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Could Stocks Save Social Security?

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Social Security is sagging a bit under the retirement of the large boomer population, and lawmakers have proposed raising taxes on high earners, cutting benefits or some combination of the two.

But new research explores the potential of adding equities to the bonds already held by the Social Security trust fund as a means of increasing yield.

And while doing so would add risk—both financial and political—to the program, other countries do hold equities as well as bonds in their retirement programs.

The brief indicates that, despite the potential for added risk, the addition of equities could improve the health of the Social Security trust fund.

The brief, from the Center for Retirement Research at Boston College, looks at the debate over whether equities are an appropriate addition to the trust fund, and also does a back study to see how Social Security would have performed if equities had been added in the past. It then does a forward-looking study to project how it might perform in the future.

Using historical returns based on reported returns of the Wilshire 5000 and the Ibbotson Large Cap Index, the brief explored the possible past performance of the trust fund assuming that the percentage in equities was phased in at 2.67 percentage points per year. It ran two projections, one beginning in 1984 and the second in 1997, in both cases assuming the 2.67 percent phase-in of equities, and found that, despite two stock market slumps and a financial crisis, strong historical average equity returns would have increased trust fund balances regardless of the year in which it began—1984 or 1997.

For the forward-looking projection, Monte Carlo simulations projected the range of outcomes for future equity returns, with equity returns assumed to be lower than in the past: 6.6 percent, compared with 9.5 percent. And there too the addition of equities improved outcomes.

The brief says that, “with equity investing, a 75-year solution could turn out to be a permanent fix for the program. Interestingly, even the 25th percentile of the mixed portfolio remains above the short-term benchmark and shows a much better outcome than any of the bond-only simulations depicted.”

However, it’s not foolproof, the brief warns. While 97 percent of the simulations indicate that equities strengthen the performance of the trust fund, “In three percent of the simulations, … equity investment produces worse outcomes.”

There are, of course, other considerations besides performance, such as the impact on capital markets and corporate governance and how to account for the possibility of higher expected returns without implying that “the government could solve all its problems simply by selling bonds and buying stocks.”

But the paper concludes that both retrospective and prospective analyses suggest that investing a portion of the Social Security trust fund in equities would improve its finances while at the same time there’s little evidence that trust fund equity investments would disrupt the stock market.

Equity investments could be structured to avoid government interference with capital markets or corporate decision making, it says, and last but not least, “accounting for returns on a risk-adjusted basis would avoid the appearance of a free lunch.”

— Check out Workers Maintain or Increase Income After Claiming Social Security: ICI on ThinkAdvisor.