December 29, 2004

They Think You're Stupid

by Alan Reynolds

Alan Reynolds is a senior fellow with the Cato Institute and a nationally syndicated columnist.

New York Times columnist Daniel Altman wrote about "Taxes and Consequences" after the election, fearing all prospective changes in the status quo. His complaints with allowing young workers to put part of their Social Security tax into personal savings accounts were stupendously supercilious. He demanded to know "who would choose where workers could put their money?"

The elitism here is obvious. Like other New York Times employees, Altman has a 401(k) retirement savings plan. So, who gets to choose where he puts his money? He does, of course. So, why does Altman presume other people are too stupid to make such choices? It's their money, after all.

But anyone who cashed-out a retirement savings plan in such an untimely way would have to pay income tax on that lump sum, often at a high tax rate. Prudent retirees instead avoid touching tax-deferred plans until age 70-and-a-half, when they are legally required to begin taking the money out. Only academics who ask stupid questions would even think of rushing to liquidate life saving during a cyclical crash such as 1933 or October 1987, which were excellent times to be buying.

The money invested in any retirement saving account goes in over many years and comes out over many years. What the stock or bond market happens to be doing during the year one begins retirement tells the retiree almost nothing about the next 10 or 20 years. The stock market rarely stays down for more than three years, and then typically rebounds quickly (as in 1983 or 2003). Meanwhile, the value of bonds often rises in recessions when stocks fall (as in 2001).

Under a partly privatized Social Security system, potential retirees' incentives to tap the retirement account slowly would be similar to existing 401(k) plans. Unlike old-fashioned Social Security, there would be no artificial incentive to retire prematurely at age 62 or 66, because the longer you keep investing in your own account the more comfortably you can retire or partly retire whenever you choose.

On Dec. 1, Wall Street Journal writer Tom Lauricella chimed in with a front-page feature saying, "The Bush administration wants to incorporate elements of the 401(k) approach into Social Security." But those who have such retirement savings plans, he warned, "have made obvious mistakes in investing their money, such as putting too much money into low-yield savings accounts or betting the house on their own company's stock. Many also don't put as much money into the plans as they could, forgoing big tax savings and employers' matching contributions."

The first and last complaints are inappropriate; the one about company stock is irrelevant. Those who put "too much money into low-yield savings accounts" have a low appetite for risk, which is as legitimate a taste as any other. To presume to instruct people on how much risk they should take with their own money is no different from complaining that other people buy the wrong cars or drink the wrong wine.

This is a peculiarly ironic point to make in this case. Those opposed to adding private choice to Social Security start by suggesting that private retirement accounts are too risky, yet end up complaining those with 401(k) plans don't take enough risks.

The Wall Street Journal writer's second complaint is that "many don't put as much money into the plans as they could, forgoing big tax savings and employers' matching contributions." That simply shows it is difficult to save, particularly for young parents.

I once advised a young father facing a budget squeeze to temporarily shrink his 401(k) contributions to the small percentage his employer matched, because the alternative was adding to his family's debts. Most of us save little until the kids are out of college. Yet 78 percent of those offered a 401(k) plan nonetheless participate as well as they can, adding more later in life when they can best afford it.

The academic complaint that few put the legal maximum into a 401(k) in any given year -- $12,000 -- sounds persuasive only to those with salaries larger than the middling five figures most of us earn, before taxes. Those statistics count me among the stupid people who do not put the maximum into a 401(k) plan. But that is because I already have more than enough stashed away in other 403(c), Keogh and IRA accounts.

Lauricella's third complaint -- "betting the house on their own company's stock" -- is a red herring. In this case, his analogy with employer-sponsored 401(k) plans breaks down completely. An analogy with federal employee retirement accounts would be much better. Private accounts funded with Social Security taxes are not employer-provided plans, so employers will have no say at all in defining which investments will be allowed. There is no chance at all that such a federally designed system would allow investing in any one stock, much less the stock of your employer.

Altman somehow missed this distinction, too. He asks, "Would they (who chose to invest part of their Social Security taxes) have been able to invest in Enron?" Of course not. That's another startlingly stupid question.

Altman also asked, "What about investing abroad?" He must have neglected to study the benefits of international diversification. Unfortunately, Congress tends to share Altman's provincial concept of risk, so they probably won't allow investing in a global stock or bond fund, but they should. For equally paternalistic reasons, the law does not allow holding short positions or "bear funds" in retirement accounts (short-term bets stocks will fall), thus making it impossible to hedge against periodic market downturns. In the name of limiting risk, such restrictions on choice force people to take avoidable risk.

The Wall Street Journal cites a study by an employee benefit consultant claiming professionally managed 401(k) plans earned a slightly better 10-year return than the do-it-yourself variety -- roughly 6.8 percent a year for the pros and 6.4 percent for the amateurs. Since amateur investors in 401(k) plans managed to earn 6.4 percent a year from 1992 to 2002, however, they suddenly look a lot less stupid than Altman and Lauricella think they are. That is nearly enough to double the size of a 401(k) account every 10 years. And the professionals may well have been taking bigger risks, since it wasn't their own money they were playing with.

Once younger people are given the choice to build such private accounts under Social Security, an extremely competitive market for professional advice will spring up to meet the demand because millions of employees, rather than a few bosses, will be newly empowered. But if Altman and Lauricella are still offering their arrogantly ignorant investment advice, you'll be safer sticking with a do-it-yourself approach.

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