the last year. While individuals retiring today may have ended with a lower account balance than they expected, they would nevertheless have significantly increased their total retirement benefits by virtue of choosing to participate in a personal retirement account.

There are three key parts to the paper:

First, a relatively simple simulation of a stylized personal account plan against stock and bond returns from 1871 through November 4, 2008. This modeling shows that all cohorts with personal accounts would have increased their total Social Security benefits, by an average of around 15 percent.

Second, a discussion of how the results from this analysis differ from similar simulations by Robert Shiller of Yale and Gary Burtless of the Brookings Institution, both of whom come to different conclusions than I do. The paper shows that Shiller's paper's methodology dealing with historical market returns tends to overestimate the number of account holders who would fail to "break even" by holding an account. Burtless's work simulates (in essence) IRA or 401k plans invested in stocks, not a Social Security reform plan where accounts are integrated with the rest of the program. As you model reform plans more closely, many of Burtless's results fall away.

Third, a broader theoretical discussion of stock returns, personal accounts and Social Security reform. This draws some important caveats on the data-driven work in the paper and notes that personal accounts might best be viewed as a saving tool, not as a means to get higher returns via investment in equities.

I'll try to post the data and calculations in an Excel file later today.