Why investing SS in the stock market is a horrible idea.

[CrusaderFrank]

There is a myth perpetuated in the world of finance that over long periods, the stock market will always net positive returns - some better than others - but it will always at least beat U.S. Treasuries.


This myth is based on the past performance of the U.S. stock market alone. Using on U.S. data creates quite a selection bias, as there is no fundamental reason to believe the future of the U.S. markets could not possibly look like the past markets of nations other than the U.S.

To give an example - look at the Japanese stock market over the past ~25 years. The Nikkei 225 has not even recovered to HALF of what it was before the crash.

Two words: Warren Buffett

Congratulations, your survivor bias is so high, you've chosen perhaps the most successful investor of our day as your only sample point.

Also, we're not in Japan.

Are the laws of nature different in Japan?

My survivor bias? It's just common sense that you can do better with equities than with bonds and I'd say between Berkshire Hathaway or bonds, I'd put it all on Berkshire

 

[Toro]

You have to assume risk averse investing. ~7% returns over treasuries over 30 year periods assumes extremely risk averse investing.

I don't know what returns over Treasuries will be. I do know that historically, equities have beaten Treasuries by a wide margin over long periods of times.

The only way this doesn't occur in the future is if there are

1. Extreme economic and political dislocations
2. Extreme equity market valuations

I am willing to bet that America isn't going to fall apart politically or economically. And equities aren't at extreme valuations. In fact, the valuation extremes are in bonds. Whenever the spread between bonds and stocks have been this narrow, the outperformance over subsequent periods for stocks has been high.

You will respond by saying "How do you know the past will be like the future?" The argument can be made to you. How do you know the government will meet all of it's SS obligations? How do you know the government won't go broke and choose not to pay out all they've promised? Just because they have in the past does not mean they will in the future. You don't know.

Take a look at what S&P 500 futures are for June 2014 delivery. I guarantee you they are not even close to 8% higher than the S&P 500 is now. They will in fact be about 2% LOWER than the S&P 500 is now. This is because the market doesn't actually think the S&P 500 will be 8% higher 11 months from now - it actually thinks that the total return will be the same as a U.S. Treasury over the same period.

I don't know what the market will do one year from now. That's not the point of this discussion. You don't invest a pension plan based on next year's return. A pension is invested looking out over multiple decades. If the economy continues to grow at a 2%-3% real rate, equities will outperform bonds. If they don't, that would mean that an ever increasing share of the return on capital would accrue to bondholders, which seems unlikely given that bonds are fixed rate instruments. Mathematically, this doesn't work.

Yet your entire premise is based on the idea that a 30+ year investment in the stock market is actually low risk.

That is totally wrong. You've got it backwards. Stocks are more risky than bonds and should be compensated as such. That is basic economics.

ONLY IF THE AVERAGE INVESTOR IS RISK AVERSE.

Yet, actually entire areas of finance assume risk neutral investors. Options pricing, for instance, is entirely based on the assumption of the risk neutral investor.

What do you mean? In Black Scholes, the higher the expected volatility, the more valuable the option. How is this consistent with your claim that investors are risk neutral?

You're making a prediction of the future based on a very tiny sample.

It's no different than what you are doing. You are making assumptions about financial market behavior just as I am. The difference is that my argument is based on economic theory, observable data and history. Given that economic theory dictates and history has confirmed that equities outperform bonds over long periods of time, the onus is on you to prove otherwise. Thus far, your arguments have been "we've been lucky" and "past performance is no guarantee of future returns." But other than that, you have not yet given a coherent argument why government bonds should outperform stocks.

Its not really "in" government debt. Its not like you get an account that accrues debt obligations and if those obligations do well you get more money and if they do less well you get less. Social security is an annuity. Its paid for by social security tax revenues +/- general revenues depending on whether the trust fund is being added to or drawn down.

The value of the trusts is based upon how much each individual contributes and the rate at which the pool compounds. That rate is a function of the government bond market. The trusts publish what this rate is every year. Liabilities are credited to the participants of the pool less payments out. You have a social security number which tracks your contributions into the pool. SS payments are calculated based on actuarial assumptions and your contributions into the pool. The solvency of the pools are a function of the contributions and the rates at which they compound. Annuities you buy from an insurance company are the same, except the insurance company invests in tradeable bonds, unlike the trusts, which debit and credit the accounts as if they were buying government bonds. In fact, the SS trusts act like a government bond fund.

