Wednesday, May 18, 2005

Facts keep getting in the way of scare tactics

Callahan's Cleveland Diary had this post on April 17:

LA TIMES ON OHIO PERS AS A "MODEL" FOR SOCIAL SECURITY In an article yesterday by Peter G. Gosselin and Edwin Chen:

KIRTLAND, Ohio — President Bush came to Ohio on Friday to highlight a state retirement savings system that he said showed that Americans would be better off handling their own old-age investments through personal accounts than relying on traditional Social Security.

But that state's version of personal accounts has attracted few takers among the people eligible — Ohio's 750,000 public employees. And records show that the most widely chosen version of the state-offered accounts has racked up a five-year earning record of 1.86%, about the same return that the president says Social Security produces.

"Boy, does he have a hard sell ahead of him in using Ohio as his example," said Keith Brainard, research director of the National Assn. of State Retirement Directors, which represents virtually all of the nation's public employee pension plans.

The article was poorly researched at best and misleading at worst.

Here's why:


The PERS plan has three choices for plan participants; Social Security has just one! You can review the choices at Plan Comparison. They consist of Traditional/Defined Benefit, Member Directed, and Combined Plan. The Social Security program can only invest in government bonds. (Invest is used loosely here.)

According to the 2004 annual report (page 9 and 103), the Member Directed and Combined options were not available until 2003. As of 2004, those plans had a total of $58,060,583 ($27,861,215 from the Combined Plan and $30,199,368 from the Member-Directed plan). This compares to the more than $8 billion in the Defined Benefit plan. Since all three plans are available, members select the Defined Benefit/Traditional plan by roughly 138 to 1; in dollar contribution amounts.

The article attempts to make an argument by focusing in on a specific choice amongst all choices; specifically the Member Directed option. Looking at the actual numbers provides more than meets the eyes at first glance.

The article refers to a 1.86% 5 year return for the Moderate Growth Portfolio (see: Total Returns). As noted above, this investment option has not been available to the members for 5 years. Porkopolis will be generous and assume it has been. But the benefits of having it available for 5 years to the members must also be taken into account. In doing so, on would have to factor in dollar cost averaging, as detailed in Albert Einstein for Private Accounts?. Dollar cost averaging benefits the periodic contributor by having his/her contributions purchase shares at the lower net asset value prices in the years the investments are not performing as well.

It gets better (or worse if you hate having the facts get in the way of political arguments against Social Security reform). From page 24 of the annual report: The Traditional/Defined Benefit Plan's net assets increased by $6.15 billion, or 10.4% during 2004, pirmarily due to investment returns.

For the same plan, the top ten investment options are the stalwarts of our capitalist system (page 64 of the annual report) : General Electric, Exxon Mobil, Citigroup, Microsoft, Pfizer, Bank America, Johnson & Johnson, IBM, SPDR (S&P 500 Index Fund), American International Group.

In fact (from page 62 of the annual report), 48% ($31.072 Billion / $64.628 Billion) of all Traditional/Defined Benfits Funds stocks (Domestic Equities)!

All the offered options involve stocks. The Traditional plan had a return of 3.59% over the last 5 years (as pointed out by the article); 48% of which was contributed by stocks (conveniently omitted by the article). If one was to accept the authors argument that the most widely choosen 'private account' option generated a 1.86% return over 5 years (even though it wasn't available to the members for 5 years), one would also have to accept the argument that periodic contributions during that time period would have resulted in a larger effective return because of the benefits of dollar cost averaging.


Anonymous Michael Meckler said...

I discussed the similar plan available to those in the State Teachers Retirement Sytems (STRS) in an essay back in February in The Columbus Dispatch (subscription required). The main point of my essay concerned the reasons why the overwhelming majority of new STRS members (something like 95%, comparable to the statistics for PERS) preferred the Defined Benefit (traditional pension) plan to versions of the Defined Contribution (private account) plan. The primary reasons involved concern over market volatility and the difficulty in making good choices from the various funds. Many of the folks in STRS have private, supplemental retirement accounts or have spouses with 401k's and so are VERY familiar with how these accounts work. They also remember far too well what happened in the market after the technology bubble burst. If you've had a "growth" portfolio, you have not done all that well during the past five years (which extends back to the highs of the bubble). So folks who already face some risk with the supplemental account or the spouse's 401k would rather have the security of a fixed pension (Defined Benefit plan) even though there is the potential of greater returns from the private account (Defined Contribution plan).

May 19, 2005 at 8:39 AM  

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