Pension funds do it. Insurance companies do it. Canada does it, and so does Japan. So, why doesn’t our Social Security system invest in the stock market–and should it?
Debate about investing some portion of Social Security assets outside of Treasuries isn’t new. Lawmakers considered asset diversification when the program was created in the 1930s–although the option considered then was corporate bonds rather than stocks, according to Nancy Altman, author of The Battle for Social Security: From FDR’s Vision to Bush’s Gamble, a history of the program.“Lawmakers who opposed Social Security objected to asset diversification,” says Altman, president of the Social Security Works advocacy coalition. “They thought this kind of government investment in the private sector smacked of socialism.”In the mid-1990s, President Bill Clinton asked a government-appointed advisory panel of outside experts to make recommendations to improve Social Security’s long-term solvency, and it identified three options that included equity investment. Two options involved setting up private individual accounts; the third recommended investing a portion of assets in the Social Security Trust Fund assets in stocks.The idea surfaced again in the early 2000s when Altman co-authored a plan to balance the program’s long-range finances with the late Robert Ball, one of the most influential figures in Social Security history. Ball served as Social Security’s commissioner from 1962 to 1973 and also founded the National Academy for Social Insurance.The Ball/Altman plan included a proposal to authorize Social Security to invest a portion of the SSTF in broadly diversified index funds. In order to safeguard against government interference in the markets, a Federal Reserve-type board with staggered terms would have been appointed to select the funds and to hire fund managers through a competitive bidding process.Ball/Altman proposed gradual investment in equities, starting with one percent of SSTF assets in 2006, adding an additional percentage point annually with a cap of 20% of SSTF assets.None of these ideas have advanced due to the difficult politics.Conservatives worry that equity investment could give government inappropriate control over the private sector, and that this control could be used to meet political goals.”I do worry that people would try to politicize the investments, although it would be possible to protect against that,” says Andrew Biggs, resident scholar at the American Enterprise Institute and a former deputy commissioner of the Social Security Administration during the Bush years.Investing in stocks also could provoke concern from segments of the public that don’t participate in the equity markets. Social Security is a near-universal program covering many workers who don’t hold stocks. That’s about half of all adults: A 2016 Bankrate.com survey found that 52% of Americans don’t invest in stocks or mutual funds; the most frequent reasons cited include a lack of knowledge about equity investing, a lack of trust in stock brokers and financial advisers, and the riskiness of investing in stocks. Just 16% of adults view the stock market as the best place to invest money they don’t need for 10 or more years.”The history of market crashes have left a lot of Americans distrustful of the stock market–much more so today than they were even 15 years ago,” says economist Gary Burtless, a senior fellow at the Brookings Institution.Conservative policy experts have argued that rather than invest the SSTF in the stock market, individuals should be permitted to divert part of their payroll tax contributions to private accounts. But that would undermine Social Security as a source of guaranteed lifetime annuity-style payments, and could leave account-holders exposed to much greater market risk than they would face with a massive, professionally managed SSTF equity investment.Measuring the Boost
How much would equities help?Burtless is the co-author of a recent research study for the Center on Retirement Research at Boston College that attempts to answer the question. The report looks at the question two ways. First, it uses historical market data to determine how the SSTF would have been impacted had it been invested partially in equities beginning in 1984; then it considers investments in equities beginning this year as part of a broader package of reforms, using Monte Carlo analysis to project a range of possible outcomes over the next 75 years.The historical analysis follows the recommendation of the mid-1990s Social Security commission–it increases the percentage of trust fund reserves invested in equities by 2.67 percentage points each year up to a ceiling equity allocation of 40%.The results are expressed using the trust fund ratio–the ratio of assets to benefits (a ratio of 1.0 is the Social Security trustees’ benchmark for short-term financial adequacy). If equity investment had started in 1984, the trust fund ratio in 2016 would have been 4.2 compared with an actual ratio of 3.0. If equity investment had started in 1997, the ratio would have been 3.8. (Social Security has been building large reserves since the reforms of 1983, which will be drawn down as the baby boom generation retires.)”History looks like what you’d expect,” says Burtless. “Stocks give you better returns than the goverment bond market.”The paper also found that if Social Security had begun investing in the stock market in 1984 or 1997, the program would own less than 4% of the market today; by comparison, state and local pension plans currently hold about 6% of total equities.The forward-looking analysis assumes that investment in equities begins only after implementation of reforms that put Social Security into actuarial balance for the coming 75-years without any extra boost from stocks.”The analysis is only interesting if you first raise the tax rate,” explains Burtless. “Since we expect the trust fund to be depleted by 2034, between now and that date the size of the fund will be small, so the differences in what you could earn on the reserves are immaterial, especially with ups and downs of the market. If you instead build up the trust fund and add return on investment from equities, then the differences become very material.”The key result of the Monte-Carlo analysis: at the 50th percentile of outcomes, the trust fund with equity investments finishes the 75-year period with a ratio of 3.3–far above the 1.0 benchmark.That would leave Social Security with a permanent fix to its periodic financial shortfalls, and it would give lawmakers room to consider ways to make benefits more generous.”If you get to that point, there could be some opportunistic ways to improve benefits for certain groups that are especially deserving–families with disabled kids or very low income beneficiaries,” says Burtless. “Or, you might be able to cut payroll taxes. Those opportunities are not going to present themselves if you’re invested only in bonds.”Still, the SSTF is stuck with Treasuries for now–and that doesn’t seem likely to change anytime soon. Says Altman: “It would be good policy, but it is difficult for people to understand.”Mark Miller is a retirement columnist and author of The Hard Times Guide to Retirement Security: Practical Strategies for Money, Work, and Living. The views expressed in this article do not necessarily reflect the views of Morningstar.com.
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