 

[Toro]

Well, what do you mean by "survivorship bias" then?

Just look at the S&P 500. Is it a sample of the general stock market over time? No. It doesn't follow the losers to the ground - it drops them from the index!

I understand that. So what did you mean by this?

Your comment about survivorship bias implies America won't survive.

Actually it in no way implies that one bit.

What do you mean by "survivorship bias" as it applies to the US stock market then? I'm assuming you mean the US economy, because even though the index drops individual stocks, it replaces them with ones that are growing, which is representative of the innovation occurring in the economy. The only way survivorship bias can be applied to the entire US stock market is if there is something cataclysmically wrong with US economy that wipes out the entire stock market.

Unless you want to clarify.

So its your assertion that its mathematically impossible for the working members of a population to provide the goods and services that the too old to work members of that population needs if the population is decreasing? You are certainly certain of an awful lot!

Not unless the working population is willing to continuously work more for less. Given that the CBO estimates the trusts will be able to pay out 75% of its promised amounts by 2040, and given the resistance by ordinary Americans to pay out more in taxes, it seems very unlikely that a declining American working population would be willing to shell out even more.

 

[Sallow]

It's not a "myth".

Stocks generally perform well over the long term.

And you base that assertion on what exactly? Generally when? The past? Or the future?

But if you invest, you need to be fully aware that the market is not a bank. Investors need to pay close attention to their investments and the economic climate.

Because if investors just pay close enough attention they can all avoid losing money?

First off..I agree with your OP.

It's a bad idea to invest SSI money into the stock market.

That said..return over the long term..is generally pretty good.

But that comes with a caveat given the wide swings.

Which makes it foolhardy to put SSI cash in.

 

[Toro]

Two words: Warren Buffett

Congratulations, your survivor bias is so high, you've chosen perhaps the most successful investor of our day as your only sample point.

Also, we're not in Japan.

Are the laws of nature different in Japan?

My survivor bias? It's just common sense that you can do better with equities than with bonds and I'd say between Berkshire Hathaway or bonds, I'd put it all on Berkshire

There is an economic reason for it.

If the cost of capital is 6%, it will be divided across all parts of the capital stack. Envision three parts of capital, a senior loan, a mezzanine piece and equity. The senior loan will be priced below the blended cost of capital, the equity piece above, and the mezz somewhere in between.

The only way that this does not happen is if there is tremendous mispricing in the financial markets such that when traded, the senior loans trade at a deep discount and the equity at a steep premium. And the only way that this can persist is if financial markets are random for a very long time. Such mispricings can, and have, occurred over several years. But eventually, the mispricings adjust and markets become rational again. To assume that stocks will underperform bonds in a growing economy over many decades is to assume that financial markets remain irrational and mispriced for generations. That doesn't happen. Economic theory would say it won't and history has borne it out.

The funny thing about OPPD is that he doesn't appear to understand what has been happening in the bond markets. BB-rated high yield debt was trading below 5%, all-time lows. Kingdom of the Netherlands bonds were yielding 495-year lows last winter. The bubble has been in bonds as investors chase yields at any price. Now is a terrible time to be invested in bonds.

 

[Toro]

So if you want statistical samples, starting in the year 1900, there are 62 discreet 50-year samples.

LOL! That's hilarious, Sorry, but if you have 2 samples you don't get a 3rd by taking half of the first and tacking it on to half of the 2nd!

There are 2.065 50 year samples over a 113 year period. DUH

"Stocks have outperformed bonds over any 50-year period" means every 50-year period. It doesn't mean only 1900 to 1949 and 1950 to 2000. It means every single 50-year period from 1900 to 2012.

You'll have to take up your argument with academics in finance. Tell me how you make out. I'd be interested.

Email this guy, tell him that he's wrong and get back to us.

 

[OohPooPahDoo]

Two words: Warren Buffett

Congratulations, your survivor bias is so high, you've chosen perhaps the most successful investor of our day as your only sample point.

