The financial pages are filled with doom and gloom these days. The Dow, which once seemed to have left 10,000 behind for a far-higher perch, is now fluttering around a more modest 9,000. The Nasdaq – which toyed with 5,000 two years ago – is now parked below 1,500, its lowest point in about five years.
The market has been rocked by corporate scandals at Enron, WorldCom and others, and businesses across the board are revising their earnings downward in response to the attention being paid to questionable accounting practices. The front page of newspapers from coast to coast are filled with horror stories about once-proud investors who have lost 40 percent, 50 percent or more of their hard-earned retirement savings.
Today's questionable business environment; however, does not weaken the case for reforming Social Security with personal retirement accounts. Personal accounts would allow workers to put some money aside in an individual account and require them to invest it in one of a limited number of balanced, diversified stock and bond market portfolios managed by professional, government-vetted management firms.
A number of politicians are claiming that the stock market losses of the last year are reason enough to abandon all talk of personal accounts.
Rep. Eddie Bernice Johnson (D-Texas) recently said, "Under private accounts, retirees would be left to the vagaries of the stock market. And as we have seen … the Wall Street giants can come crashing down in a heartbeat."
Senate Majority Leader Tom Daschle (D-S.D.) recently said, "After what's happened to the stock market in the last few weeks, we think [personal retirement accounts are] a terrible idea."
Rep. Johnson, Sen. Daschle and other opponents of personal accounts are taking a very shortsighted view of the market.
True, the market is volatile. From day-to-day and even year-to-year the market fluctuates widely, but over the long term, the market always makes positive gains. For example, in every 35-year period over the last 128 years the market has yielded an average annual 6.4 percent real rate of return. Even the lowest earning 35-year period, which ended in 1921, yielded an average real rate of return of 2.7 percent. That means long-term investors will make out just fine, even if there are down years while they hold their accounts.
Some worry about how workers with personal retirement accounts will fare if the market slumps in the year they want to retire. For example, critics like Rep. Johnson note that between January 1973 and September 1974 – one of the market's largest declines – the market lost about 40 percent of its value. Of course, the market headed back up and was rivaling its 1973 high by 1976, but what about the worker who intended to retire in September 1974?
Investors who retire in a down year – as long as they have maintained a diversified, market-wide portfolio – will survive. Imagine a worker who retired in 1974 and had saved a portion of his income each year of his working life in a balanced portfolio that tracked the market as a whole. According to the nonpartisan Congressional Research Service, even with the 1973-74 decline, he would have averaged a 6 percent return each year on his investment. The compounded value of all the years of gains more than offset the sluggish market of the early 1970s.
That's why investing in the stock market for a long-term goal like retirement is relatively safe, and why personal retirement accounts are not so risky, especially when compared to the status quo.
Remember that the current Social Security system is unsustainable in its current form. When the Baby Boomers start retiring within the next decade, the amount the rest of us pay in taxes won't be enough to pay for all the benefits we've promised. The first deficits appear about 2017. Between then and 2075, when today's newborns will have retired, Social Security's debts will total more than $25 trillion. Already, Social Security provides a meager 2 percent return or less on taxes contributed. If we raise taxes or cut benefits to close this gap, the return will become even smaller.
Personal accounts are a solution because they prefund some of the benefits of tomorrow's retirees. By saving and investing today, we can avert a financial disaster down the road.
A majority of Americans agree. In a recent USA Today poll, 57 percent of Americans still believe that allowing individuals to invest part of the payroll taxes they currently pay into Social Security would be a good idea. This is true even after the collapse of WorldCom, the dismal economic news and the scare campaign of personal account opponents.