Even a Bad Investor Can Beat Social Security

I had a discussion with a friend about the recent proposals to allow individuals to divert part of their Social Security taxes into private investments. “The problem is that most people, including me, don’t know much about financial planning,” said my friend, echoing one of the oft-heard arguments against privatization. “Social Security isn’t great, but at least I’m better off with it than I’d be if I made stupid investments and lost my money.” My friend’s comment prompted me to do some back-of -the-envelope calculations to see just how bad an investor you can be and still beat Social Security.

Let’s suppose that, like my friend, you’re 32 and you’ve paid $46,788 into the Social Security fund. According to the Social Security Personal Earnings and Benefit Estimate Statement, you can expect to receive $610 per month when you are eligible for full benefits at age 67. To make the calculations simpler, let’s pretend Uncle Sam has excused you from paying another penny into Social Security for the rest of your life and has returned to you the $46,788.

Now you want to invest it. You’re not hip to the latest hot stock tips, so you opt for a more conservative approach and a more conservative return. Easy enough: you put the $46,788 in a basic tax-deferred retirement account that invests in 30-year government bonds at a yield of 7% compounded--a yield at which they’ve been hovering recently, but one that is well below their 7.87% average yield for the last 10 years. When you turn 67 in 35 years, your $46,788 will have grown to almost $499,536. If you then invested the $499,536 at 6%, say, by maintaining it in an annuitized retirement account, you could leave the principal untouched and you could withdraw $2,498 per month in interest alone. That is more than four times the amount you’d receive from Social Security.

It isn’t just a lack of investment savvy that makes privatization a bad idea, some people argue, it’s that many people are gullible. They’d make downright stupid investments and lose money. Still, the question remains: How bad an investor can you be and still beat Social Security? Very bad.

Suppose you gave two-thirds of your original lump sum to a nice man who promised to make lots of money for you in copper futures. He called yesterday to tell you he’s sorry, but he lost every penny of the $31,192 you gave him.

Now you’re left with $15,596. Can you invest this amount in a relatively unsophisticated way and still beat Social Security? Yes. Just put the $15,596 into the same tax-deferred retirement account mentioned earlier. At 7%, your $15,596 would grow to almost $166,512 by the time you reach 67. If you then invested the $166,512 at 6% in an annuitized retirement account, you could withdraw $833 per month in interest alone without touching the principal. This is still $223 a month more than what Social Security says you can expect to receive.

I showed these calculations to my friend. “Wow,” he said. “I’d be better off investing my retirement savings myself, even if I’m not the smartest investor around.” Let’s hope the folks in Washington come to the same conclusion before it’s too late.