Personal retirement accounts may not solve all problems

At least 32 people have written to us yesterday alone asking about personal retirement savings accounts and their role in privatization of Social Security. As Lisa in St. Louis asks, "I do not understand how creation of personal retirement savings account will ensure the solvency of Social Security. While there is a possibility that returns from the stock market may be higher, they could also be lower for years, hurting the retirement benefits of seniors. Please explain to me if I understand it correctly." (Related article: Retirement benefits may actually fall under Bush plan)

Will personal retirement accounts (PRA) solve the Social Security problems?

Lisa is exactly right. The personal retirement savings accounts are being "sold" to Americans because they sound attractive to young Americans, as found in some polls (though the same Americans change their opinion once they find out that their retirement benefits might actually go down or disappear altogether). In the words of Peter Wehner, President Bush's director of strategic initiatives, the private accounts are an easy way to sell the idea of reform. He wrote in a leaked memo, "...our advocacy for personal accounts is tied to our commitment to an Ownership Society -- one in which more people will own their health care plans and have the confidence of owning a piece of their retirement. We simply cannot solve the Social Security problem with Personal Retirement Accounts alone. If the goal is permanent solvency and sustainability -- as we believe it should be --then Personal Retirements Accounts, for all their virtues, are insufficient to that task." (Related article: Bush's real agenda behind privatization of Social Security)

How will the Social Security problems will be solved then?

By making a change in how retirement benefits are calculated. Its ultimate effect will be to lower retirement benefits but the expectation is that some of these losses will be offset by higher returns in the personal retirement accounts.

But many experts are not convinced that every American can suddenly become a smart investor and not lose her/his shirt on Wall Street. It is no secret that even the smartest brains on Wall Street keep underperforming for years. An average individual almost always underperforms, as well, particularly someone who is a beginner and does not understand the intricacies of investing and trading. Brooks Hamilton, a Dallas pension lawyer and benefits administrator, says, "There's no reason to believe that amateurs can suddenly become terrific money managers," in an article published in the Kiplinger Finance magazine.

During last 20 years, the stock market has averaged a 12% annual return and that is on the high side due to the boom of the 90s. However, Dalbar Financial found that individual mutual fund investors earned only about 4% per year. Vanguard finds that participants in its 401(k) plans earn only about 6% a year. Or in other words, basically all individual investors do a terrible job when it comes to investing.

Ed Dravo, president of Dravo Financial, an investment management company, writes in Slate magazine, "If employees are earning only half of the market averages, that means that in coming decades, there could be serious shortfalls in income for retirees." (Related article: Americans concerned about retirement incomes)

What does it mean for you?

While Americans are intrigued by the idea of investing in the stock market and many dream of becoming rich overnight, using their Social Security contributions to do this may not be the right choice. If Social Security is privatized, then Americans need to get a crash course in investing and trading and learn how to get it right, invest very carefully in low risk/low return investments, and not meddle too much with their accounts - an advice that is often given to 401(K) participants by most financial advisors.

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