No Market Magic for Aging U.S.
“Ownership,” President Bush declared in his acceptance speech Thursday night, “brings security and dignity and independence.”
At best, the president was two-thirds right.
Dignity and independence, maybe. Security, definitely not. As anybody who owns anything will tell you, the risk of losing it all is part and parcel of the deal.
What Bush is proposing is particularly dicey. His idea is to help accommodate future waves of baby boomer retirees by allowing younger workers to take some of the money they now pay in Social Security and Medicare taxes and instead stick it into personal accounts that are invested in stocks and bonds. He didn’t give specific figures, but administration staffers have mentioned allowing 2% of payroll taxes to be diverted into securities.
That could add up fast. The total paid into Social Security last year was $543 billion. If 2% was diverted to personal accounts, it could mean as much as $11 billion in new investments annually.
The trouble is with the underlying assumption that the stock market will magically finance an abundant retirement. Such thinking is seriously out of date.
Indeed, Roger Ibbotson, who pioneered the study of long-term returns in stocks and bonds, believes that the market is likely to perform much more poorly during the next 10 to 25 years than it has in the last three-quarters of a century.
From 1926 through 2003, according to his firm Ibbotson Associates, stocks enjoyed an average annual yield of 10.4%. But Ibbotson expects returns to trend lower, for the simple reason that companies have been overvalued in recent years, given their level of profits.
Ibbotson is convinced that the pattern in which the average stock’s price has soared from 10 times earnings to 25 times earnings, as it has over the last decade, won’t be repeated.
“I don’t say today’s P/E ratio will go down,” says Ibbotson, who also is a professor at the Yale School of Management, “only that we won’t see such a rise again.”
Beyond these market fundamentals lie incredible demographic pressures.
In 1950, there were 7.3 active workers for every person over age 65. Today, there are 3.3 workers for every retiree. And within this decade, the number will fall to fewer than three workers.
Confronted with this trend, asset funds will quickly find themselves forced to pay out more money than they are taking in.
To do so, investment managers Robert Arnott and Anne Casscells point out, funds will have to sell off pieces of their giant stock portfolios to “a proportionately smaller roster of potential buyers” -- namely, workers and their pension plans. That, in turn, will put downward pressure on stock prices, the two write in a paper titled “Demographics and Capital Market Returns.”
The bottom line: Many investment experts foresee returns on stock market investments settling around 6% a year over the next decade.
And an average, remember, is just that -- a generalized picture of what’s happening over a certain period. Within this time frame, of course, can be years of relatively meager results.
It’s a little like playing musical chairs. Depending on when the music stops, you may or may not find yourself in a comfortable spot.
Recently, for example, the stock market has not been kind to workers counting on their 401(k) plans to get them through their golden years. The reason: They “have not recovered from the impact of the bear market,” the Employee Benefit Research Institute, a Washington-based industry group, says in a new report. Workers in their 60s, who have been saving for 30 years, “were still down 15.5% between year-end 1999 and the end of 2003,” the report notes.
Stanford University economist John Shoven, who has advised Republican administrations on tax and retirement policy in the past, is not an advisor to Bush -- or an admirer of his plan. Neither, though, is he much impressed with Democratic candidate John F. Kerry’s stance that he will not touch Social Security.
The program, Shoven believes, must be overhauled to deal with the 75 million or so baby boomers set to start retiring at the end of the decade -- or else Social Security will find its coffers drained.
But, as Shoven stresses, there are only two ways to truly reform Social Security. One is to increase the taxes that workers pay into the system. The other is to reduce the benefits that Social Security pays out.
Neither Bush’s nor Kerry’s proposals recognize this reality. Bush, by stating that he will not raise Social Security taxes but will foster an “ownership society,” is looking for the equivalent of a free lunch. Kerry, by vowing not to trim benefits, is condemning Social Security to a long-term state of crisis.
Shoven, who directs the Stanford Institute for Economic Policy Research, proposes a plan that would balance the guaranteed benefit of Social Security with the risk of an investment account. He would compel employees to pay an additional 2.5% in payroll taxes into an account that the Social Security program would augment with a comparable contribution, making for an investment fund of 5% of an employee’s wages.
To raise the government’s share, Shoven would reduce the guaranteed benefit for all recipients to $600 a month from the current average of $800. No exceptions. “Bill Gates would get $600 and the company receptionist would get $600,” Shoven says.
That professorial proposal is only one sensible suggestion to stave off a disaster. Many more good ideas will surely emerge as the population ages -- just not, it seems, from George Bush or John Kerry.
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James Flanigan can be reached at jim.flanigan@latimes.com. For previous columns, go to latimes.com/flanigan.