Also, we're not in Japan.

Are the laws of nature different in Japan?

My survivor bias? It's just common sense that you can do better with equities than with bonds

In other words you can't explain why.

and I'd say between Berkshire Hathaway or bonds, I'd put it all on Berkshire

What amazing hindsight you have!

 

[OohPooPahDoo]

I don't know what returns over Treasuries will be. I do know that historically, equities have beaten Treasuries by a wide margin over long periods of times.

We're not talking about history. We're talking about the future.

The only way this doesn't occur in the future is if there are

1. Extreme economic and political dislocations
2. Extreme equity market valuations

Great analysis. We'll just exclude any potential future we don't like. That's not selection bias at all.

And equities aren't at extreme valuations.

Equities have never ever in the history of the stock market ever been at "extreme valuations" in the present. Its only in hindsight that the valuations appear extreme. Why do you not get this?

In fact, the valuation extremes are in bonds. Whenever the spread between bonds and stocks have been this narrow, the outperformance over subsequent periods for stocks has been high.

If you pick 1000 different investing strategies and apply them to the 100 year sample you have provided you're bound to find several that beat the average. if you pick 1000000 different strategies to try you'll find 1000 times more.

How do you know the government will meet all of it's SS obligations?

I don't. Nor is anything I've said predicated on an assumption that it will.

You have severely misunderstood me to be someone like you. Unlike you - I cannot predict the future. I'm not saying bonds will out-perform stocks. In fact, I'm not saying anything about the future - except that you can't predict it and I'd prefer Social Security to not be based around an assumption that you can.

What do you mean? In Black Scholes, the higher the expected volatility, the more valuable the option. How is this consistent with your claim that investors are risk neutral?

Black Scholes assumes the risk neutral investor.

You are making assumptions about financial market behavior just as I am.

I'm not. I'm making zero assumptions.

The difference is that my argument is based on economic theory, observable data and history.

Your argument is based on a slice of history that happens to reinforce your argument.

If a beef cow were to predict its future based on its past it would have nothing but a rosy outlook. Free grass and feed as far as the eye can see. Until slaughter day.

Given that economic theory dictates and history has confirmed that equities outperform bonds over long periods of time

,

Actually economic theory cannot adequately explain why equities outperform stocks. Look up "equity premium"

 

[OohPooPahDoo]

"Stocks have outperformed bonds over any 50-year period" means every 50-year period. It doesn't mean only 1900 to 1949 and 1950 to 2000. It means every single 50-year period from 1900 to 2012.

Actually - if we get rid of the requirement that each 50 year sample not include points from any other 50 year sample - there are an INFINITE number of 50 year periods between 1900 and 2012. Why do you arbitrarily decide that each sample must be staggered one year apart from the other? Why not two years? Why not 1/2 year?


In fact - for any sample size over 50 years - we can pick an infinite number of 50 year samples if we eliminate the requirement that each sample not include parts of other samples.


So congratulations. You and the finance academia you laud so much have been able to magically produce an INFINITE number of 50 year samples with only 100 years of data!!!!!!!!!



Do you realize that if you ask 1,000,000 people to predict which way the stock market will move each month, that after 20 months, on average about one of them will have been correct with every prediction even if they were all picking at random? Would you give your money to that guy to invest? I mean why not, right? He's been correct 20 times in a row in predicting the monthly stock market move? What are the odds of that? He MUST be good, right? SURVIVORSHIP BIAS - learn about it.

 

[boedicca]

It's kinda sad...but very funny to see OPPD make a total idiot of himself.

Toro's cat knows (or would know if he had one) more about economics than does OPPD. He's lost the debate with Toro before it even started.

 

[Boss]

By spending exceeding revenue. Duh. What are you, a fucking idiot?


Wow - no - clearly - you're the genius.

So we've obviously NOT been paying our debts, if we are spending more than our revenue. We are ACCUMULATING debt, not paying our debt. If you charge $5,000 on your charge card, and pay the minimum $140 monthly payment, you are not paying your debts. That's called FLOATING your debt. When you continue to spend $5,000 and pay $140, you will gain MORE debt, you are NOT paying the debt off.

Awesome. You're so smart. You're missing the entire point of this thread.

