Money for The Market

The Washington Post, Tuesday, September 15, 1998; Page A21

The recent decline in the stock market -- which may have been caused in part by the Lewinsky scandal -- has sharpened the debate over an issue that's far more important than whether this particular president stays in office.

It's the debate over whether Americans should be allowed to invest their Social Security money in their own private accounts -- a public policy argument whose outcome will mean hundreds of billions of dollars to hundreds of millions of people over the next century.

Foes of private accounts are now pointing to the market correction as evidence that reformers are on a reckless path.

"The events of August should shut up, once and for all, those privatizers who want to make Social Security . . . dependent on investments in the stock market," said Rep. Pete Stark (D-Calif.).

Sorry, but this is one privatizer who won't shut up -- and who believes that, as painful as the sharp drop in the market may be, it is fortuitous since it allows both sides of the Social Security debate to join a critical argument at an early juncture.

There is no denying that a market decline will appear far more frightening to people whose life savings are invested in stocks than to those who depend solely on a government-run program.

And stocks have certainly fallen sharply in the past two months. Between its peak on July 17 and last Friday, the Dow Jones industrial average dropped 17 percent, and the broader Standard & Poor's 500 Index (S&P), 14 percent.

Imagine a woman who has been investing in a private stock account, planning to retire in mid-September and purchase an annuity -- an investment that will spew out income for the rest of her life. Thanks to the recent correction, her annuity income will drop by one-sixth.

As former Social Security commissioner Robert Ball put it, "It makes a great difference whether you retire when the market is low or when the market is high. If you turn it into a lump sum and buy an annuity, it governs the way you live for the rest of your life."

But there is a fallacy here. Whether market corrections occur at the beginning, the middle or the end of your investing life does not matter. Yes, you'll feel disappointed by a decline on the brink of retirement, but you will still be far better off with your money in the stock market than in Social Security.

In the current case, while the S&P has dropped 14 percent in two months, that index has, nevertheless, returned 146 percent over the past five years, 362 percent over the past 10 years and 1,833 percent over the past 20 years. (All figures assume that dividends are reinvested.)

The market could drop another 50 percent tomorrow, but an investor who started in 1978 would still have made 10 times his initial investment.

Are we just having a lucky 20 years? No. According to Jeremy Siegel of the Wharton School, stocks have produced an annual average real return of 7.2 percent since 1871. But, for someone born in 1960, Social Security will provide real returns of only between one percent and 2 percent, according to estimates by experts.

The five percentage points that separate stocks and Social Security make an enormous difference. Over 40 years, an investment of $1,000 at 1.8 percent becomes $2,000 but, at 7.2 percent, it becomes $16,000.

Yes, stocks are risky, but only in the short term. Since 1926, there has never been a 15-year period (1926-40, 1927-41, etc.) in which stock returns were negative. And, Seigel found, there has never been a 30-year period in which stocks did worse than an annual average return of 2.6 percent after inflation.

Certainly, bear markets happen, but they tend to be short. The 1973-74 market, the worst since the Great Depression, saw a 43 percent decline, but investors earned back their losses in 3 1/2 years. Between Aug. 25 and Dec. 4, 1987, the S&P fell 33.5 percent but was back even by July 1989.

It's true that we can't tell the future from the past, but consider the systemic gambles. Social Security could go bankrupt, or return even less as benefits are cut or taxes raised. That's a political risk that exceeds the financial risks of the market.

Still, the critics persist. "I wonder if the appetite for privatization is as robust today as it was the week before this," said Sen. Frank Lautenberg (D-N.J.) on Sept. 4, after a tumble in the Dow.

But Lautenberg should know better. In 1952, he joined a start-up company called Automatic Data Processing, Inc., and later became CEO. ADP made Lautenberg a very rich man, and, because of the democratic nature of the stock market, it made others rich, too. If you had put $10,000 into ADP 18 years ago (long after its founding), you would today have $292,000..

Not every stock is ADP. Investing requires diversification, prudence and patience. To provide investors with comfort and to protect them against their worst instincts, simple regulations may be necessary -- such as requiring a shift to mixed stock-and-bond accounts within 10 years of retirement.

Such regulations would be easy to devise, and while they might impair individual freedom, they would be a small price to pay for eliminating the current system -- which unfairly prevents millions of Americans from joining in the successes of entrepreneurs like Lautenberg and from enjoying a more prosperous and happy retirement.