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   Are Private Accounts a Bonanza?

  No, and here's why:
The Privatizer's logic fails the "are-you-diverified" test.
Every investment adviser will tell you to diversify, especially for retirement. That could mean 40% in Treasury bonds and 60% in stocks. Pick your own numbers, but let's say that's best for Joe, even though T-bonds only earn 4% and stocks earn 8%. That's because stocks are risky and Joe does not want to risk his whole retirment in the stock market.

Now along comes the privatizer man who says, "Hey Joe, vote for me and I'll help you make 4% more on a big piece of your retirement nest egg." Joe says, "Great you got my vote!"

Now the privatizer man tells Joe to cash in his T-bonds and put them in a private-account stock fund he made for Joe, and Joe does just that. Now he earns 8% on all that money he was only earning 4% on.

But one day, Joe sees his investment adviser who asks "Joe, are you diversified?" ... You get the picture. If diversification is good, as every investment adviser says, then cheating on the diversification rule is not going to win you a bonanza, even though you average more (barring any bad luck) on the money you put into stocks.

Who did I learn this from?
Olivia S. Mitchell, a member of Bush's privatizing commission!
That's right, back before she joined that commission, she wrote a really great, very technical, very well respected report that worked this out and she has never taken it back—because it's right. Here's what she said.
  "Many advocates of social security privatization argue that rates of return under a defined contribution individual account system would be much higher for all than they are under the current social security system. This claim is false." —Olivia S. Mitchell (paper)  
  How Much Social-Security Benefit Do I Lose When I Go Private?
Right now you would lose 6% interest. Here's how it works. At a White House briefing (popNote) on Feb. 3, 2005, a senior advisor stated that "the person comes out ahead if their personal account exceeds a 3 percent real rate of return." Now a "real rate of return" means above the rate of inflation, which is now 3% per year. That means right now you have to earn more than 6% in the stock market to come out ahead.

You might make more in the stock market, but why is it that stocks pay more than bonds, and why does anyone ever buy a T-bond, let alone the $7 trillion of bonds that have been sold--maninly to big-time investors--to cover the national debt. Stocks have to pay more because they are risky and the extra they pay is called a "risk premium" because it just covers the cost of risk. People buy T-bonds because they want to diversify and partially protect themselve against the risky stock market.

http://zfacts.com/p/801.html | 01/18/12 07:17 GMT
Modified: Mon, 01 May 2006 23:18:50 GMT