With Halloween upon us, there are lots of scary bats, witches and monsters about. And with the election just a couple of days away, we once again see the issue of the privatization of Social Security surface in the election ads. We don’t like to take sides politically in our blog and won’t debate issues around how such a concept would actually be implemented, but we do think it’s important for people to know that it’s not as scary and radical as it’s often made out to be.

We’d like to discuss here, the basic idea and show that it could have merit, if it’s implemented in a common sense way that considers the concerns of all of the Social Security stakeholders, future and present.

At the heart of the issue is whether one could earn more by investing in “the market”, a portion of what is now going into the Social Security system. Part of the controversy involves what one means by “the market”. If “the market” means just investing in U.S. common stocks, then we would be concerned about such a concept. If “the market” means a broadly diversified portfolio which becomes more conservative as the owner ages, that becomes a more agreeable concept.

Even so, a recent article in the Wall Street Journal titled “Private Social Security Accounts: Still a Good Idea” by William G. Shipman and Peter Ferrara, showed how investing in stocks alone over a long period would provide far better returns than Social Security. The article cites the following example:

“Suppose a senior citizen ‘Joe the Plumber’ –who retired at the end of 2009, at age 66, had been able to set up a personal account when he entered the work force in 1965, at the age of 21. Suppose that, paying into his personal account what he and his employer would have paid into Social Security, Joe was foolish enough to invest his entire portfolio in the stock market for all 45 years of his working career. How would he have faired in the recent financial crisis?”

The article goes on to say that if you assume Joe and his wife invested in a portfolio consisting of 90 percent large-cap stocks and 10 percent small-cap stocks, they would have accumulated $855,175, even taking into consideration a 37% loss in 2008. According to the article, this was equivalent to a 6.75% return, annually from 1965 until 2009. Note also that their portfolio would have been severely impacted by the tech stock bubble and the 9/11 terror attack fallout. Their return would be 75% greater than what they would have earned, had their funds been invested in the Social Security system.

A large number of Americans are invested in the market in their 401(k) plans and outside of those plans. If they could invest part of their Social Security contributions in “the market” in an intelligent manner (yes, that may be the problem!), stay broadly diversified, rebalance frequently and take a more conservative stance as they approach retirement, it is highly probable that they can beat the returns of Social Security. If not done properly, it could be very scary. If done right, it could be very rewarding.