How Capitalism Will Save Us (22 page)

Some critics believe that we’re better off with lower-risk programs, such as government-run retirement accounts composed only of government bonds. One alternative to 401(k)s that received considerable attention was proposed by Teresa Ghilarducci, professor of economic policy analysis at the New School for Social Research. Ghilarducci has proposed replacing 401(k)s with a guaranteed retirement account administered by the Social Security Administration. Workers would get a six-hundred-dollar annual inflation-adjusted subsidy from the U.S. government and would have to invest 5 percent of their pay into the account. That money in turn would be invested in special government bonds that would pay about 3 percent a year.

Such a plan may sound appealing in today’s environment. But in the Real World it’s a bad idea for a variety of reasons. Foremost among them:
do we really want to entrust our retirement savings to government policy makers or, for that matter, to the Social Security program—which does not exactly have the best track record for sound financial management?

The Social Security Trust Fund was founded to provide a safety net to workers in retirement. You would put money in during your working life and draw on it when you retired, much like an annuity. It was supposed to be an insurance system—hence the term
trust fund
. But if a private-sector company were run like Social Security, its executives would probably get jail time.

You’ve paid countless thousands of dollars into Social Security over your lifetime. But unlike the funds in your 401(k), the money isn’t being held in a dedicated account that’s yours and guaranteed to be there at your retirement. Unlike a traditional annuity, no reserves are set aside to meet future obligations. Thus, as baby boomers draw on their benefits, the system faces insolvency.

In 2008, a Heritage Foundation report stated that “in net present value terms, Social Security owes $6.5 trillion more in benefits than it will receive in taxes.” Many doubt the government will have the funds to make good on those IOUs when baby boomers start retiring in greater numbers.
⁴⁰

Since government is not a business, it has little if any understanding of how to preserve, much less to grow, capital. Its domestic core competency is what it does most often—spend taxpayer money. That’s the reason Social Security dollars aren’t there. As the Cato Institute’s Michael Tanner has explained:

Not only that, Social Security’s rate of return has, in the words of the Heritage Foundation, “decreased steadily and dramatically.” According to its report, “a worker born around 1920 could expect a rate of
return from Social Security taxes of about 7 percent after inflation. A worker born in the mid-1980s, however, could expect a return of less than 2 percent.”
⁴²

Even when retirement funds are managed for the government by an independent system, investment decisions are not always about what’s good for investors, but are about the priorities of politicians. Around the country, state-run pension systems have been criticized for politically motivated investments—for example, deciding to invest in struggling companies to save union jobs or, alternatively, declining to invest in companies that have done business in politically sensitive countries.

Since they were introduced in 1978, 401(k)s have helped to create the most affluent generation of retirees in U.S. history. According to the Federal Reserve’s Survey of Consumer Finances, in 1983, the average retiree (aged sixty-five to seventy-four) had a median income of $16,100 and median assets of $76,300. Stocks made up 26 percent of these financial assets. Over twenty years later, in 2004, the average sixty-five- to seventy-four-year-old had a median income of $33,300 and median assets of $190,100. Stocks made up 51.5 percent of these financial assets.

Investing always involves risks. As individuals, and as a society, we’re better off learning to manage those risks ourselves rather than letting the government take over our savings and getting a miserable return on our money.

The fact that equity markets can go up and down does not mean people would be better off handing their retirement savings over to government bureaucrats. It means that people need to learn the basic principles of prudent investing. The first thing you’re taught in any finance course is diversification—that it’s essential to spread your investments among different companies and sectors—as well as the importance of making age-appropriate investments.

Young people can invest their 401(k)s entirely in equities because they have time after a down market to wait for their portfolios to recover. As you get older, more of your money should be invested in less volatile, short-term instruments like bonds and certificates of deposit. Retired mutual fund visionary John Bogle of Vanguard says that the portion of your 401(k) invested in such fixed-income securities should match your age. For example, if you’re sixty years of age, 60 percent of your nest egg should be in short-term bonds. Thus, if the market crashes,
your losses are minimized. If you decide to retire, you can draw down on your fixed-income side while letting time heal your equity side.

Critics of 401(k)s don’t realize that some of the current pain has been created not by the market slide but by government rules forcing 401(k) owners and IRA owners to make withdrawals every year after the age of seventy and a half. (How Washington came up with seventy and a half is anyone’s guess.) When the market crashed in 2008, many beneficiaries wanted to
not
withdraw from their retirement funds, feeling that they would forego current income to let their capital build up again. But Washington forces them to withdraw assets that have been depressed in value. Why? So the government can tax their money, of course.

Even with market swings like the crash of 2008, studies have shown that stocks are the best long-term investment. Wharton School finance professor Jeremy Siegel has studied the hypothetical performance of stock and bond investments going back to the 1800s: “Over twelve-month periods, stocks outperform bonds only about 60 percent of the time. But as the holding period becomes greater, the frequency of stock outperformance becomes very large. Over twenty-year periods, stocks outperform bonds about 95 percent of the time.”
⁴³

How many Americans, even today, would eagerly embrace the feeble 3 percent returns of a mandatory government program like that outlined by Teresa Ghilarducci? One can understand apprehensions about investing in a sometimes volatile stock market—especially among those nearing retirement. But stocks are not the only private-sector option for retiree investments. In the early 1980s, the county government of Galveston, Texas, and two other Texas counties pulled out of the federal Social Security program. Fearful of stock market fluctuations, the counties invested its employee money in annuities, guaranteed-interest contracts from sound insurance companies.

Former judge Ray Holbrook, who oversaw the creation of the program, wrote that twenty-five years later, “our results have been impressive: We’ve averaged an annual rate of return of about 6.5% over 24 years. And we’ve provided substantially better benefits in all three Social Security categories: retirement, survivorship, disability.” Depending on their salaries, county workers get returns that are anywhere from 50 percent more than to three times the amount they would have gotten under Social Security. The judge recounts,

S
candinavian nations—Sweden, Norway, Denmark, and Finland—are often held up as proof that a social welfare state can be economically successful. Writing in
Scientific American
magazine, Columbia University economist Jeffrey Sachs voiced the view, held by many free-market skeptics, that these countries show you can have high taxes and regulation and still be prosperous.
⁴⁵

Sachs writes, “On average, the Nordic countries outperform the Anglo-Saxon ones on most measures of economic performance.”
⁴⁶
Citizens are protected by social welfare programs and labor regulations yet enjoy the benefits of a private sector with competitive, open markets.

Cato Institute senior fellow Dan Mitchell agrees that “there is much to applaud in Nordic nations. They have open markets, low levels of regulation, strong property rights, stable currencies, and many other policies associated with growth and prosperity. Indeed, Nordic nations generally rank among the world’s most market-oriented nations.”
⁴⁷