Individual Accounts in Social Security: Practical Aspects of Risk and Regulation

Individual Accounts in Social Security:
Practical Aspects of Risk and Regulation
D. Don Ezra
Frank Russell Company
[email protected]
Cato Institute
February 6-7, 2001
Washington, D.C.
Outline
Lessons from the fundamentals of investing
Do people make sensible investment
decisions?
Implications for planning
Fundamentals of Investing
The accumulation and drawdown of wealth
2500000
Accumulation 30 years
Drawdown 15 years
$13
1500000
Contributions
+ T-Bill Returns
1000000
$3
500000
Contributions
0
Years
45
42
39
36
33
30
27
24
21
18
15
12
9
6
$1
3
0
Dollars
2000000
Contributions +
Equity Market
Returns
Fundamentals of Investing
The accumulation and drawdown of wealth
2500000
Accumulation
30 years
Lesson # 1
Contributions +
Equity Market
Returns
$13
Investment returns multiply
1500000
the power of contributions
enormously
Contributions
+ T-Bill Returns
1000000
$3
500000
Contributions
0
Years
45
42
39
36
33
30
27
24
21
18
15
12
9
6
$1
3
0
Dollars
2000000
Drawdown 15 years
Fundamentals of Investing
The accumulation and breakdown of wealth
2500000
Accumulation
30 years
Lesson # 2
Contributions +
Equity Market
Returns
$13
The fundamental choice:
1500000
“Do you prefer to eat well
or sleep well?”
Contributions
+ T-Bill Returns
1000000
$3
500000
Contributions
Years
Where do you want to be?
45
42
39
36
33
30
27
24
21
$1
18
15
Sleep
well
12
9
3
well
6
0 Eat
0
Dollars
2000000
Drawdown 15 years
Fundamentals of Investing
The accumulation and draw down of wealth
No Return
T-bills
$1
2500000
Bonds
$3
60/40 E/B
$4
$9
30 years
$13
15 years
Equities before retirement,
then annuitize (bonds)
Contributions +
Equity Market
Returns
$8
$13
1500000
Contributions
+ T-Bill Returns
1000000
Lesson # 3
500000
$3
Contributions
Years
45
42
39
36
$1
33
30
27
24
21
18
Much of the investment
return accrues after
retirement
15
12
9
6
3
0
0
Dollars
2000000
Equities
Do people make sensible investment decisions?
First ….look at some data
Second ….report on some anecdotal evidence
On the whole, they take their age into
account in a sensible way
% Exposure
20s
Age Range
30s
40s
50s
60s
Equities
76
76
72
66
54
Fixed income
16
16
20
26
38
8
8
8
8
8
Balanced funds
Exposure to equities
(riskiest) falls as
retirement nears
Source: ERBI, 401(k)
February
On the whole, they understand that
diversified funds are less risky than
their own company stock
When employer-directed
Participant
- directed
portion
32
When not
employerdirected
23
27
38
42
6
8
11
Total
% exposure to Account
Company stock
52
Equity funds
Balanced funds
Source: EBRI, 401(k)
February 2000
High exposure to equity and
balanced funds preferred to forced
investment in company stock
Positives and negatives from anecdotal evidence
Focused communications achieve results
- increased desire to continue investment education
- increased voluntary participation in investment accounts
- increased willingness to take equity risk
But also
- aggregate statistics conceal individual variation
- paternalist would be horrified by some attitudes and choices
Implications for planning
Ensure availability of investment education
Permit “eat well versus sleep well” choice,
after retirement as well as before
Up for grabs: freedom to make
further choices