Beckett of Pittsburg, PA, asks :
What would happen to individually invested accounts if the stock market
crashed again? Would there be no safety net left?
Most plans for individual accounts maintain some fallback program that
will provide a minimal benefit (usually about $400-500 a month in today's
dollars). Retirees would still have this money, if their investments
in individual accounts turned out poorly. A way to think about this
division between the guaranteed benefit and the individual account is
as a cutting away of the current guaranteed benefit. At present, we
hope that workers will have company pensions and individual savings,
in addition to their Social Security, to support them in their retirement.
Unfortunately, many workers don't get pensions on their jobs and are
unable to save much during their working years, so Social Security is
all they have to rely one. If government mandated individual accounts
replace a portion of the current Social Security benefit, then it further
reduces the money that retirees can rely on.
Essentially all proposals for individual accounts have some type of
safety net backing them up. The National Commission on Retirement Policy
recommended establishing a new minimum benefit, making poor and low
income people better off than currently even if they lost their entire
individual account. Australia backs up an employer-mandated, individual
account with a means-tested Social Security system. Martin Feldstein
has suggested a system in which the Social Security benefit depends
directly on the investor's success with individual accounts. There are
important advantages and disadvantages associated with these various
approaches, but the important point is that some type of safety net
would remain in combination with any system of individual accounts.
More important, investors should plan investments so that they are
less vulnerable to a stock market crash. Early in life, it is appropriate
to be heavily invested in stock. One then has plenty of time to adjust
future saving to make up for stock market disappointments. As one nears
retirement, one should gradually get out of stocks and into bonds. Data
on 401ks and IRAs suggest that people do, in fact, change the composition
of their investments in this manner as they get older.
Tanner and Darcy Olsen respond:
History certainly has demonstrated that markets are volatile--they can
rise and fall with little warning. But history has also demonstrated
that markets go up over the long term, and the long term is what matters
when it comes to saving for retirement. Since 1926, the average real
rate of return on the stock market has been 7.56 percent. Even the worst
20-year-period from 1929 through 1948, which includes the stock market
crash of '29 and the Great Depression, had a positive real rate of return
of 3.36 percent. Compare that to Social Security's 1 to 2 percent return.
Workers who are uncomfortable with stocks could choose to invest conservatively
in government bonds, for example, which typically yield a 3 or 4 percent
In addition, virtually all legislative proposals for private accounts
include a safety net to protect workers. If a worker has not accumulated
adequate funds by retirement, the government could "top off" the worker's
account. The guaranteed benefit could be set to ensure that every worker's
retirement income is at least at or above the federal poverty line.
The safety net could be financed out of general revenues.