Do Equity Investments Make Sense in Social Security?

social security investments

Image Credit: © Andrii Yalanskyi | Dreamstime.com

New findings from the Center for Retirement Research (CRR) at Boston College questions the appeal of Social Security reserves in equities.

The research notes that Social Security assets in equities could yield higher returns to safer assets—meaning reduced tax hikes or benefit cuts for long-term solvency—yet critics worry about the impact of equities in private markets, or its potential “signal that trading bonds for stocks creates magic money.”

“Equity investment has higher expected returns relative to safer assets, so Social Security might need less in tax increases or benefit cuts to achieve long-term solvency,” reported the CRR. “On the other hand, equity investments involve greater risk and raise concerns about interference in private markets and about misleading accounting that suggests the government can get rich simply by issuing bonds and buying equities.”

The findings question whether past achievements involving equity investments, such as its success with the Railroad Retirement System and the Federal Thrift Savings Plan (TSP) in the U.S., along with the Canada Pension Plan, could mean the same for Social Security. As Social Security trust funds rapidly deplete, equity investments could be the only solution left for the government program to finally thrive, says the CRR.

According to the findings, economists argue that “efficient risk-sharing across a lifecycle requires individuals to bear more financial risk when young and less when old, and since the young have little in the way of financial assets, investing the trust fund in equities is one way to achieve that goal.”

Yet, those against the investments contend that Social Security equity investing could have negative effects on the stock market and corporate decisionmaking.

Therefore, the CRR asks readers to consider questions when assessing whether equities are appropriate for Social Security, including the size of the equity investment initiative compared to the economy, how government officials choose investments, and whether government agencies use expected returns or risk-adjusted returns to evaluate the impact of equities on plan finances.

Federal government plans with equity investments

The CRR poses three federal government plans as models for equities in government funded programs.

The first being the Canada Pension Plan, a major component of Canada’s retirement system, with a similar setup to that of the U.S. Social Security program that offers a pay-as-you-go plan with a modest reserve. While the program was a success when introduced in 1966, it eventually began to experience rising payroll contribution rates and increasing plan costs due to lower birth rates, longer life expectancies, and lower real wage growth.

Canada ultimately created the CPP Investment Board that (CPPIB), that would implement an investment strategy including stocks and bonds, real estate, infrastructure projects, and private equity. Over the last ten years, the Fund has experienced an annualized net return of 10%, reports the CRR.

In its findings, the CRR also considers two other U.S. programs that found success with equity investments in its plans: The U.S. Railroad Retirement System and the Federal Thrift Savings Plan. Today, the Railroad Retirement actuaries assume a 6.5% return, while the TSP reports zero difficulties in selecting an index and no issues of government interference in the market.

Equity investments in Social Security

Given the examples, the CRR concludes that equity investments can be included in Social Security trust funds but does require it to hold hefty weight—a feature that the government program currently does not have. To recreate a trust fund would require a tax hike to cover both the program’s current costs and to produce an annual surplus to build up trust fund reserves, found the CRR.

If Congress were unwilling to raise taxes, there is the option of borrowing. “Indeed, one proposal would have the government borrow about $1.5 trillion and invest those funds in stocks, private equity, and other instruments that offer higher expected returns than interest on government debt,” said the CRR. “In the meantime, the government would also borrow to cover Social Security’s shortfall. After 75 years, money from the trust fund could be used to repay the borrowing that went towards paying benefits.”

This, however, does not provide real economic changes, says the CRR, and only offers just the chance to pocket the return in excess of the bond rate.

Ultimately, the CRR finds that increasing taxes or borrowing might not be feasible nor wise to consider. “Thus, while the mechanics are totally manageable, the time may have passed for raising taxes enough to accumulate a meaningful Social Security trust fund that would make investing in equities worthwhile,” the CRR concluded.

SEE ALSO:

Exit mobile version