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Friday, September 2, 2011

The Teachers' Social Security Safety Net

Over at Justin Baeder's blog, there is a lively discussion of Social Security. I suspect I provoked some of it. Please read the original blog entry and its comments for the context of what I am about to write.

Justin says, “...but as a 30-year-old, I'd much rather just pay SS tax and never get anything back (to provide a societal safety net for others) than have additional money taken from me only to be given back later at a very poor rate of return.”

Kudos to you, Justin, if you are really fine with paying in and never getting anything back in order to provide a safety net for others. There are plenty of people who resent Social Security precisely because it is a safety net. They would rather think of it as an investment or an entitlement instead of the insurance program it was designed to be. Before the Baby Boomers came along (don't blame them, blame their parents:), the 1% premium was cheap insurance. In the 1980s, it was raised to 6.2% to save for the Baby Boomers. It would be nice if the premium could drop back once the Baby Boomers are gone, but I do not see this happening for at least three reasons.

1. The Boomer Echo-Baby Boomers had kids, and the Echo Generation is having kids, so the population is permanently higher than without the Baby Boomers.
2. Spoiled Government-The government has gotten used to having the extra funds to borrow for General Fund expenses.
3. Longevity-People are living longer, thus needing the safety net for longer periods of time.

As far as the 12X return is concerned, please remember that one dollar is not the same as another. If I bought, for example, Netflix stock a year ago for around $150 and sold at about $200 recently, those dollars are roughly the same dollars, so the 33% gain is an accurate perception. However, if I bought GE in the early 1970's for $1.00 and sold for $55, close to GE's historic high 30 years later, it appears to be a super impressive 5400% gain. But consider what $1.00 could buy in the 1970's versus what it could buy in 2000. Here is a sample: A $0.05 ice cream cone from Thrifty cost $2.79 now, a 56x or 5480% increase. Here's another: It used to cost $0.25 to go swimming for four hours in the community pool. Now it costs $5.00, a 20x or 3100% increase. I remember these figures because I used to ride my bike to the pool every Saturday and get an ice cream cone on the way home out of my dollar a week allowance. In terms of buying power, the $1.00 of 1970 and the $55 of 2000 are roughly the same.

Consider an index fund that tracks the DOW. From the 1970's to 2000, the index fund would have posted a gain of only 14x or about $1310%. If you retire now, you have had no additional gain due to the “lost decade.” Beloved Thirty-Somethings, this could happen to you. If the index fund is your retirement, regardless of the appearance of being a multi-bagger, it did not keep up with inflation, and will only lose ground to future inflation during retirement when the typical retiree converts it to a fixed-income stream.

The 12x return on Social Security only has the illusion of being huge. The fact is the 12x increase is potentially sustainable because past dollars, present dollars and future dollars are not the same. Even so, the nominal 12x return on Social Security payments will not even pay the rent.

So Justin is partially right. Individual investors have the potential to get a return greater than that of Social Security. The question is whether individual investors can actually achieve such a return, and more importantly, keep it. Statistics say that regardless of what the historical returns of the market may be, the typical individual investor gets a 1% return. And to get that paltry return, they have to break the first rule of investing: do not put money at risk you cannot afford to flush down the toilet. Retirement savings surely qualify as money most people cannot afford to lose.

People have learned the hard way they cannot count on their 401(k) plans, not only because of market risk, but also because studies have found that most 401(k) plans are actually pretty low quality. In my mind, maybe the best thing to do is buy a house when the rent vs. buy comparison is in your favor. Even if you end up spending twice the price of the house because you took the full 30 years to pay, you would have paid a similar amount anyway as rent and have nothing to show for the rent after 30 years. At least with a house, after 30 years you have secured a roof over your head. You can keep it for only the cost of the approximately 1% property tax and homeowners insurance, reducing your total retirement expenses by at least 25%-30%. Then your Social Security benefits, if you need the safety net, can go toward other expenses---like food.

Many, many people, even after a lifetime of hard work and doing everything right, are finding themselves looking over the edge of the abyss. Dear Thirty-Somethings, this could be you. And if you are a public school teacher, there are people out there going after your so-called exorbitant pension.


  1. A fair look at Social Security. You are absolutely correct that most people have not done well investing their own money. So long as Goldman et al can digitally game the market's up-ticks and down-ticks, feel free to study all you want, it's a gamble you're not likely to win. Thanks for doing your homework. For another look that compares returns for The Greatest Generation and the Boomers, see

  2. From your link, "If both men had invested their contributions and earned 5% per year in returns, Senior could only have had $60,000 when he retired. He did very well indeed with his $172K return on a $20k investment. Junior however would have had $640k at 5% on his investment. Junior actually lost $115k in the deal."

    Problem is while the historical returns of the market are greater than 5% annually, the historical returns of the individual investor are 1%, making Social Security's 3% look like a pretty good deal.

    And that is before considering that the benefits for those who really need the safety net will likely exceed the contributions by a mile. A recent report observed that the baby boomers are the first generation to do worse than their parents.

    Many boomers are in that yawning chasm between their last unemployment check and their first Social Security check. When Social Security claculates their benefits based on the income of the last 35 years, all those empty years will pull the benefit amount down. Voila! So-called Social Security problem solved!