Private retirement accounts produce negative returns

Workers who opt to invest in the personal retirement accounts outlined in President Bush's Social Security privatization plan are likely to earn less to retire on than those who stay in the traditional system, according to a new study by Yale University economist Robert J. Shiller. The research finds that on the date of retirement, the personal accounts would have negative values 71 percent of the time. This is in line with the analysis by Peter Foss in which he recommended that Americans stay away from personal retirement accounts even if these become available. (Related article: No net gain for young Americans from private retirement accounts)

The paper "Estimating the Returns to Life Cycle Personal Accounts for Social Security" evaluates the risk and return of investing in a "life cycle portfolio," the centerpiece of the President's personal account plan that all workers would automatically be invested in after age 47 unless they opt out. Life cycle portfolios invest aggressively in the stock market when the worker is young, and gradually shift to more conservative investments as the worker ages. (Related article: Raising wage cap better than private retirement accounts)

Shiller simulated the future returns of the personal accounts using historical U.S. stock, bond, and money market data from 1871-2004. The analysis is based on a worker born in 1990 who starts participating in the accounts in 2011, retires in 2055 at age 65, and contributes the full 4 percent of earnings into the personal account. He ran 91 simulations of the data over six portfolio allocations.

The results show that a baseline personal account portfolio would be in the red at retirement 32 percent of the time and yield a median rate of return of 3.4 percent. However, Shiller considers these results, based on U.S. data alone, to be overly optimistic. When the data is adjusted to reflect the average international returns of 15 countries, including the U.S., over the same time period-a more realistic gauge of future performance according to Shiller-the personal accounts lose money 71 percent of the time and yield a median return of 2.6 percent. (Related article: What is an ownership society?)

"To say that there is a money machine in the stock market, that it can be tapped to yield great wealth without significant risk if one uses life-cycle investment methods, is a big mistake," said Shiller. He argues that the poor performance of the accounts is largely a result of the 3 percent real interest rate, or offset value, that workers would "pay back" to the government at the time of retirement.

"The most important reason for the disappointing performances of the life cycle portfolio is just that the returns of the safer assets are below the 3 percent real rate used to compute the offset. The returns on the stock market are not high enough to make the life cycle portfolio a good investment. While the plan is described as a way of 'fixing' Social Security, in effect, the new personal accounts are nothing more than a plan to encourage people to buy stocks and bonds on margin, that is to borrow money to buy stocks, with the Federal government as the lender offering a 3 percent real interest rate on the loan," according to Shiller.

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