Here are the numbers proving Bush's privatization plan won't work

[bonddad]

I think the new term is modernization, but that could change depending on the public response to the new frame. Whatever the term used, Bush wants people to invest part of their FICA payroll tax into the stock market. He claims it will return 6%, which is higher than treasuries. In this, he is technically correct. The market, on average, has a higher rate of return than bonds. However, he makes several assumptions that don't dovetail with reality. We'll get to those in a minute. First, let's examine exactly what Bush is saying.

The Bush plan calls for people to divert a certain amount of their FICA withholding tax to private accounts. The maximum annual dollar amount quoted is $1000. To figure out what this would be worth when the person contributes, I used the future value of a multiple payment annuity formula. All this means is I computed the future value of regularly contributed specific amounts of money over a specific period of time.

For example, if a person contributes the maximum under the Bush plan ($1000/year) and he contributes from each paycheck and pays into the system twice a month, he will contribute $41.6667 every 2 weeks.

All that being said, here are the numbers I got using the following assumptions.

Person X starts contributing the maximum amount of money into his private account 40 years before retirement. He contributes $41.67 every two weeks at a 6% annual return for 40 years. At the end of 40 years, this gives him $166,503.65. At 7% the amount is $219,433.4004.

Just for kicks, let's say the guy starts to contribute at age 35, so he participates in the system for 30 years. There is a big drop-off in performance. At a constant 6% rate of return, he'll have $83, 934 and at 7% he'll have $101,901.

The totals are then annutized. Fancy name. What that really means they are paid out at regular intervals at regular times. Assuming our person X retires at 65 and lives 13 years until 78, he obviously gets the best deal by paying into the system for 40 years at a 7% return because he'll get $1,406.62/month. The 40 year scenario at 6% yields a monthly payment of $1,067.33. Not bad. But, if he started to pay into the system a mere 10 years later and got 7%, he'll have 653.21/month. If he only got 6% over 30 years, the payment drops to $538.03

So, up front, before we even consider the sporadic nature of stock market returns, we have learned that Bush's plan will take at least 40 years to reach its potential. People who contribute for a shorter period of time will have small payments from their total return that the government will have to compensate for. In addition, during those 40 years, the diversion of money from Trust payment contributions to stock market contributions will create a deficit in the trust fund and annual outlays.

In other words, Bush 1-2 trillion debt increase to pay for the plan is too low. Way too low. It doesn't take into account the amount of debt required to make-up the deficit caused by the diversion FICA contributions into private accounts over a period of 30-40 years to enable his plan to come to fruition.

But, here's where the problem really kicks in. The formula requires an assumption of a specific annual rate of return and assumes the rate of return is constant - the money invested will continually increase by the specific amount each year. This works well for bonds, but not for stocks. Stock market returns vacillate over time depending on the underlying performance of the economy. According to John Mueller, former economic counsel to the U.S. House of Representatives' Republican Caucus, the 20-year average real return on the stock market fell to zero three times since 1900--from 1901 to 1921, from 1928 to 1948, and from 1962 to 1982 - or 60 years out of the last 100 (60%). This means that money invested at the beginning of each period would be worth more or less the same after 20 years. If somebody withdrew their money at the end of any of those periods, they would have little return to show for their investment. In addition, note how these periods of 0 growth in the stock market are spread over time. No matter when you started to invest your money over this period of time, you would run into a 20 year period where there would be 0 growth in your money. If you started to invest in 1900, you would 20 years of 0 growth. How about 1960? You would have 20 years of 0 growth from 1962-1982. Pick any year over that time and count forward 40 years. Guess what? You hit a 20-year period of 0% growth.

So what does this mean? 40 years of constant rate of growth in the stock market is pure crap. The longest period over the last 100 years that a person could invest without running into a 20-year period of 0% growth is 20 years - from 1948 to 1962. On the back end of that, he would have an addition 6 years before he withdrew his money. Assuming a person started to invest in 1948 for the maximum period of 40 years, he would have 20 years of growth, not 40.

Using the same formula with 20 years and 7%, the investor gets $43, 569.24 or 279.29/month. In other words, he gets to live in a cardboard box and eat cat food during his retirement.

This analysis is far from perfect. I didn't count administrative expenses etc.... But, you get the idea.

[stevebreeze]

1. couple of more point on the stock market return

The SS trustees says the GDP will grow by on 1.8% for most of the next 74 years. If it grows that slow( 1/2 the rate since the civil war) stocks will not return 7%.

Price to earning ratio of stocks is now around 20/1 far higher then the normal ratio of 14.5/1 obviously of stocks are now overpriced NOW they will rise more slowly in value until they are closer to what history tells us they are worth.

The account fees that Wall Street is drooling over will take 1% or so a year off of market increases.

Totaled up it is very unlikely that stocks in private accounts will outperform the current system.

[ArmHayseed]

2. Where's the data?

Does anyone know where to find the data on the market back to 1900? It appears as though the only index that has any info back that far in the Dow and past 10/01/1928 I can only find the monthly high & lows. I don’t believe there are any mutual funds that date back to 1900 but does anyone know for sure?

Also, this 1 to 2 trillion dollar shortfall the first year. If it’s caused by workers opting out of SSI, it sounds as though there would be another shortfall the same size each following year plus any additional workers who opted out. Am I right or wrong?

[papau]

3. First Mutual Fund was Mass Investors Trust at about 1925

Stock data is usually all post 1929.

But the data going way back is available - at least as to year end close - from many sources,