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

[CrusaderFrank]

The Social Security "trust fund" isn't even invested in real treasury bonds! They're buying Bernie Madoff bonds-- that is bonds that can't be sold to the general public but only sold back to the issuer. Its a purchase money note

Sent from my DROID RAZR using Tapatalk 2

 

[OohPooPahDoo]

It argues, it's a bad idea to keep our money and invest in a stock market

No it doesn't. It argues that social security funds being invested in the stock market is a bad idea. Outside of that I'd encourage you to buy as much stock as you can - it will make my portfolio more valuable.

 

[blastoff]

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?

BINGO!!!

And OWN being the key word. All of such programs I've ever heard discussed gave the individual the CHOICE to either stay in the traditional SS program or opt in on any variety of market plans similar to various 401K programs.

Not something for a lot of people IMO, but many of us would jump at it in a heartbeat.

 

[OohPooPahDoo]

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

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

Of course it isn't random - you can predict it, right?

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

You ARE excluding those events. You are saying because they would be so detrimental, they should not be included in the analysis. This kind of attitude is part of what lead to the recent housing induced economic crisis. For instance, the sellers of default swaps believed that if it ever got to the point where all those swaps became worth a ton of money to the buyers, the entire economy would be in shambles anyway and nothing would matter.

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.

At least for those who are still around? LOL! Classic survivor bias. You've selected the sample that correctly predicted the tech bubble and abandoned the sample of professionals who failed to predict it, lost their jobs, and became shoe salesmen or dentists - and declared that the pros got it right!

Stocks should outperform other asset classes such as government bonds over time because stocks are riskier.

Actually according to you - over time - stocks are not risky. That would seem to be your entire point. That if I invest over ~30 years, my returns may be lower than someone else who invested in another ~30 years, but I am virtually guaranteed to at least have preserved my capital and make a little bit above Treasuries. If that is indeed what you are saying - that's a LOW risk investment. You can't have it both ways - arguing that stocks pay more over the long haul because they are riskier and at the same time maintaining they're actually not very risky. Which is it?

Here are all the assumptions in Black-Scholes.



Black?Scholes - Wikipedia, the free encyclopedia

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

Do you understand what Black Scholes computes? It is the mean expected value of a European call or put option at expiration (in the future), discounted by the risk free rate to the present day. What is mean expected value? I will explain it

take two options.

Option A) has a 90% chance of expiring $11.11 in the money and a 10% chance of expiring worthless.

Option B) has a 10% chance of expiring $100 in the money and a 90% chance of expiring worthless.

By risk neutral pricing, option A) is worth 0.9X$11.11 + 0.1*$0.00= $10 and option B) is worth 0.9*$0.00 + 0.1*$100 = $10. They are worth the same! Although the risk profiles are very different, the market will price these options near one another.

Search for the term "neutral" in the wiki article. You can also use the web. There is plenty of literature on risk neutral pricing (its also referred to as arbitrage free pricing).

The Black Scholes equation itself is derivable from the risk free assumption. http://www.soarcorp.com/research/BS_risk_neutral_martingale.pdf

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

Actually, it does.

Not according to the economists.
Equity premium puzzle - Wikipedia, the free encyclopedia

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.

CAPM doesn't explain WHY the equity premium exists - it only provides a method for pricing securities in a market where the equity premium DOES exist.[/I] You have to plug in your "expected rate of return" from the market to get the formula to work. If you take a look at it, Capital Asset Pricing Model (CAPM) Definition | Investopedia, you'll see that if the market return = the risk free rate return, the second term on the RHS becomes zero and the LHS becomes equal to the risk free rate. CAPM assumes there is an equity premium - it doesn't explain why there is one.

 

[OohPooPahDoo]

The Social Security "trust fund" isn't even invested in real treasury bonds! They're buying Bernie Madoff bonds-- that is bonds that can't be sold to the general public but only sold back to the issuer. Its a purchase money note

LOL. Does that mean savings bonds aren't real treasury bonds, either?

Its my understanding the Treasury IOU's are actually sellable at all. The Trust fund simply holds them, collects the coupon payments, and then the principal at the end, using the proceeds to either reinvest in treasury IOUs or pay beneficiaries as needed. I could be wrong though, I haven't verified this.


