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December 22, 2004

WSJ.com - Model Reveals Social Insecurity

Modelling Social Security private accounts on the U.S. Federal Government's Thrift Savings Plan is a lot better than almost every other private account option I can think of. But there is still the danger that account holders will use their (limited) set of investment options to churn their portfolios, buying risky equities high and selling them low. This is not appropriate for what is supposed to be the baseline, low-risk tranche of retirement income.

WSJ.com - Model Reveals Social Insecurity: By TOM LAURICELLA Staff Reporter of THE WALL STREET JOURNAL December 22, 2004; Page C1: ...the Thrift Savings Plan, the government's version of a 401(k) retirement program. Now, it is being touted as a model for the private investment accounts that are central to the Bush administration's proposal to revamp Social Security. "People are not going to be allowed to take their own money for their retirement account and take it to Vegas to shoot dice," President Bush said last week. Any investment accounts, he added, would be "similar to the thrift savings plans that we federal employees have available to us now."...

A look at the TSP shows that the limited menu of investment options -- the TSP offers five options, less than half as many as the typical corporate 401(k) retirement plan -- doesn't protect participants from losses in the stock or bond markets. Nor are participants insulated from making the common investing mistake of chasing hot performance and, as a result, buying when prices are high and selling when prices are low... those who made changes in recent years rushed to buy stocks at the height of the bull market. Then, after stock prices collapsed, participants moved out of their stock funds and into bonds.... Financial advisers generally say investors should stick with an appropriate investment strategy and not overreact to the market's ups and downs....

Created in 1986, the TSP today has 3.4 million participants and holds more than $147 billion in assets. Of its five investment options, four are index funds managed by Barclays Global Investors.... The TSP was launched with just three... the Standard & Poor's 500-stock index... a Lehman Brothers bond-market index and a fund in which participants' money is invested directly in short-term U.S. government securities. In May 2001, the TSP added a fund that tracks an index of small-company stocks and an international-stock index fund.

The TSP often wins praise for extremely low fees. In 2004, the total cost to participants has been a meager 0.06% of assets, which would amount to just $6 in fees on every $10,000 invested through the plan. Even by the standards of low-cost index funds, that's a bargain....

Posted by DeLong at December 22, 2004 11:40 AM


Is there a difference between fees and administrative costs? I thought the admin costs of the Social Security Trust Fund were something like 0.5%, supposedly a low figure and much lower than other costs for other countries that have privatized their pension systems.

Posted by: Brian S. at December 22, 2004 11:59 AM

Again...presumably, privatized Social Security would require or allow investors to purchase an annuity at some point, and that ain't gonna cost 0.06%.

(Added note: Brian S.---this might be a partial answer to your question.)

Posted by: liberal at December 22, 2004 12:09 PM

The analogy is flawed. The Thrift Savings Plan is the equivalent of a 401(k) plan. Many people already have private 401(k) investment plans. What they don't have are lifetime guaranteed pension plans that federal employees have. Social Security is the civilian equivalent. Try privatizing federal pensions and listen to the squealing.

Posted by: JackM at December 22, 2004 01:40 PM

"the total cost to participants has been a meager 0.06% of assets, which would amount to just $6 in fees on every $10,000 invested through the plan. Even by the standards of low-cost index funds, that's a bargain"

I guess Paul Krugman doesn't have the resources to dig up that kind of information.

Btw, Social Security is definitely not the equivalent of a government pension. If you quit working for the federal govt. you can take your contribution out and roll it into an IRA, for one thing.

Posted by: Patrick R. Sullivan at December 22, 2004 03:23 PM

In general regular annuities are fairly cheap because they are directly comparable in the same way that a US fixed rate mortgage is. They do suffer from some adverse selection which makes them more attractive to the longer lived wealthy and that might become more significant if the market is forcibly broadened but for those that buy them they are much cheaper than the saving phase for example (see Murthi, Orszag & Orszag 2000).

In addition to the problem of replacing a very secure earnings linked layer with something that looks like a currently second tier pension, it is highly unclear that putting really enormous amounts of money into tracker funds is a good idea. The 30 year buying spree would leave index funds owning a significant percentage of the stocks of the largest companies and the price of equity varying vastly between the company 500th in size and the company 501st. Eventually it would lead to enormous corporate governance issues and large companies buying small ones to arbitrage the disparity in equity prices. In 30 years it would look like nationalisation and the people charged with voting the shares would be ridiculously influential and have to serve many masters. Will there be an elected Investment Officer in Chief? Well maybe.

