Investing Social Security Funds in the Stock Market: Some Economic Considerations

Publication Date: April 2005

Publisher: Library of Congress. Congressional Research Service

Author(s):

Research Area: Banking and finance

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Abstract:

For the time being, Social Security receipts are more than enough to fund current benefits. But beginning in 2017, under current law, benefits are projected to exceed Social Security receipts. At that point, if not before, either benefits will have to be cut, taxes will have to be raised, or the shortfall will have to be made up either by tapping non-Social Security revenues, which would reduce the unified federal budget surplus, or by an increase in federal borrowing.

Any current proposal to extend the financial life of Social Security is likely to include increases in taxes, cuts in benefits, or both. In addition to those possibilities, is the notion of allowing beneficiaries to contribute some of their Social Security payments directly into personal accounts. Because equity has historically yielded a higher rate of return than have Treasury securities, it is argued that allowing individuals to invest some of their contributions in the stock market would offset at least some of the effects of either tax increases or benefit cuts in any package of reforms.

Between 1926 and 2003, the average annual total rate of return on large corporate stocks was 7.2%, after adjusting for inflation. That was 4.9 percentage points higher than the average real return of 2.3% on long-term government bonds over the same period. But there is substantial variation in rates of return, which diminishes as the holding period grows longer. Even with relatively long holding periods there are still instances of below-zero rates of return. The longest holding period with a below-zero return for stocks was 18 years and 11 months. Although, longer holding periods have historically reduced the volatility of stock returns that does not necessarily mean that the risk associated with holding stocks falls as holding periods lengthen.

A recent subject of speculation has been the risk that the retirement of the babyboom generation will coincide with a substantial sell-off of assets. Sometimes referred to as the "asset market meltdown hypothesis," the concern is that as increasing numbers of retirees sell the assets they have accumulated over their working lives in order to continue the lifestyles to which they have become accustomed, asset prices will decline. Theory alone seems insufficient to predict what might happen to asset prices when the baby boom generation begins to retire. There are reasons to believe that they will sell some of their assets, but there are also reasons to believe that those sales will not be so large as to disrupt financial markets or cause a precipitous drop in the prices of assets traded in those markets. This report will not be updated.