The Trust fund is merely an accounting trick and there is no secret to this. Social security is a paygo program and always has been and even with the trust fund it is. It keeps the government from having to adjust the SS tax rate as often as it would have to otherwise. The trust fund allows for excess SS taxes to effectively go to the general fund in years when SS collects excess (when the Trust fund is built up), and it allows for a shortage of funds to automatically be provided by the general fund in years when SS collects a shortage of taxes. This insulates the process from the politics and prevents the politicians from having to debate every couple of years whether to raise or lower SS taxes. Unfortunately I think it has insulated them from it too much.

 

[Norman]

The investment theory you presented doesn't matter in this case at all. Even if you agree with it you even according to that theory are better off with more choices, have you not heard of diversification? Do I really have to explain this for the billionth time?

Government bonds do not pay any interest if all tax payers own them, since those same tax payers have to pay for the interest! The interest is just a monetary illusion and it doesn't tell about the real interest at all. There can be a real interest in this kind of case if government say, builds roads with the money. The tax payer can then use the said road which helps his productivity.

Problem is, vast amounts of government spending doesn't go into investment but spending. It's like buying stake for yourself and expecting that to pay for your retirement. But yes, initially you still get that stake, and that is my friends what every politician loves to serve.

Now if you had Norway's government's bonds then that would actually be an legitimate investment. It does not matter how they spend the money, you will be getting your money + interest either way.

Pay as you go = wellfare = not an investment plan. It's plain and simple. It does not matter a single bit if the interest on the government bond is 10%, 15% or 100% a year. You are the payer of that interest unless it's a foreign bond.

 

[OohPooPahDoo]

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.

Your statistical method is fatally flawed.

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

LOL! What do you think happens to Wall Street managers who are bad at predicting the stock market? They may go on to build rockets or drive cabs but they won't be around Wall St. for long.

If we apply this to your argument, then the success of the United States has been random, i.e. lucky.

Luck isn't the entire story, but the success or failure of any nation certainly has a huge luck component to it. They might be speaking Spanish in Great Britain right now if it weren't for a fortuitous storm that destroyed the Spanish Armada. We might be speaking German in the U.S. right now if the Germans had come up with the A-Bomb before us (scientific and technological progress at times is almost exclusively luck related)

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."

Here you seem to be using the term "lucky" is the sense of divine luck, while in the preceding paragraph you use it in the sense of random luck. There is no divine luck.

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.

Many of those things were required - along with random luck - for us to progress as a nation. This really has nothing to do with the stock market though.

 

[OohPooPahDoo]

Government bonds do not pay any interest if all tax payers own them, since those same tax payers have to pay for the interest!

Government bond owners receive interest. U.S. taxpayers pay the interest. If you want more interest than you pay in taxes - buy bonds.

 

[Norman]

Government bonds do not pay any interest if all tax payers own them, since those same tax payers have to pay for the interest!

Government bond owners receive interest. U.S. taxpayers pay the interest. If you want more interest than you pay in taxes - buy bonds.

So somehow the bond is able to generate interest without anyone paying that said interest?

I agree that's true if an INDIVIDUAL buys a government bond, yes then it's an asset, and mostly OTHER tax payers pay for the interest. However, if all the tax payers are forced into government bonds, it's misleading to say there is any interest. It's like writing an IOU to yourself and calling that an asset. That is what happens with social security.


It is tax and spend. Problem is you are pretending that social security is some sort of investment plan that makes great returns. There are by and large no returns in reality, it's just wellfare.

 

[OohPooPahDoo]

Government bonds do not pay any interest if all tax payers own them, since those same tax payers have to pay for the interest!

Government bond owners receive interest. U.S. taxpayers pay the interest. If you want more interest than you pay in taxes - buy bonds.

So somehow the bond is able to generate interest without anyone paying that said interest?

Is that what I said? No, its not. What I said was: "If you want more interest than you pay in taxes - buy bonds." Do you need me to explain the meaning of that English sentence to you?

I agree that's true if an INDIVIDUAL buys a government bond, yes then it's an asset, and mostly OTHER tax payers pay for the interest. However, if all the tax payers are forced into government bonds, it's misleading to say there is any interest. It's like writing an IOU to yourself and calling that an asset. That is what happens with social security.

Social Security is pay as you go. Have you been paying attention?

Problem is you are pretending that social security is some sort of investment plan that makes great returns.

