Academic journal article Policy Review

Lessons Our 401(k)s Taught Us

Academic journal article Policy Review

Lessons Our 401(k)s Taught Us

Article excerpt

THE NEED TO REFORM the tottering Ponzi scheme that is our Social Security system is widely accepted among policy makers, even if the political willingness to tackle the subject is lacking. Today's system, in which current workers pay the benefits of current retirees, is going to crash in the next century on the demographic rocks of the Baby Boom's retirement. And even if somebody can figure out a way to avoid that problem by tinkering at the margins of the system, the fact would still remain that Social Security is a rotten deal - when they retire, people can look forward to a lousy rate of return on the money they have paid in during a lifetime of work.

As for where workers can get a better rate of return, the answer is not, obviously, through the government-run system. The only serious hope is with the private sector, as a host of studies, from The Heritage Foundation, the Cato Institute, other think tanks, congressional committees, and official commissions have concluded. For conservatives, private accounts for individuals, into which people would deposit a portion of the money they currently hand over in payroll taxes, are the best solution. The research persuasively shows that over anyone's working life, regardless of income level, such accounts, properly invested, will make retirees much better off than even the best they can expect from the current system. The difference can amount to hundreds of thousands of dollars.

The two key words to remember are "properly invested." The benefits that people can realize are not the same as the results they will realize if they fail to follow sound investment advice on how to structure their accounts, how to allocate assets between stocks, bonds and other instruments, how to maintain a diversified portfolio, etc. In fact, most serious plans for partial Social Security privatization include regulatory safeguards designed to steer people in the right direction.

In a Cato plan, for example, a national "Board of Trustees" would oversee investment decisions, and the system would require that Americans "invest in only approved asset classes," keep their investments within "maximum percentage limits on each asset class," and change their "portfolio composition as retirement age nears," among other things. The regulations in the Cato plan are not just a nod to the politically achievable - a concession market-minded reformers must make out of the recognition that a wholly unregulated system is a political non-starter. They are also an acknowledgment that sound investing is not something all Americans will do automatically.

In fact, there is a depressingly large and growing body of evidence that given complete freedom to manage their own private Social Security retirement accounts, too many Americans would make poor investment decisions, thereby depriving themselves of some or all of the benefits of privatization. Typically, those who, in the context of Social Security reform, raise concerns about the savviness of Americans as investors are coming from the anti-privatization side of the debate - those who have a political interest in keeping Americans beholden to the government-run scheme, regardless. Their complaints are often no more than a polemical smokescreen for a hidden anti-reform agenda.

But it's a mistake to dismiss concerns about investor knowledge altogether - a fact that is implicitly acknowledged by the regulations to govern investment decisions in current reform proposals. The reform debate needs to look at where Americans are in terms of their investment knowledge, as well as the political pressures Americans and their elected representatives may try to exert on a partially privatized Social Security system. The case against sticking with the current failing system will be no weaker for the exercise; in fact, a clear-eyed assessment can only strengthen the case for reform by clarifying what is at stake in private accounts.

What investors (don't) know

ANY AMERICANS, ALAS, know little about stocks, bonds, and retirement. …

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