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America Needs an “Idiot-Proof” Retirement System

Volatility in the stock market over the last couple of weeks has caused enormous unease among investors big and small. Tens of millions of people with much of their retirement money in the market are worried about seeing a sudden plunge in prices. Many of these people will sell their stock to protect themselves from further losses, which demonstrates the basic problem with making retirement income dependent on an unstable, unpredictable exchange.

The story is that people tend to make bad decisions when they manage their money in the stock market. They are likely to sell at a low point after the market has just taken a big tumble, as has happened in the last two weeks. Then they buy back in during a run-up, paying much more than if they’d just held on to their stock.

It’s natural to want to “stop the bleeding,” no matter what professionals advise. As a result, people who actively manage their money typically get considerably lower returns than people who just buy and hold their stock. And this is before counting the brokerage fees and other costs associated with trading.

This pattern is important to keep in mind in the context of proposals to privatize Social Security, which may find their way back into political debate, as several Republican presidential candidates seem to think privatization is a good idea. A decade ago, President George W. Bush tried to privatize Social Security, but he abandoned the effort without ever putting a bill before Congress. In Washington, however, no bad idea stays dead for long, so we may have to argue once again over the future of Social Security.

Social Security is supposed to provide core retirement income, money that people who spent a lifetime working can count on with certainty. Just as software engineers design cellphones and computers to be “idiot proof” because they know many of us will do stupid things with these devices, Social Security is there for us no matter what mistakes we make in our financial planning. If we buy high and sell low, it’s a safety net.

In fact, the benefits of Social Security go beyond protecting us from our unforced errors. We know that the stock market has periods of upswings and downturns. If we happen to reach retirement age during a downturn, like the one in 2008–09, we would have much less money to support us in retirement than if we had retired a couple of years earlier or later. By contrast, Social Security benefits are determined by our lifetime earnings. The particular year that we retire will not affect the size of our benefits.

In addition to providing a guaranteed benefit, Social Security also saves workers a huge amount on administrative costs. Bush’s Social Security commission estimated that the administrative costs of the private accounts it was proposing would be roughly 10 times as high as the administrative cost of running the Social Security program. That was optimistic. Existing systems of private accounts, like those in Britain and Chile, have administrative costs that are 20 or 30 times as high as those of our Social Security system.

Such inefficiency might actually help to explain the ongoing interest in privatization. The costs of administering a privatized system are income to financial firms. Social Security currently pays out a bit more than $700 billion a year in retirement and survivors benefits. If this money came from individual accounts, it would correspond to a stock of assets in the neighborhood of $14 trillion. And if the administrative costs for managing these accounts were equal to 1 percent of the value of the accounts, which is roughly the case in countries with privatized Social Security systems, it would imply fees of $140 billion a year. That’s real money.

Panicking over declining stock prices is never a good idea. It’s always best to wait. But that’s cold comfort to anyone planning on retiring today, or next week. That’s why we need a foolproof—and market-proof—retirement system like Social Security.

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Dean Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University.

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