Posted by: Jack (not M) at December 22, 2004 03:24 PM

I can only mention again that it is pointless-to-disingenuous (to worse) to criticize a proposal for change without comparing it to the status quo.

For example, if the claim here is that it's bad that people might lose money on their contributions invested in private accounts, shouldn't we also mention that today's workers are *guaranteed* to lose money via the SS status quo benefit formula?.

If that's the criticism, "might have a loss relative to contributions, upon retiring" then the comparison is:

A) Private accounts: risk of loss on a diversified portfolio over 40 years -- remote, it's never happened in any 40-year period in history.

B) Status quo: losses relative to contributions are guaranteed by the benefit formula, up to a 50% loss for workers today in their 30s, and if SS stays paygo up to 65%.

If "risk of loss" is your measure, which is your choice?

Yes, markets have risk -- but to *guarantee* a loss on investment over 40 years takes a government.

Posted by: Jim Glass at December 22, 2004 03:27 PM

Jim Glass,

well, then it's easy to argue that it's better for everyone to lose a little than for a few to lose a lot....and the rest having to bail out the losers.

Chile and Britain are spending money to bail out losers. Total costs have not gone down for this reason.

By the way, after fees and inflation, the vast majority of regular people don't make much or any money on the stock market.

Posted by: Truth Teller at December 22, 2004 05:30 PM

Jim Glass wrote, "I can only mention again that it is pointless-to-disingenuous (to worse) to criticize a proposal for change without comparing it to the status quo."

Except that, in case you haven't noticed, Bush hasn't come up with a concrete proposal. And refuses to.

"Yes, markets have risk -- but to *guarantee* a loss on investment over 40 years takes a government."

Except that---duh---Social Security isn't an "investment."

Posted by: liberal at December 22, 2004 05:30 PM


SS does more than provide retirement benefits. Do the returns you talk about include the disability and life insurance aspects of SS?

Posted by: GT at December 23, 2004 01:05 AM

Does anyone publish the distribution of winners and losers amoung the investors in the Thrift Savings Plan? Might give us an idea of what portion of Social Security recipients would need to be bailed out.

Posted by: fred at December 23, 2004 07:54 AM

All I can say is that if Bill Clinton had been ready five years ago to "mend, not end" Social Security using the Thrift Savings Plan as a model five -- we'd all be arguing about Al Gore's plan for getting us out of the quagmire in Afghanistan.

[What have you been smoking? The key to Republican strategy in the 1990s was to deny Clinton *any* victories on anything. "No Clinton proposal shall pass" was their operating procedure. Or did you just not get the memo?]

Posted by: Pouncer at December 23, 2004 10:27 AM

What is needed is a baseline tranche of silence and space.

Posted by: cloquet at December 23, 2004 12:13 PM

"well, then it's easy to argue that it's better for everyone to lose a little than for a few to lose a lot....and the rest having to bail out the losers."

So, since you don't dispute Jim's figures you are arguing that everybody losing 50% or more is a little? Boy you must have been really foolish over the last few years to have that kind of perspective. You need a new financial advisor who hasn’t convinced you that such losses are reasonable and unremarkable. Few people if any in a well designed selection of investments would choose so poorly as to have half what they put in after a forty year period. So if my choice is 100% of workers losing 50% versus say 2% having such losses I am mystified by your argument. Of course I doubt anybody after a twenty to forty year period would do so poorly and I am about as bearish on the prospective returns as one can be. Returns might be low for a great many people. Almost no one would have negative returns.

As for the Disability and Insurance aspects, unlike with SS heirs could keep the assets. That is a much better deal than the insurance aspects of SS.

"Except that---duh---Social Security isn't an "investment."

I would agree. Nothing which guarantees a particular return can be called an investment. Hey, I work in financial services. Why don't you look me up, promise to give me 10% of your wages each year and I promise to give you exactly half that amount in ten years? Are you a taker?

This line of argument suggests a reform that should satisfy all these type of comments. How about we give the workers private accts, have them invest it in money market accts. After inflation the losses still shouldn't be as large as the SS return. However, at least then the workers could pass the remainder to their heirs.

Posted by: Lance at December 23, 2004 02:01 PM

The Thrift Savings Plan site tsp.gov has a wealth (sorry) of information. Employees receive a lot of advice about investing, and I expect that if something like the TSP were available to everybody, then all the personal finance columnists would be giving advice too. What makes the TSP attractive to the new participant is the matching money from the employing agency. If Bush offered something like that he'd have to jump back so as not to be run over by people rushing to join.

Posted by: ej at December 23, 2004 05:51 PM