Saturday, February 26, 2005

Albert Einstein for Private Accounts?

Einstein didn't say he was for personal Social Security accounts, but Porkopolis is sure he would have been in favor of them:

Bring Ohio Home, and Porkopolis have a spirited, yet friendly blog discussion going on the topic of Social Security Personal Accounts. Porkopolis is strongly in favor of personal accounts, Bring Ohio Home is opposed. Bring Ohio Home is run by a dedicated and smart fellow Ohioan. The site is a great resouce for almost everything politico-Ohio. Hopefully, he'll come around on personal accounts. It would be great to have an Ohio Democrat making the case for personal accounts, thus Porkopolis' efforts to convince Bring Ohio Home.

In his latest post, Paul asserts that investing in the S&P 500 during Bush's tenure would have lost money. Porkopolis posts a strong rebuttal supported with a case study, pointing out the benefits of what Albert Einstein called "man's greatest invention": the compounding of returns on investments along with another investment discipline: dollar cost averaging.

Here's to hoping that logic prevails over knee jerk emotions from our democratic friends and neighbors. This issue is to big to be left festering for the next generation.

Text of Bring Ohio Home's post with Porkopolis' rebuttal:

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Another Look At How Social Security Privitization Would Be

A third (I think) in a series of posts of how the fundamental theory behind Social Security Privitization is going.

Since 01/22/2001 (Bush's first business day in office), the Dow Jones Industrial Average is up 82.96 points. That is over a period of 1,492 days for an annualized return of 0.19%

The Standard and Poors 500 index is down 158.74 points for an annualized return of -2.89%.

Porkopolis Rebuttal:

Paul:

I deleted my previous comment post because it had some calculation errors and I noticed that your S&P 500 numbers did take into account total returns from dividend re-investments. I did my calculations in a rush and didn't double check them. I confirmed your numbers with the yahoo finance site at:

http://finance.yahoo.com/q?s=%5ESPX

So your numbers are accurate and do take into account total return for that period. However, please read on for the rest of my rebuttal:

1. 4 years is too short a time period to consider for retirement investing. No one who needs a portion of their money in 5 years or less should be in the Stock Market. This is Finacial Planning 101. That type of money is better placed in a Money Market fund or inflation adjusted U.S. Savings Bonds.

2. Even though you quoted a positive return for the Dow Jones, it is not a sufficently deversified index. No financial planner worth his/her salt recommends it. It's just quoted every day in the financial press for historical reasons.

3. Let's assume we accept the ill advised 4 year investment period for a personal Social Security account. You still would of come out ahead! This is because you would have been taking advantage of dollar cost averaging; i.e., you would have been making investments every pay period. During that 4 year period the investments would have compounded: At the end of year 1 you get dividends on the total of year 1; at the end of year two you get divdends on the total of year 1, year 2 and the dividend from year 1; at the end of year three you get divdends on the total of year 1, year 2, year 3, and the dividends from the end of year 1 and year 2...and so on. (Actually, most mutual fund companies make quarterly dividend payments, which is even better).

I used a spreadsheet to do a calculation with your specific time period applying this compounding effect. Here were the assumptions I made:

i. An individual making $50,000 a year and invests 12.4% in a total return S&P 500 fund. 12.4% is the employee/employer match rate. So an individual is investing $6,200 per year.

ii. Total Investment gains or losses are done at the end of each period. Example: Jan 22, 2001 to Jan 22, 2002 is a period.

iii. Jan, 22, 2005 to Feb 22, 2005 is a period. Investment in that period = $6,200 / 12 = $516.67 .

iv. I used historical prices from the yahoo site noted above.

Total compounded returns from Jan 22, 2001 to Feb 22, 2005 were $2,010.05

Total invested was $25,316.67 ( (6,200 * 4) + $516.67)

Total Return = 7.94% (2010.05 / 25316.67 * 100)

Annualized Return = 1.94% (7.94% / 4.08 years) where 4.08 = 4 years and 1 month

So even in this very short, ill advised time period a worker making periodic investments would have made a positive return on his/her investments.

You might want to make the case for someone that was already retired losing money without adding any additional investments to take advantage of the compounding effect. That person should not have been in the stockmarket to begin with. They should of had their retirement savings, at that point in time (Jan 22, 2001), in an Inflation Adjusted U.S. Savings Bond and/or Inflation adjusted Treasuries. They would have taken the risk (and rewards) in the stock market only during their working/productive years and then gradually moved it into Treasuries as they approached retirement. Another option would be to purchase an annuity from a top rated insurance company.

Again, I can send you the spreadsheet with the actual calculations for your review.

1 Comments:

Blogger Paul said...

I'm curious if Brit Hume dug up a quote from Albert Einstein about Social Security ...

I'm certainly no Einstein but I will address some, at least, of your points:

1) 4 years is certainly too short a time period when you are in your 30s. But it is important to remember that at certain times the stock market has done significantly worse than the anemic 0.19% annualized return of the Dow. October 1987, October 1989, most of 2000 and October 2002 all come to mind. The fundamental point is that the stock market, goes up and it goes down.

2) I understand that Dow Jones isn't the end all and be all of the stock market. S&P 500 is much more representative, but not perfectly so. I certainly wouldn't quote NASDAQ to anyone.

3) You must be an accountant. My head hurts and I'm going to bed. I will look at the figures when I get a chance.

March 1, 2005 at 12:21 AM  

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