February 3, 2005

Where did my retirement go?

The President officially introduced his plan for Social Security last night in the State of the Union Address. the idea of Social Security reform via the use of private accounts has been bandied about for some time now, but I believe this is the first time the President has made a pitch to the nation directly. From my understanding, the idea is to allow workers under age 55 to divert a portion of their payroll taxes to an investment account with a limited number of investment options. The idea of the limited options is to ensure that individuals can minimize risk while still attaining some returns. You wouldn't want some wide-eyed worker to throw his retirement away on penny stocks.

I'm not quite sure what to think of this plan. At first glance, it seems like a good idea. Let me decide where to invest my money, and I know that by the time I retired I would have walloped whatever small benefit I would have received under the current Social Security plan. Personally, I'd rather not pay any Social Security tax and just be allowed to invest that money in an IRA at a discount online brokerage, but I'm pretty sure that's not the way it's going to work. It's just my pipe dream retirement scenario.

The trick is, not everyone is going to be as conscientious with their savings. This is one of the reasons Social Security exists; to give people security. A staggering number of people do not save any of their own money for retirement, so it's vital that these people have at least the small amount provided by Social Security to fall back on. Not every senior citizen can fall back on family for care. This is the reason that the new Social Security program will still require people to save while also limiting investment options to those similar to investments available in the Thrift Savings Plan for federal employees. In that plan, there are five options (see TSP.gov). Two are fixed income, bond and government security focused funds. There are also three stock funds available, all of which are index funds. Once invests in an S&P 500 fund, once in the Wilshire 4500 Small Cap Index, and one in an international index fund. These funds are broadly diversified, so it is unlikely any one of them will ever quickly lose a large chunk of their value, though the international fund is the most volatile of the three, due the relative instability of foreign companies in comparison with their American counterparts.

Every person who isn't wallowing in in high interest debt should probably be putting at least a little bit away each month into some sort of index fund, as the U.S. stock market has proven to be the best investment vehicle historically. Up to this point, I've probably sounded pretty positive on the deal, and I mostly am, but I have a few questions that I only have vague ideas about how to answer. There are of course the questions about how much the transition will cost and what it will me to current retirees and those who will retire shortly, but I feel like many people smarter than I have addressed those questions, and it's not hard to find a Democrat willing to poke some large holes in the President's plan, so I'll leave them to answer those questions. My main question is what this infusion of capital into the market will do to the market. As of the 2000 Census, there were over 165 million people in this country between the ages of 20 and 65. Assuming most of those 165 million will be paying into Social Security via the payroll tax and the increasing population of the United States, there will be a large influx of cash into the stock market should Social Security be privatized. This would greatly increase the amount of money invested in the companies that make up the S&P 500, for example. Even though those are huge companies, that large an influx would surely have an effect, and the mutual fund company would own a large share of said companies. As for prices, it seems to me that the share prices of the affected companies would skyrocket at first, as millions of shares are snapped up by the index funds. Rather than mirror the S&P 500, it seems more likely that it would influence it. Perhaps the only way to avoid this would be if the companies decided to issue more shares, but share dilution is something every smart investor despises, as it dilutes the value of his portfolio. I'm not sure how it would work out, but I'd hope that the people in charge are figuring out what would happen if this plan goes through.

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