The point of the thread is sheer ignorance. It argues, it's a bad idea to keep our money and invest in a stock market, as opposed to giving our money to Nancy and Harry to fritter away. I fundamentally disagree, even if we can only keep our money and bury it in a can, we're better off than giving it to out of control Federal government, to blow and squander. Even if we lost our ass and only retained half of our investment, we're better off than not having the money to pay retirees.

 

[Toro]

We're not talking about history. We're talking about the future.

The future isn't random. You seem to think it is.

Great analysis. We'll just exclude any potential future we don't like. That's not selection bias at all.

What other events besides extreme political or economic dislocations or extreme valuations would you include?

Equities have never ever in the history of the stock market ever been at "extreme valuations" in the present. Its only in hindsight that the valuations appear extreme. Why do you not get this?

Perhaps it wasn't to the theoreticians and non-practitioners, and to those who don't understand financial market history, but it was easy to see for the professionals who ran money during the tech bubble. At least for those who are still around.

If you pick 1000 different investing strategies and apply them to the 100 year sample you have provided you're bound to find several that beat the average. if you pick 1000000 different strategies to try you'll find 1000 times more.

What averages are you talking about? It's not about averages. The stock market is the average. Stocks should outperform other asset classes such as government bonds over time because stocks are riskier.

I don't. Nor is anything I've said predicated on an assumption that it will.

You are saying that we shouldn't invest SS in stocks. That makes the assumption that government bonds are a better bet.

You have severely misunderstood me to be someone like you. Unlike you - I cannot predict the future. I'm not saying bonds will out-perform stocks. In fact, I'm not saying anything about the future - except that you can't predict it and I'd prefer Social Security to not be based around an assumption that you can.

You are making an assumption that government bonds are a better bet than stocks. You are predicting that the government will continue to pay the obligations in the future.

Black Scholes assumes the risk neutral investor.

Explain why volatility is part of the formula then?

Here are all the assumptions in Black-Scholes.

The Black–Scholes model of the market for a particular stock makes the following explicit assumptions:

There is no arbitrage opportunity (i.e., there is no way to make a riskless profit).
It is possible to borrow and lend cash at a known constant risk-free interest rate.
It is possible to buy and sell any amount, even fractional, of stock (this includes short selling).
The above transactions do not incur any fees or costs (i.e., frictionless market).
The stock price follows a geometric Brownian motion with constant drift and volatility.
The underlying security does not pay a dividend.

Black?Scholes - Wikipedia, the free encyclopedia

Where does it say that an investor is "risk neutral?"

Your argument is based on a slice of history that happens to reinforce your argument.

My argument is based upon economic theory that has been confirmed by history.

If a beef cow were to predict its future based on its past it would have nothing but a rosy outlook. Free grass and feed as far as the eye can see. Until slaughter day.

You are saying that America is the cow. One day it will be slaughtered. I disagree. If it is the cow, SS is finished anyways.

Actually economic theory cannot adequately explain why equities outperform stocks. Look up "equity premium"

Actually, it does. The equity risk premium states that equities should earn a higher return because equities have greater risk. This is what CAPM is built upon, which derives from modern portfolio theory, which won the Nobel Prize in economics.

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 1990

You should call the Riksbank and tell them they're wrong.

 

[Toro]

Actually - if we get rid of the requirement that each 50 year sample not include points from any other 50 year sample - there are an INFINITE number of 50 year periods between 1900 and 2012.[/SIZE] Why do you arbitrarily decide that each sample must be staggered one year apart from the other? Why not two years? Why not 1/2 year?

Fine. There are infinite number of 50 year-periods. That further confirms my point. Pick any date, any day, any time, any second, any millisecond, and prove I'm wrong.

Do you realize that if you ask 1,000,000 people to predict which way the stock market will move each month, that after 20 months, on average about one of them will have been correct with every prediction even if they were all picking at random? Would you give your money to that guy to invest? I mean why not, right? He's been correct 20 times in a row in predicting the monthly stock market move? What are the odds of that? He MUST be good, right? SURVIVORSHIP BIAS - learn about it.

That's not survivorship bias. Survivorship bias is excluding data from the sample that is no longer around.

