The Social Security tax rate is 12.4%, so in a sense we're all saving a lot. The real question is what's being done with the money.

It's fun to consider an alternative universe in which your lifelong Social Security "contributions" go into stocks. Let's do a constant, 2008-dollar calculation. Let's assume you earn the median U.S. income of $48,000 throughout your life, and 12.4% goes into a personal retirement account that is invested in stocks, which are allowed to compound tax-free.

* For saving from ages 18 to 68, at a real rate of return of 8% per year, your age-68 retirement fund, in 2008 dollars, is $3,538,559.

* For saving from ages 22 to 65, at a more modest real rate of return of 6% per year, your age-65 retirement fund, in 2008 dollars, is $1,146,413.

People find these results too good to be true, but the math is incontrovertible. (Hope I didn't blow it! Check it yourself.). The result depends on your assumptions, but it's pretty good for all realistic assumptions. Which would you rather have on retirement:

(a) a fund that's in the $millions, or
(b) Social Security?

It's tragic that your SocSec money, which is taken away from you, is not put into proper investments. Moreover, the enhanced level of investment resulting from the stock approach would promote economic growth. The money could be invested worldwide in index funds to insulate against the demographic demons that plague Social Security.

By the way, Barack Obama apparently prefers alternative (b), Social Security. Here's a recent quote:

<< Imagine if your security now was tied up with the Dow Jones. You wouldn't feel very confident about the security of your nest egg. >>
-- Obama, Friday, 13-June-2008

Obama's plan is to increase taxes to bail out Social Security, which, of course, is in a chronic state of crisis. He's really saying that capitalism is a failure, and that we need to turn to socialism. This statement is somewhat self-contradictory, since a failure of capitalism would deprive socialism of the tax base it needs in order to survive.

Excellent points. Although it's a moot argument, I do wonder what the impact would be if the US government were a majority shareholder in a significant number of US and international corporations, as would be the case if social security funds were invested in the stock market.

One plus of social security for the "investor" is that it adjusts payouts for inflation, thereby increasing the effective yield. (If I'm not mistaken) Unfortunately for the taxpayer, the money to make this happen comes directly out of his/her/your/my pocket.

But all this is beside the point. It's scary that so many Americans have become so willing to rely so heavily on the government.

I'll charitably overlook your wildly optimistic scenario of the worker who earns 8% real returns while working continuously from age 18 to 68 and consider your slightly less optimistic scenario:

For saving from ages 22 to 65, at a more modest real rate of return of 6% per year, your age-65 retirement fund, in 2008 dollars, is $1,146,413.

There are still several problems with this.

1. Where do you arrive at real returns of 6%? Ignoring for the moment the unrealistic inflation stats we have been spoonfed for the past 25 years, no extended period witnessed such returns besides the 1982-7 and 1992-2000 booms. The Dow has actually returned something like 4.73% nominal returns from the October 1929 peak (380) to the October 2007 peak (14,000)--a 78 year span. Calculate (1.0473) exp 78 = 36.77, which is pretty close to 14,000/380 = 36.84.

In gold terms the dollar has dropped from 1/20 ounce (in 1929) to 1/800 ounce last October, or by a factor of 40, which is actually greater than the rise in the Dow.

Hence, by a neutral measure such as gold, the Dow has actually lost ground. It is unrealistic to expect any real returns, let alone 6% real returns over a 50 year or 43 year working life.

2. Taking the median household income you've cited of $48,000, multiplying by the contribution rate of 12.4%, and multiplying by 43 years in the workforce yields $255,936 in constant dollars--not your inflated $1,146,413.

3. The real problem with Social Security is that it is a pyramid scheme which gave outsized benefits to earlier generations and will stiff later generations. This is compunded by government theft, or diversion to other spending and to tax cuts for the rich, which we have seen a lot of since the last time payroll tax rates were jacked up in 1983. Most Boomers will never recoup the real value of the SS money they put in, and later generations will come up even shorter.

4. Diverting SS into the stock market and away from government bonds would tend to cause the latter's yields to rise--something rarely discussed. This would not be salutory for the overall economy.

You got $255,936 as the result. The calculation looks right, but you completely left out any kind of returns from the investments. (The returns do more than just compensate for inflation. They generate a real increment even after accounting for inflation.)

As for the calculation of stock market returns, the calculation there looks OK, too, but I think you left out the effect of dividends.