I'm not. Social Security is an insurance product, not an investment product - and it should remain that way. You could buy the almost same thing in the private market by packaging a disability insurance plan with a life annuity.

 

[whitehall]

Every pension system in the entire Country is heavily invested in the DOW. It's not a myth that the stock market will recover no matter what administration tries to kill it.

 

[Toro]

Government bond owners receive interest. U.S. taxpayers pay the interest. If you want more interest than you pay in taxes - buy bonds.

So somehow the bond is able to generate interest without anyone paying that said interest?

Is that what I said? No, its not. What I said was: "If you want more interest than you pay in taxes - buy bonds." Do you need me to explain the meaning of that English sentence to you?

I agree that's true if an INDIVIDUAL buys a government bond, yes then it's an asset, and mostly OTHER tax payers pay for the interest. However, if all the tax payers are forced into government bonds, it's misleading to say there is any interest. It's like writing an IOU to yourself and calling that an asset. That is what happens with social security.

Social Security is pay as you go. Have you been paying attention?

Problem is you are pretending that social security is some sort of investment plan that makes great returns.

I'm not. Social Security is an insurance product, not an investment product - and it should remain that way. You could buy the almost same thing in the private market by packaging a disability insurance plan with a life annuity.

Annuities are paid out of pools of capital that invest in other assets besides government bonds.

Insurance companies invest capital in the stock market.

 

[flacaltenn]

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.

Looking over 10, 20 or 30 years for an investment fund that is supposed to last forever is simply wrong and bad economics. The Nikkei 225 peaked in 1989. But over the past 50 years, the Nikkei 225 has generated significantly positive returns.

Over 50 years, a balanced portfolio of stocks and bonds has generated roughly 8% a year. Over the same time period, a portfolio of 100% government bonds has generated about 4%. $100 million invested at 4% per year will be worth $460 million in 50 years. $100 million invested at 8% per year will be worth $4.6 billion.

This is a no-brainer. That's why other countries such as Canada and Norway invest their equivalent of SS in stocks.

If you think that the stock market won't beat the government bond market over 100 years or more, then there is something seriously wrong with the US, and those SS promises won't be paid anyways.

Nothing wrong with your analysis.. However -- let's look at how we got here and what SHOULD have been done..

It's OK to run a SS Surplus if --- you don't blow the money on other crap and put in an IOU.

Instead of an IOU -- if the FEDS had simply used the surplus during history to buy EXISTING US TREASURIES on the market (taken them out of circulation) --- then our national debt would be several $Trill less today --- leaving us in a better state to finance deficits today..

We were told 25 yrs ago -- we'd have to address the deficit if wanted to avoid the ultimate SS crisis..

Don't like the idea of the politics involved in buying securities. UNLESS the govt is restricted to buying mutual funds or indexes..

 

[flacaltenn]

The only portion of SS ever "invested" was the fractional SURPLUSES while they existed.

Almost ALL of the money funding and dispersed for SS benefits WAS NEVER invested in anything..
Any one who believes anything else is a mental midget and a tool...

And it's only the myth of the Trust Fund accounting that PRETENDS the stolen and squandered surpluses was ever invested...

 

[whitehall]

WTF is the left trying to say? Invest in government? How did Social Security work out? Buy stuff and hoard it away? Buy metals and wish for bad times when precious metal becomes more valuable? The bi-polar left rails about corporate wealth and at the same time praises the president when the stock market spikes.

 

[Boss]

It argues, it's a bad idea to keep our money and invest in a stock market

No it doesn't. It argues that social security funds being invested in the stock market is a bad idea. Outside of that I'd encourage you to buy as much stock as you can - it will make my portfolio more valuable.

Hey dimwit, where do you think social security funds come from? It's OUR money! I'm happy that you realize and understand, if I invest MY money, it helps you. Now, if I could actually GET my money so I can invest it, everything will be just fine!

The problem is, you're a brainwashed little tool for the left, who doesn't want to relinquish power and control of MY money. It helps to fund too many of your idiotic knee-jerk whims.

 

[Two Thumbs]

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.

just be honest for a change

OohPoo; I'm against it b/c it's a republican idea, but I had to come up with some other reason so I didn't sound like the bigot I am.

It would be a refreshing change.

 

[Londoner]

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.