Survivorship bias is the logical error of concentrating on the people or things that "survived" some process and inadvertently overlooking those that didn't because of their lack of visibility.

Survivorship bias - Wikipedia, the free encyclopedia

What you are referring to is randomness and a statistical outcome where one cannot differentiate between skill and luck.

If we apply this to your argument, then the success of the United States has been random, i.e. lucky. That's what I was referring to earlier. For your argument to apply, for US stocks to not outperform bonds over very long periods of time, it would require the US to no longer be "lucky."

Or, you can believe there is a fundamental reason why the United States has seen remarkable growth over the past 200 years due to its culture, its laws, its people, its remarkable adaptiveness, and its institutions, which has caused the economy to grow and stocks to be such great investments.

 

[auditor0007]

They idea that you cant invest your own money is ludicrous.

But then so is the lie that SS is our own money. It's a ponzi scheme. Our money is going to people who are already collecting.

It's always been that way and there is nothing wrong with it being that way. It's a pay as you go plan, not an investment plan. Again, there is absolutely nothing wrong with that. What is wrong is taking surpluses from the fund to use for other things and then saying it is owed back to the program. That is just robbing Peter to pay Paul and should never have been permitted in the first place.

 

[Boss]

They idea that you cant invest your own money is ludicrous.

But then so is the lie that SS is our own money. It's a ponzi scheme. Our money is going to people who are already collecting.

It's always been that way and there is nothing wrong with it being that way. It's a pay as you go plan, not an investment plan. Again, there is absolutely nothing wrong with that. What is wrong is taking surpluses from the fund to use for other things and then saying it is owed back to the program. That is just robbing Peter to pay Paul and should never have been permitted in the first place.

Sorry, it HASN'T always been that way. And there is something VERY wrong with it being that way, especially with the knowledge that those who are currently paying, aren't going to receive any benefit. That's a ponzi scheme. The program started out being a trust fund, and the working baby boomers were socking away billions, so the grubby little hands of Congress figured it wouldn't cause any harm to "borrow" a little for this or that, and once that started happening, the practice snowballed, and now all the money is spent. The baby boomers, who worked and contributed their whole life, have nothing. There is not another baby boomer generation to follow them, the boom in babies stopped with the next generation. So who is going to pay the retirement pensions for these 70 million baby boomers? Do you not understand why it's totally stupid to have a 'pay as you go' system?

 

[FA_Q2]

They idea that you cant invest your own money is ludicrous.

But then so is the lie that SS is our own money. It's a ponzi scheme. Our money is going to people who are already collecting.

It's always been that way and there is nothing wrong with it being that way. It's a pay as you go plan, not an investment plan. Again, there is absolutely nothing wrong with that. What is wrong is taking surpluses from the fund to use for other things and then saying it is owed back to the program. That is just robbing Peter to pay Paul and should never have been permitted in the first place.

A pay as you go system requires that the economy AND the population is in perpetual growth, a sheer impossibility. At some point, the population will NOT grow as fast as required and behold, that time is now.

You realize that this is the SAME problem with a Ponzi scheme, right? That scheme works wonders AS LONG AS YOU ARE GETTING MORE PEOPLE GOING IN THAN GOING OUT. Strangely, that is exactly what the SS program requires as well. There MUST be more people entering the system than leaving at all times to keep it working. That, quite frankly, is insane.

 

[Norman]

They idea that you cant invest your own money is ludicrous.

But then so is the lie that SS is our own money. It's a ponzi scheme. Our money is going to people who are already collecting.

It's always been that way and there is nothing wrong with it being that way. It's a pay as you go plan, not an investment plan. Again, there is absolutely nothing wrong with that. What is wrong is taking surpluses from the fund to use for other things and then saying it is owed back to the program. That is just robbing Peter to pay Paul and should never have been permitted in the first place.

But that is what pay as you go plan is by definition. There is no real fund. If you want to pay (interest) to the fund you need to tax it from the people - exactly the same if there wasn't any fund at all. Thus saying that something was robbed is kind of wrong.

Also pay as you go plan doesn't necessarily require an ever growing economy and population. The plan hurts people whether the economy grows or not. It just less noticable if there are more people and greater economy to pay for it. The interest is STILL effectevely lost though, it's just easier to pay for it if the population has grown.

