(Bruner 14)
The Social Security Trust fund could also invest in corporate bonds which are a less risky investment. Corporate bonds have different levels of risk depending on their classification. Standard & Poor's and Fitch assigns bond credit ratings of AAA, AA, A, BBB, BB, B, CCC, CC, C, and D. (S&P Long-Term Issuer Credit Ratings 1) AAA tends to be the less risky of the corporate bonds and offers the lowest rate of return, and D tends to be the most risky with highest rate of return. Portfolio managers could choose different types of bonds and come out with portfolio that is not very risky and with a higher return than just having Treasury bill. Overall, bonds are a really safe investment t that pays a fixed income unless it defaults meaning that the company goes bankrupt. As demonstrated on the chart, on average corporate bonds have a low standard deviation and offer a rate of return above Treasury Bonds. Therefore, they seem to be attractive investment for the Trust Fund or the individual accounts.
Many people are already taking additional risk by investing in diversified portfolios separate from the social security program. For these people, the composition of the social security investments is not very important. They can regulate their portfolios to offset the changes in risk and return of Trust Fund and match their desired rate of return and risk. For example, if Trust Fund is projected to have interest rate of return of 1% and they want a portfolio prospected to generate 7% return, then they can simply invest in stocks or bonds that are expected to have really high returns. On the other hand, less than half of the working class has retirement’s accounts outside the social security program. For these people, the composition of the Trust Fund is really important and probably they will want the inclusion of stocks and corporate bonds in the portfolio.
Even though the implication of using a diversified portfolio by the Trust Fund are positive, there are political pressures that could make the government interfere with good investment policies. The government will not want to risk the retirement money of the whole US population, so it will continuously intervene with the portfolio managers’ investments and probably end up lowering the return of the portfolio. Similarly, this intervention will happen with individual accounts managed by the government. Therefore, if the government starts investing in stock and bonds in either the Trust Fund or individual accounts, it should create an institution that protect the fund investments and portfolio decisions from political pressures. (Palmer 16) It is really hard to predict how this new institution will work; however, it should have several laws that will limit undesirable effects. For example, experts believe that the Trust Fund or individual retirement accounts should own a maximum of 10% of any firm, since the company could default. This new institution will definitely increase future revenue and lower the Trust Fund future deficit.
Even with this new design it will be really hard to stop the government from intervening. However, the new status of investing in stocks or bonds will be better than the current in which the Trust Fund only invests in Treasury bonds. As seen in the chart below, by investing 40% of Trust Fund assets on corporate bonds and stocks that are prospective to yield a 6.4% real return, the Fund will eliminate 34% of the 75-defecit. (Kennelly 49) This investment seemed to be really conservative. The fund could invest all its money on stocks and corporate bonds, and eliminate almost the entire deficit. Now, the question arises if the government should invest in stocks and corporate by using individual accounts or through the current Trust Fund. Through the Trust Fund, the government will have to take the major decision on where to invest and will be responsible for the outcomes. Through the individual accounts, workers will decide on where to invest.
(Kennelly 49)
There are several advantages on using mandatory individual accounts. Each person will have the freedom to decide in which assets to invest. A risk tolerant person will invest in stocks and derivatives, while a risk adverse person will invest in corporate and treasury bonds. Therefore, each person will be satisfied, since they will be able to select the combination of risk and return that is consistent with its preference.
Secondly, workers can change the composition of their portfolio as they are becoming older. When a person becomes older, he generally becomes more risk adverse, since he will has less time to recover from a bad investment. For example, the market can fall at any moment just as it happened during the Great Depression and recession of 2008. An old person will lose all most of his life investment during that year with no time to recover the money. Therefore, as a person gets older he will move from stocks to corporate and treasury bonds. The different investments choices available through individual accounts during the different stages of life will definitely improve the welfare of the people allowing them to retire with higher amounts of money if their investments go well.
Thirdly, the intervention of the government with the investments of the workers will diminish allowing workers to invest in what they want. (Palmer 18) However, there will always be a significant influence of the government, since they will want protect people from bad investment choices. The government will probably set some limits on the individual accounts like not allowing workers to invest more than 10% of their portfolio in one company. The major decision between investing in stock, corporate bonds, and treasury bonds will be left to the workers.
Fourthly, assets can be passed to your children through individual accounts. A worker might die at an early age by a heart attack, a car accident or any other reason and might not even use their retirement accounts. Through the current Trust Fund system, all your assets will be lost and your children will not acquire any of the money saved by their parents. On the other hand, through individual accounts all the assets saved will be bequeathed, since the assets are owned by each individual.
Finally, the government would be refrained from spending large accumulation of money in individual accounts. If large surpluses are available by a policy change, the Trust Fund could spend the money for other purposes outside the social security program such as building schools and hospitals. (Palmer 18) These new uses of the money will discontent the elderly, since their benefits will not increase. However, holding individual accounts will stop the government of using the money for other purposes, since it will be owned by the individuals.
There are several opposing views for the usage of individual accounts. Many people have no knowledge of the different investment opportunities and the different outcomes that can happen when in investing in the market. Some will probably end up making poor investment choices and end up retiring when the market value of assets is low or the costs of annuities is high. In particular, low-income people will make the most mistakes, since they tend to have less or no knowledge on the market and cannot afford great portfolio managers. Therefore, to protect people from making inadequate investments, the investments should be done by the Trust Fund rather than individual accounts. Also, the administrative costs will be lowered through the Trust Fund. (Palmer 19) The Trust Fund will only require a group of great portfolio managers to make the investments and have economies of scale. On the other hand, when investment is done through individual accounts, each individual will have his own preferences and each will probably need a portfolio manager or a consultant.