According to Jeremy Siegel, The average compound rate of return on stocks from 1926 to 1991 is 10.0%.
(http://www.econlib.org/librar­y/Enc/StockPrices.html)

According to the Bureau of Labor Statistics "CPI Inflation Calculator",
$1 in 1926 has same buying power as $7.69 in 1991. That factor of 7.69 in 65 years implies an average inflation rate of 3.2%.

So, inflation-adjusted return on stocks in that period would be 10.0% - 3.2% = 6.8% per year. I did calcs assuming 6% and 8%, bracketing that value.

<< The real problem with Social Security is that it is a pyramid scheme which gave outsized benefits to earlier generations and will stiff later generations. >>
Very true. They used a pay-as-you-go method, so that the first generation could receive without paying in. Politically, that helped make the program popular. But as a consequence, everyone lost the value of compounding their Social Security savings over decades. This may be the world's worst bargain.

<< Diverting SS into the stock market and away from government bonds would tend to cause the latter's yields to rise--something rarely discussed. This would not be salutory for the overall economy. >>
This is true, but there's an important counter-effect. If the economy were very vibrant (from all the investment generated by Social Security), and if so many people were wealthy (also from Social Security investments), you wouldn't need as much government as we have now.

I have a question: My husband retired more than a year ago. He has always tried to keep my in the dark about money. And he was a real miser when it came to my spending anything for the house, kids and myself, but he managed to buy whatever he wanted in the way of tools, truck, computer, stereos, etc.

Now that he has retired, he has tried to make me think that we must be on a strict budget and can't afford anything. He and the money manager figured at one point that we could live on X amount of dollars per month, and by their calculations, we would still have all the principal when we died. That X amount was much lower than we lived on when he was working. We had 1.7 million when he retired, now with the stock market going down, we have 1.65 m. After I really squawked and pointed out that I didn't think that I should have to live penuriously in my old age so that we could give all the money to the kids when we die. hubby and MM decided on a better monthly allowance which is automatically deposited in an account for our use.

Okay, I am living OK on the amount agreed upon, however, when I want to buy badly needed new carpeting, need to have collapsing patio cover replaced, etc., husband tells me that we cannot under any circumstances take any more money out of the investments besides what we have automatically deducted monthly. I think that he is lying to me. We need at least $15, 000 for these very needed repairs, and I think that he can prevail upon the MM to cough that up. What reason would there be for us not to take extra money out of the account of stocks and bonds that we really need? Husband says he is extremely worried that we will run out of money when we are old and he doesn't want to end up in some cheap nursing home where he won't get adequate care and die in misery without expensive procedures. One of his retirement benefits is a (Part B type of) additional benefits to Medicare. What do you think? should we do without new carpeting/wait until husband can build patio cover by himself (it's has taken him more than six months just to put up sheetrock and paint sheetrock in the garage) So, I think that the patio cover would be much more work and he doesn't always have the expertise to do all of his little projects by himself. He enjoys doing all of these little projects, which will make it ten years from now before we do the needed painting, repairing that need to be done to sell our house.

My original question: why can't we withdraw extra money from our retirement investment accounts when we need it for specific repairs on the house? I feel so frustrated because Hubby and MM go out to lunch periodically to fine tune the investment accounts. I am not invited.

I think I can be forgiven for forgetting about dividends; since about 1991 the dividend yield of the Dow has been under 3%, and is currently running about 2%. A far cry from the 10% dividend yield of 1932. Using a 1926 to 1991 evaluation period skews the average dividend yield up.

In any event, I think my methodology of accounting from peak to peak (or trough to trough) makes more sense than accounting from 1926 to 1991--which leaves out the last 17 years.

Taking Siegel's 10% nominal returns and subtracting my calculated 4.73% annual gain in the Dow would imply an average dividend yield of 5.27%, which I think is too high. I suspect by at least 100 basis points (one percent).

Using the Dow as I've done actually overstates average returns, as many companies fail and the constituents of the DJIA are reassembled periodically--from new winners, not losers. I use the DJIA instead of the S&P 500 as the latter index does not go back to 1929.

In the last 40 years the DJIA and the S&P 500 have had almost exactly equivalent gains, about 1,300%.

<link>

The S&P is of course also periodically reassembled with winners, not losers.

The NASDAQ has gained a higher percentage since its inception than either the DJIA or the S&P 500, but has also experienced more volatility (higher gain implies more risk).