 

[FA_Q2]

They idea that you cant invest your own money is ludicrous.

But then so is the lie that SS is our own money. It's a ponzi scheme. Our money is going to people who are already collecting.

It's always been that way and there is nothing wrong with it being that way. It's a pay as you go plan, not an investment plan. Again, there is absolutely nothing wrong with that. What is wrong is taking surpluses from the fund to use for other things and then saying it is owed back to the program. That is just robbing Peter to pay Paul and should never have been permitted in the first place.

But that is what pay as you go plan is by definition. There is no real fund. If you want to pay (interest) to the fund you need to tax it from the people - exactly the same if there wasn't any fund at all. Thus saying that something was robbed is kind of wrong.

Also pay as you go plan doesn't necessarily require an ever growing economy and population. The plan hurts people whether the economy grows or not. It just less noticable if there are more people and greater economy to pay for it. The interest is STILL effectevely lost though, it's just easier to pay for it if the population has grown.

That’s incorrect. With a decreasing working population, there is NOT enough money coming in to cover the expenses going out. That is a cold hard fact and no way around that. This is why a growing population is REQUIRED. Obviously, you are going to draw more in a yare than you are going to pay as such you require more than a single worker paying into the system than drawing from that system. The close that number gets to a 1:1 ratio, the worse the problem gets, hence you need more going into the system than you have exiting it in order for it to be sustainable.

We had seen this coming; that is why the SS taxes were DOUBLED. Of course, we spent that too so there really was zero gain in that debacle.

 

[Boss]

I'm sorry, but I am still not seeing the "disadvantage" to a system where individuals are responsible for their OWN retirements, through a system of contribution to a personal retirement account with their name on it, as opposed the the current arrangement. Especially if such a plan were voluntary or partial. What's the problem, what's your beef? Your democrat congressman doesn't want this, because it takes away his little slush fund. But why are YOU opposed? ...Because it's something conservatives are FOR?

 

[Norman]

It's always been that way and there is nothing wrong with it being that way. It's a pay as you go plan, not an investment plan. Again, there is absolutely nothing wrong with that. What is wrong is taking surpluses from the fund to use for other things and then saying it is owed back to the program. That is just robbing Peter to pay Paul and should never have been permitted in the first place.

But that is what pay as you go plan is by definition. There is no real fund. If you want to pay (interest) to the fund you need to tax it from the people - exactly the same if there wasn't any fund at all. Thus saying that something was robbed is kind of wrong.

Also pay as you go plan doesn't necessarily require an ever growing economy and population. The plan hurts people whether the economy grows or not. It just less noticable if there are more people and greater economy to pay for it. The interest is STILL effectevely lost though, it's just easier to pay for it if the population has grown.

That’s incorrect. With a decreasing working population, there is NOT enough money coming in to cover the expenses going out. That is a cold hard fact and no way around that. This is why a growing population is REQUIRED. Obviously, you are going to draw more in a yare than you are going to pay as such you require more than a single worker paying into the system than drawing from that system. The close that number gets to a 1:1 ratio, the worse the problem gets, hence you need more going into the system than you have exiting it in order for it to be sustainable.

We had seen this coming; that is why the SS taxes were DOUBLED. Of course, we spent that too so there really was zero gain in that debacle.

What I meant is that if you have, for example a population of 100.000 who earn 100K a year and a other population of 50.000 who earn 10K a year, obviously it's easier to pay 10 million in retirement benefits for the first population.

The loss of 10 million is just as real either way though. And in a case where the population doesn't grow you would massively have to increase taxes. But in BOTH CASES you have lost 10 million. The "failure" is there either way, it's just easier to pay for it with increasing population and improving economy. Just like it is for anything. That 10 million could have been used to do other things if not for the SS. The benefits of growing economy and population are partially lost.



Now, if the population invested into stocks and equities overseas, the interest would actually be real and not just taxed back from the population. There would be no 10 million hole, there would be perhaps 1 million gained in interest instead, no one would have to be taxed. And it would not matter if the population shrank like a shark. That would be a real invstment plan.