SS allows the rich to steal from the poor.

Let me explain to you how the American Government works. Let's go back to Reagan.

First you lower taxes on the wealthy. Then you raise taxes on wage earners, telling them the money will be held in trust for Social Security. Then you raid the trust in order to hand out subsidies to corporations and pay for things like Star Wars. Then, 50 years later, you tell the poor that they will have to take a haircut on benefits.

But it gets better. It's important that the poor don't realize how bad you are fucking them. So you set-up radio and TV stations that bitch 24/7 about welfare payouts to the lazy, but you never mention who government really serves. Instead, you use your considerable media assets to redirect the understandable rage of the poor away from the concentrated wealth that owns government.

 

[Norman]

Government bond owners receive interest. U.S. taxpayers pay the interest. If you want more interest than you pay in taxes - buy bonds.

So somehow the bond is able to generate interest without anyone paying that said interest?

Is that what I said? No, its not. What I said was: "If you want more interest than you pay in taxes - buy bonds." Do you need me to explain the meaning of that English sentence to you?

I agree that's true if an INDIVIDUAL buys a government bond, yes then it's an asset, and mostly OTHER tax payers pay for the interest. However, if all the tax payers are forced into government bonds, it's misleading to say there is any interest. It's like writing an IOU to yourself and calling that an asset. That is what happens with social security.

Social Security is pay as you go. Have you been paying attention?

Problem is you are pretending that social security is some sort of investment plan that makes great returns.

I'm not. Social Security is an insurance product, not an investment product - and it should remain that way. You could buy the almost same thing in the private market by packaging a disability insurance plan with a life annuity.

Okay, I may have understood you wrong and you referred to an individual buying bond. However that is not what this topic is about. To me it sounds like you are trying to say SS is better than stocks because the returns are better. If not, could you clarify what this topic is even about? For the record, I don't think many people are saying SS should be invested into stocks only.

And no you coud not buy something like the SS on the markets. That kind of plan would be shut down as a ponzi scheme. Insurance companies are required to invest their surpluses and have plenty of excess funds. Something from the markets is always going to be fully funded plan. Ponzi schemes are illegal.

 

[Toro]

Of course it isn't random - you can predict it, right?

You had a link that mentioned the book, Triumph of the Optimists. In it, it details the history of stock market returns of 16 countries, which basically represent the Western economies. Since 1900, every single nation has seen equity returns greater than bond returns. That includes Germany, which experienced hyperinflation, a Great Depression, and destruction of the country not once, but twice. It also includes most of the other European countries that were ravaged by war twice which killed tens of millions of people as well as the Great Depression. The United States includes the Great Depression. Schiller goes back to the Civil War, and confirms the same thing, so include that. Most of the economic growth of the world has occurred since 1800, and until recently, most of it occurred in the West. This demonstrates incredible resiliency and dynamic adaptiveness of Western societies and its political and socioeconomic structures. To assume that the future won't be like the past is to assume that there will be some cataclysmic or earth-shattering change in Western societies, one worse than two world wars, hyperinflation, a depression, etc.

Can it happen? Maybe. A declining population is certainly a threat. But the onus is on those to articulate why the future will not be like the past. It's not good enough to say it's random (because it's not) or we might be one day be Zimbabwe or Bangladesh (your "survivorship bias" argument). For those of us who think the future will be like the past, we assume that the culture, laws, institutions, and remarkable adaptability and productivity of our society will not change. You must tell us why these will change.

You ARE excluding those events. You are saying because they would be so detrimental, they should not be included in the analysis. This kind of attitude is part of what lead to the recent housing induced economic crisis. For instance, the sellers of default swaps believed that if it ever got to the point where all those swaps became worth a ton of money to the buyers, the entire economy would be in shambles anyway and nothing would matter.

What I'm saying is that what has ruined economies in the past are calamitous political or economic events, and what has caused significant underperformance by equities is dramatic overvaluation.

Even calamitous economic events of Western societies of the past have not been enough to derail tremendous economic growth over time. Equities are the growth component of the capital structure within the economy. As the economy grows, more and more profits will accrue to equities relative to fixed income.

If there are all these other events that can disrupt our society that would cause stocks to underperform bonds over long periods of time, what are they?