In short, I don't deny that counting dividends, stocks overall may have risen by 10% nominally, but there has been risk associated with these gains.

As for your citing the BLS to the effect that $1 in 1926 has same buying power as $7.69 in 1991, I would counter that basic necessities have risen faster than the 3.2% you imply--particularly since 1973. Take energy, food, housing, tuition, medical care--even gold. Gold was $20 in 1926 and over $300 in 1991, having risen by a factor of 15, not 7.69. I take the liberty of doubting the BLS statistics, as they have a built in political incentive to downplay inflation. In any event, why stop at 1991? I showed how gold had risen 40-fold since 1929, and the same is true for oil. True, soft commodities have not risen as much, and technology has actually declined--though not as much as the Hedonics of BLS would have you believe.

In summary, the problem with your argument stems mainly from the BLS figures. Check out John Williams' Shadowstatistics site for a more accurate reading.

from what i've read here, it would seem that the smart thing would be to invest a portion of the money and leave some in the traditional SS mechanism.

wait a minute. that's what both moynihan and president bush recommended and the democrats screamed like stuck pigs. could it be because they want you poor and dependent?

i'd say that would be an affirmative.

IrvingChang: from what i've read here, it would seem that the smart thing would be to invest a portion of the money [in the stock market] and leave some in the traditional SS mechanism.

Seeing as most people rely on Social Security for only part of their retirement needs, the bulk of which is provided by other sources (investments), we already have a mix of fixed income and equity investments.

Your point again was?

Just as a general point: how valid is it to use long-term past data to predict long-term future data. Are the factors that unlie the growth in the stock market changing? For the better? For the worse?

I can think of at least three reasons that would justify lower expectations going forward:

1: There is more capital out there chasing whatever opportunities exist. That means more competition and lower "prices" for the capital.

2: Energy issues may significantly constrain growth

3: Much of our growth, even in industrialized nations, comes from geographic expansion. Note how many of our big companies now have half or more of their sales overseas. What happens when we run out of geography into which we can expand?

Regardless of what the historic returns have been, it is a pretty rosey assumption that they will continue.

You are assuming that the US government would invest in an economically rational way like a prudent fiduciary. It's duty and power to do so would be subject to whatever statutory provisions Congress imposes.

Large public pension funds like CalPers are subject to a variety of non-economic political pressure, including preference towards in-state investments and moral investment/disinvestment requirements. I suspect that it would be far worse at the federal level, and that Congress would be tempted to treat the Social Security fund as an immense pork barrel for the industrial policy du jour -- ethanol, preserving failing smokestack industries, or what have you. The same process that produces bridges to nowhere will make the federal government the sucker of last resort for every bad idea that can buy influence on K Street.

In addition, the CalPers experience demonstrates that large public pension funds are by no means passive investors. They take an aggressive role in corporate governance, and they can have considerable influence on whether takeover bids succeed or fail. Do you want Uncle Sam swinging that kind of club?

'Your point again was?'

this is my point

<link>

Martin,

Your post omits one huge chunk of the SS equation and posits its intent as some sort of investment plan. I think that leads you to some wrong conclusions.

First, the omission is that SS also provides for disability and for the premature death of the wage-earner who leaves behind dependent children. It has never been stricitly a retirement plan.

Second, it is Social, meaning we're all in it together, Security, meaning an assured base. Moreover, it may more truly be described as a welfare program, transferring income from present-day workers to retirees. It is an implied covenant between generations.

But I'd some other factors as well.

Before SS, workers generally worked themselves to death. Retirement hardly existed. And, since none of us knows how long we'll live, in order to plan for retirement, in a universe absent SS, the average worker would have to over save! Can't count on dying at 80, after all! And that would have a somewhat depressive effect on the overall economy.

SS therefore might have provided a net gain by freeing up income to spend on consumption. (Creating a demand-pull effect on corporations, which then hire more workers, increase investment, etc.)

Wow! Some great numbers crunching here. Thanks, Genedio.

Sakura,

You've raised some good questions here. I think point two may have the greatest impact of all. We have all essentially bet our retirement portfolios on the existence of the cheap fossil fuels which have literally powered all the world economic growth. And if that supply is reduced, growth goes down the toilet. Bye-bye Dow Jones.

Questions:

1. Who would pick the stocks?

2. Should your stock return be reduced because you would have to buy the equivalent disability insurance? Remember, it is OASDHI not only OASI.