Despite Poor Economy, Study Finds Private Investment Offers Better Returns Than Social Security

February 27, 2012 - 1:48 AM
CATO Institute

(CNSNews.com) – Workers who invest privately over time will retire with higher incomes than those who rely exclusively on benefits from Social Security, according to a new study from the CATO Institute.

“If workers who retired in 2011 had been allowed to invest the employee half of the Social Security payroll tax over their working lifetime, they would retire with more income than if they relied on Social Security,” the study found.

“Indeed, even in the worst-case scenario – a low-wage worker who invested entirely in bonds – the benefits from private investment would equal those from traditional Social Security.”

Over the last 40 years, investors saw an average yearly return in the S&P 500 index of 6.85 percent, in addition to 3.46 percent and 2.44 percent for corporate and government bonds, respectively. These percentages are in comparison to a 2.2 percent rate of return on Social Security benefits for a “middle-income earner retiring in 2012.”

To prove the argument that private investment in a combination of stocks and bonds leads to higher income upon retirement than solely receiving Social Security benefits, the study sets up a hypothetical scenario over a period of 40 years.

The scenario involves three workers of different income brackets who started working in 1968 and retired on November 7, 2011. All three chose to take half of the Social Security payroll tax they would have paid for government benefits and instead diverted it to a private account.

The scenario breaks down into three distinct investing strategies. Two involve exclusively investing in stocks or bonds and the third gives the workers investment portfolios that are equally representative of stocks and bonds.

Taking into account the economic downturn of 2001-2002 as well as the 2008 financial crisis, all three workers would theoretically still have received a higher rate of return than had they paid the full Social Security tax over time and relied solely on government benefits.

“Clearly, the worker would have seen a significant decline in accumulated assets during the market declines of 2001-2002 and 2008-2009,” the study said. “However, despite these losses, the worker would always be better off than if he or she had received Social Security’s rate of return.”

“In every case, a worker would have received higher monthly benefits from private investments than from Social Security. In fact, even in the worst case scenario, a low-wage worker who invests entirely in bonds, the worker does no worse than Social Security.”

After displaying the results of wage accumulation and returns for each worker with each investment strategy, the study does acknowledge “a few caveats.”

It cautions that the trends and averages of past returns will not necessarily be replicated in the future. In fact, the study cites the estimates of Social Security Administration actuaries that predict lower equity returns along with lower returns from Social Security.

The study counters criticism of a lack of adjustment for the risk associated with private investment by pointing out that a worker will still receive the same amount of return on a given investment regardless of the amount of risk involved.

“On the other hand, workers receive whatever return they receive, not a return reduced by risk adjustment. Risk adjustment may measure a psychological factor about the desirability of various investments – how people ‘feel’ about those investments – but they do not measure the return that people actually receive.”

To highlight the need for privatization, the study discusses the shortcomings of the Social Security system. As of this year, the Social Security Administration is experiencing a deficit, giving out more benefits than it takes in from tax revenue, and has almost $21 trillion in unfunded long-term liabilities.

The study predicts the Social Security Trust Fund will be “exhausted” by 2036, and will then have to rely solely on pay-roll tax revenue.

The study, “Still A Better Deal: Private Investment vs. Social Security,” was conducted by CATO senior fellow Michael Tanner. He and other CATO experts have published numerous works advocating the increased privatization of Social Security.