At least for those who are still around? LOL! Classic survivor bias. You've selected the sample that correctly predicted the tech bubble and abandoned the sample of professionals who failed to predict it, lost their jobs, and became shoe salesmen or dentists - and declared that the pros got it right!

Which has nothing to do with your assertion that stocks are only grossly overvalued in retrospect. Those who believe that stocks are only overvalued in retrospect are the guys who lost their jobs.

Actually according to you - over time - stocks are not risky. That would seem to be your entire point. That if I invest over ~30 years, my returns may be lower than someone else who invested in another ~30 years, but I am virtually guaranteed to at least have preserved my capital and make a little bit above Treasuries. If that is indeed what you are saying - that's a LOW risk investment. You can't have it both ways - arguing that stocks pay more over the long haul because they are riskier and at the same time maintaining they're actually not very risky. Which is it?

Completely and totally wrong. I have said it before and I will say it again - stock returns are higher because they are more risky. They are more risky because they are more volatile and they have the last claim on assets in the capital stack. What I am saying is that because SS is an institution that should last forever - and if it's not, then it won't pay out what it has promised regardless - it should absorb that risk and accrue higher returns over time.

(You may not realize this, but you are making the same argument that diehard free market economists at right-wing think tanks like the American Enterprise Institute were making before the tech bubble collapsed.)

The longer the duration of the institution, the more risk it should take. The shorter the duration, the less risk it should take. If SS is expected to wind down in 5 years, it should be invested almost entirely in bonds. If SS is expected to be around in 150 years, it should have a high risk component. Every pension actuary knows this.

Search for the term "neutral" in the wiki article. You can also use the web. There is plenty of literature on risk neutral pricing (its also referred to as arbitrage free pricing).

I said way back that a basic tenet of economic theory is that there is a trade-off between risk and reward. Every student in finance 101 is taught this. Risk neutrality does not change this. Risk neutrality does not mean that investors don't want to take any risk, nor that they don't want to be compensated for taking risk. It says that prices must be adjusted for risk preferences. "Risk aversion" does not mean people don't want to take on any risk. It means that they over-estimate risk, and need to be paid more to take it on. It means people will take a lower return for a more certain outcome than a higher return with a less certain outcome, even if the expected probabilities are the same.

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

Not according to the economists.
Equity premium puzzle - Wikipedia, the free encyclopedia

Actually, yes according to your link.

The equity premium puzzle is a term coined in 1985 by Rajnish Mehra and Edward C. Prescott in their seminal work of the same name, and refers to a lack of consensus among economists on why demand for government bonds - which return much less than stocks - is as high as it is, and even why the demand exists at all. The intuitive notion that stocks are much riskier than bonds is not a sufficient explanation as the magnitude of the disparity between the two returns (the equity risk premium) is so great that it implies an implausibly high level of investor risk aversion that is fundamentally incompatible with other branches of economics, particularly macroeconomics and financial economics. ...

The most basic explanation is that there is no puzzle to explain: that there is no equity premium. ...

Note however that most mainstream economists agree that the evidence shows substantial statistical power.

Economists believe that the equity risk premium is explained by risk, if not the magnitude. One explanation is that using volatility as the sole measure of risk is insufficient to measure all risk. Risk aversion mentioned above may explain this discrepancy.

CAPM doesn't explain WHY the equity premium exists - it only provides a method for pricing securities in a market where the equity premium DOES exist.[/I] You have to plug in your "expected rate of return" from the market to get the formula to work. If you take a look at it, Capital Asset Pricing Model (CAPM) Definition | Investopedia, you'll see that if the market return = the risk free rate return, the second term on the RHS becomes zero and the LHS becomes equal to the risk free rate. CAPM assumes there is an equity premium - it doesn't explain why there is one.

CAPM is a formula which derives from modern portfolio theory. I included it to demonstrate that theory shows higher risk leads to higher return.

Modern portfolio theory states that there is a trade-off between risk and return. In MPT, the higher the risk, the higher return.

Modern portfolio theory (MPT) is a theory of finance that attempts to maximize portfolio expected return for a given amount of portfolio risk, or equivalently minimize risk for a given level of expected return

Modern portfolio theory - Wikipedia, the free encyclopedia

EDIT - To clarify, economic theory states that an investor must be compensated to take on more risk. Ergo, higher risk, higher return. Higher risk unto itself is why returns are higher for riskier assets.