I’m such a big fan of simple calculations to sanity check behavior. People so frequently go into big decisions without even understanding the most fundamental basics of the situation. A great example comes from movies. Here the wonderful TMQ explains why the most recent Bond movie proposes an absolutely ridiculous orbiting space death ray. And then there is always the fantastic Impossible Movie Physics which practically eviscerates the Hulk and the Core.
However, when you can do this in a non-fiction setting… say the current administration’s social security policy, you bring about a whole new level of horror. Thanks to the New York Times’s odd archiving policies, where old articles about which I already know the news, cost more than fresh news, I will type in the key components of a very nice summary of a Week in Business column here:<o:p></o:p>
“Under the current system, investment returns from Social Security are “abysmal’, Mr. Bush said in one recent speech, because the trust fund is allowed to hold only low-yielding Treasury bonds… Letting working people invest some of their Social Security money in the stock market would allow them to earn higher returns[…]
It sounds like a no-lose proposition… Treasury bonds can be expected to yield a real annual rate of return of about 3 percent. Equities, by contrast, can be expected to earn 6.5 percent.[…]
But that logic is as flawed as a perpetual motion machine. If it were true, the government could erase Social Security’s entire projected deficit by selling bonds at 3 percent and buying stocks that yield 7 percent.
Why doesn’t the government do just that? Because higher returns are inseparable from higher risk.[…]
‘A consensus is forming among economists that equity pricing as indicated by price-earnings ratios may be somewhat higher in the long-term future than in the long-term past,’ wrote Mr. Goss.
‘This is consistent with broader access to equity markets and the belief may be viewed as somewhat less “risky” in the future than in the past,’ he added.
If investment funds or stock brokers made that claim, they would probably be breaking the law.” -- Edmund Andrews, NYT December 2004
I think Edmund Andrews is too conservative. Why not invest the trillions of dollars in the stock market and magically wipe away the national deficit! In all seriousness, this is exactly correct. The market prices stocks to accommodate risk.
If equities really were less risky, they would get lower return.
Basically, if it passes in the current state, we should expect hundreds of stories in 10-20 years time where people made much much less than they would have investing in standard bonds, either because growth in stocks was reduced returns due to the decreased risk, or growth in stocks was erratic and people had to cash out at a downswing. Does anyone in government actually think about this stuff before they say it?
Of course I, who am now 30, would prefer to take on the risk, because I have long enough to ride out most of the up and down swings and expect to not require the dollars I invest as in my 401(k) or other retirement fund to be my sole source of retirement income.
But I hardly represent the average investor or retiree, either because I’m naïve or very lucky (or both).
D