Secondly, opponents believe that there is the risk of social pressures when investing through individual accounts. They believe that some people will act “socially responsible” and end up investing in too conservative assets. (Palmer 19) These people will not make the best combination of risk and return. Through the Trust Fund, the governance structure will be done by the fund and can end up making better investment decisions.
Thirdly, individuals might not save enough through individual accounts and might end up spending all of their savings before they die. On 2010, men had a life expectancy of 82.1 years and female had a life expectancy of 86 years. (Kennelly 8) However, that does not mean all people die that age. Some tend to live much longer and die over 100 years old. Therefore, these people might waste all their money before they die, since they never expected to live for such a long time. These people will be in a severe problem. At that age is really hard to get start working again and firms might consider you unproductive. Therefore, these people will have a poor quality of life for their remaining years and probably will have to depend on the government or on their children.
Finally, opponents believe the usage of individual accounts will lead to undesirable changes in the distribution of benefits. The Trust fund provides higher benefits to the disabled, children who have lost their parents, and to divorced people. Through individual accounts, the government will not have any ownership of the money and will have to cut the benefits of those people. Also, individual accounts will not allow distribution of income. Each person will get the amount he saved for retirement. Therefore, this tax system through individual accounts will no longer be progressive and will not benefit the most needed.
Although there many disadvantages of using individual accounts, I will recommend a system that is based on individual accounts similar to the one imposed in Chile. Each employee and his employer will have to set aside 5% of worker’s payroll. This payroll will be deposited to a firm which will be chosen by the worker. However, it cannot be any firm; the government should set some restrictions on which firms will provide the retirement accounts. The government should only allow firms that had good returns on the past and are fully informed on how the new system will work.
These firms will offer a variety of different portfolios. They can offer one portfolio that is really conservative that only invest in corporate and treasury bonds, and an aggressive portfolio that invest only in stocks. This will satisfy individuals, since they will be able to choose their risk and return preference. Also, individuals will be allowed to change their portfolio. Individuals will move to a less risky portfolio as they get older, since they will have no time recover the money of a market crash.
The investment in these individual accounts should be completely mandatory, not optional. The government sets a minimal standard of living for all people. (Thompson 30) Therefore, some people will not end up saving money and will rely on the government when they retiree. This will be really unfair for the prudent people, since they lowered their living standard by setting aside money each year while other people just easily got the money from the government. Therefore, to make a just system the government should make the saving on individual accounts mandatory.
The government should charge both employee and employers an additional 1% of the worker’s payroll to continue to provide benefits for the disabled, and to children who have lost their parents. These people are either not in condition for working, or are too young to work and lose their education. Therefore, the government cannot take their benefits by implementation of individual accounts, so it should continue providing the services by charging the additional 1%.
The new system should force individuals to purchase an annuity which is an investment that provides a fixed income. Many people could outlive their assets. People can take money too much money from their retirement and may end up wasting all their retirement funds before they die. Furthermore, some people might even die at really old age perhaps 100 years old and might also waste all retirement fund they die. Therefore, the government should force individuals to buy an annuity which will provide money forever.
This new system I proposed will be really beneficial especially for two reasons. First, it will completely eliminate the deficit of the Trust Fund. The government will no longer have to pay for the retirement of people, but rather each person will have to save for their retirement. Secondly, it will allow individuals to invest in the assets that they want. Each individual will be able to choose the risk and return of their preference. Furthermore, the overall benefits of the population will be higher, since individuals will invest in assets with higher rate of return than treasury bonds.
Works Cited
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Bruner, Robert F. "The Fidelity Magellan Fund." (1995): 1-14. Print.
Kennelly, Barbara B. Social Security: Why Action Should Be Taken Soon. Washington, D.C.? (400 Va. Ave., SW, Suite 625, Washington 20024): Social Security Advisory Board, 2010. Print. December 2010.
Ostaszewski, Krzysztof M. "Cato Institute Social Security Choice Paper No. 6." Privatizing the Social Security Trust Fund? Don't Let the Government Invest (1997): 1-10. Web. 14 Jan. 1997. <http://www.cato.org/pubs/ssps/ssp6.pdf>.
Palmer, John L., and Lauren H. Thompson. Evaluating Issues in Privatizing Social Security. National Academy of Social Insurance. Report of the Panel on Privatization of Social Security, Nov. 1998. Web. 09 Nov. 2011. <http://www.nasi.org/research/1998/evaluating-issues-privatizing-social-security>.
Peters, Katie. "Privatization Threatens Medicare and Social Security." Center for American Progress. 23 Mar. 2004. Web. 09 Nov. 2011. <http://www.americanprogress.org/issues/2004/03/b40071.html>.
"S&P Long-Term Issuer Credit Ratings." Mihaylo College of Business and Economics | California State University, Fullerton. Web. 10 Nov. 2011. <http://cbeweb-1.fullerton.edu/finance/mstohs/BondRatings.htm>.
Thompson, Lawrence. "Reasons for Creating a Mandatory Retirement Programs." Older and Wiser. Washington D.C.: Urban. 25-36. Web. 10 Nov. 2011.
Social Security: Why Action Should Be Taken Soon. Washington, D.C.? (400 Va. Ave., SW, Suite 625, Washington 20024): Social Security Advisory Board, 2010. Print.
Thompson, "Reasons for Creating Mandatory Retirement Programs"
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