Critics of the Bush administration plan to reform Social Security with personal accounts have a seemingly endless supply of reasons why it can’t possibly work. You know the litany: It’s too risky. It’s too expensive. It’s too complicated.
The critics never mention that there’s already a government-administered retirement system that has shown for over 15 years that personal accounts are prudent, inexpensive, and simple. It’s the Thrift Savings Plan of the United States federal government, currently serving 3.3 million government employees.
The years since Thrift was first offered in 1987 couldn’t make for a better laboratory to crash-test a personal-account system. During this period there have been both bull and bear markets that were among the most severe in history. Through year-end 2003, investments in Thrift personal accounts have earned $44.4 billion in profits for system participants — an average of more than $13,000 per participant.
Over time and on average, 65 percent of the value of Thrift participant accounts has been invested in a special money-market account operated by the U.S. Treasury. That’s been responsible for about $20.3 billion of the total investment gains. But almost as much — $19.8 billion — came from an S&P 500 Index fund. That’s remarkable because, on average, only 30 percent of the value of participant accounts has been invested in the S&P 500 fund.
This is a textbook lesson in why it makes sense to invest in equities. Even though they are riskier in the short-term, they have a higher expected return in the long-term. That’s why the S&P 500 fund has earned just about as much for Thrift participants as the plan’s money-market account, with only half the money invested.
Yes, after the bubble burst there were three difficult years for stocks — 2000, 2001, and 2002. In those bear-market years, Thrift participants overall lost money in their accounts, with losses in the S&P 500 fund overcoming gains in the money-market account (as well as the third fund tracking the Lehman). But the non-stock funds did well in those years, and 2003 was a great comeback year for stocks. (This year has been okay, too). So the least-lucky participants, those who started right at the top of the market in 2000, have already gotten back to even — on average — and those who started even a little earlier or a little later are solidly ahead.
How did Thrift participants react to the bear market? Not a bit like the scared rabbits that critics pretend the non-professional investors are. They didn’t dump right at the bottom; there were net redemptions from the S&P 500 fund in only 1 year — 2001. And when the market finally hit true bottom in the early spring of 2003, there were the biggest net contributions to the S&P 500 fund in Thrift’s history. Today, 43 percent of participant investments are in the S&P 500 fund (with another 10 percent in the other two stock funds).
And what about Enron? Don’t the critics always carp that gullible investors will lose their retirement fortunes in stocks, like Enron, that suddenly implode? Amazingly enough, any Thrift participant who invested in the S&P 500 Index fund did indeed invest in Enron, because Enron was a member of the S&P 500 Index until it was removed in late November, 2001 (after all the damage had been done). But Enron was only 1 of 500 stocks, so its risk was diversified away, just like the textbooks say.
The use of index funds has other advantages too — advantages that perfectly answer the critics of personal accounts. For one thing, index funds are simple to understand. Thrift started with one for stocks and one for bonds — about as simple as you can get. Two years ago Thrift added two more funds — one for smaller company stocks and another for non-U.S. stocks. Still, it’s so simple that even the most inexperienced investor can get it.
And index funds are cheap to operate. As I discussed in detail in my column last week, investment management fees for index funds are ruinously small for the managers. And speaking of cheap, Thrift is a model of efficiency. Its administrative costs are only about six one-hundredths of 1 percent of invested assets. That compares especially favorably to Social Security, which has administrative costs that are more than five-times greater, even though you’d think its vast scale would lead to significant economies.
Index funds also have the advantage of being very resistant to meddling by government bureaucrats. Critics of personal accounts complain that any government-sponsored retirement system creates an irresistible temptation for politicians to guide participant dollars toward favored investments, or for politicians to grandstand by interfering with corporate governance. Indeed, all those things have happened in large pension plans sponsored by state governments. But there’s never been a whiff of it at Thrift. That’s because investment in simple index funds is clearly mandated in the legislation that created it — it would take an act of congress to permit a bureaucrat to funnel Thrift money into some pet investment.
Ironically, the Thrift Savings Plan — a perfect model of the future of Social Security reform with personal accounts — was created as part of the last round of Social Security reform. Legislation passed in 1983 as part of the reforms recommended by the Greenspan Commission mandated for the first time that federal employees participate in the Social Security system. The idea was to force millions of new young participants to move back the day when the demographic time bomb threatening Social Security will inevitably explode. As you can imagine, federal employees weren’t thrilled, and Thrift was part of a complex package of adjustments designed to make them feel better about it.
The Thrift Savings Plan proves that there’s nothing too risky, too expensive, or too complicated about personal accounts for Social Security. So what are the critics really worried about? I think they’re afraid that personal accounts are too empowering. Once a nation of voters becomes a nation of empowered investors — there’s just no telling what kind of empowerment they’ll want next.