Unexpectedly Intriguing!
25 March 2005

As recently noted, the St. Louis branch of the Federal Reserve recently published a "what-if" study by economists Thomas A. Garrett and Russell M. Rhine that looked at whether or not Personal Retirement Accounts (PRAs) would have been beneficial to those who retired in 2003. In their study, Garrett and Rhine looked at alternative investments in either Certificates of Deposit (CDs) or in a Standard & Poor 500 (S&P 500) based mutual index fund. Their basic conclusion: PRAs would have been more beneficial for over 95% of the potential pool of recipients had the option been available to them.

Along these lines, the Heritage Foundation, home of the Political Calculations(tm) "Gold Standard" Social Security calculator, has also recently published its own study drawing many of the same conclusions. The report, by Senior Policy Analyst Kirk A. Johnson, found that for the baby boom generation:

  • Personal retirement accounts would have increased retirement security by some 30 percent for baby boomers;
  • Personal retirement accounts would have substantially increased the net worth of baby boomers, especially low-wealth families;
  • About 98 percent of baby boomers would have been better off had they been able to take advantage of personal retirement accounts; and
  • With personal retirement accounts, baby-boomer families could have increased their retirement wealth by between $41,000 and $214,000 at age 65, in inflation-adjusted 2001 dollars.

The Heritage Foundation has also published a detailed report in addition to the summarized version linked above. The study is particularly interesting in that in its simulation, lower income workers would be allowed to invest a significantly larger percentage of the portion of their income currently taxed for Social Security than higher income earners, allowing them to disproportionately benefit from the PRA option.

The downside to this kind of "what-if" analysis is that it is too late for the majority of the baby boom generation to be able to benefit from a PRA option for Social Security. That's not a real problem for them however, since the program will be capable of adequately supporting their retirement at promised levels throughout their expected lifespans. However, for those born after 1960, the projected inability of Social Security to provide retirement benefits at promised levels after 2041 *will* negatively impact them, as they may reasonably expect to live past the forecast depletion of the OASI Trust Fund in 2041, and have their benefits cut back as a result.

Now, for my two cents. The real secret to making any PRA option successful is twofold. First, the types of investment available to investors must be fully diversified, so that all one's eggs are not in a single basket marked "Enron," "Worldcom," etc., but are instead invested in large index funds, such as a Wilshire 5000 based index fund, or the type of investment options available through the Thrift Savings Plan, which distributes money invested, and risk, among a multitude of publicly traded stocks and other investment options. With this kind of investment, it's just not a big deal if one or two or a hundred companies go completely belly up because the other companies in the portfolio will grow at rates sufficient to take up the slack.

Second, the proposed PRA investor needs to have sufficient time for their investment to grow. There are a number of studies, most significantly the work of Wharton's Jeremy Siegel, that demonstrate that those investing in the stock market over the long term will win out over market volatility and risk in the end, with rates of return that those solely dependent upon Social Security can only envy. That's why I support PRA's for today's younger workers, and you should too.

Update: This post has been edited to correct a number of errors in grammar. It seems that once again, I have to learn to not write and post before that first cup of coffee in the morning....

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