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April 16, 2005

When is a Combination of 1.86% and 0.26% Better than 1.8%?

When President Bush says it is.

The Los Angeles Times reports on Bush's "60 stops in 60 days" visit to Kirtland, Ohio, to pitch his yet to be defined plans for "saving" social security. Ohio has several optional investment oriented retirement plans for public employees. The Ohio Public Employees Retirement System (OPERS) has 522,000 members of which about 10,000 (<5%) have elected one of several personal accounts. The two most popular ones are the "moderate" and the "aggressive" portfolios.

I show their five-year annualized rate of returns on investment as reported by the Times compared with the Social Security Trust Fund rate of return.

Notes:
* lost money in two of the last four years and during the first quarter of this year
**Bush's number for Social Security trust fund in the same period. It's unlikely he overstated this.

The Times tells us;

By contrast, the fund that pays for the system's traditional pensions, which is handled by professional money managers, had a five-year return of 3.52%.

First, we have the usual apples to angles comparison in Bush's complaint about the rate of return of the Social Security Trust Fund. The 1.8% is what the fund makes from its investment in special Treasury Bonds. However, the growth in benefits is currently tied to salary inflation and is guaranteed. The rate of return of 1.86% or 0.26% is the return on the individual's investment and is not guaranteed. This is no small difference. A more apples to apples use of the numbers would suggest that the Social Security Trust Fund should invest in something with a better rate of return than Treasury Bonds. Currently the law does not allow it. To clarify the point: the rate of return on investment is being confounded with payout rate at retirement. Even in private plans, the relationship is not one to one, in plans like social security, where a substantial portion of the payout comes from taxes, there is very little relationship at all. Currently, the Social Security Trust Fund is taking in more than it is paying out. Unless some mid-course correction is made, this will change in about a decade. But, even if the Trust Fund goes dry in around 50 years, taxes will still be able to pay 70%-85% of the then greatly increased payments then due retirees.

Second, the cost of privatization is never accounted for in any of these calculations. And that cost is very high. If you use OPERS' "moderate" portfolio, the 0.06% advantage over the Trust Fund's rate of return would likely not cover the "start up" costs for severaly centuries.

For the sake of completeness, there were two individuals at the Kirkland affair that claimed they got 6% and 7.1% returns respectively. The one claiming 6% said the return was guaranteed. I would like to see the figures. My guess is that these are payout numbers not rate of return on investment.

If there is any good news in all this in comes at the end of the article,

His (Bush's) declaration appeared to reinforce a suggestion made Thursday by his top economic advisor, Allan B. Hubbard, that the voluntary retirement accounts might be acceptable to Bush even if they were offered as an "add-on" to Social Security, instead of being financed by current payroll taxes, as the president was advocating.

But do we really need another 401k or IRA plan? What wrong with expanding the ones we have?

Posted by DuaneSmith at April 16, 2005 11:39 AM | Read more on Current Events |

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