Bush's Retirement Plans

September 28, 2004

There have been many criticisms of Bush's proposed private retirement accounts. Many critics have focused on the American public's generally poor history with 401k plans and other owner-directed savings vehicles. While I agree that, generally, the public in general invests poorly, I think there's a broader concern about this plan that hasn't really been discussed.

Many advocates of the President's plan jubilantly tout the concept of increased returns for the investor. By investing in the stock market, the supporters claim, plan participants will see much higher returns than had they stayed with a traditional Social Security plan. Historically the stock market has averaged around 10% annualized returns - far better than fixed income portfolios. In fact, if you invested just $5,000 at that rate for 40 years, you'd retire with over $225,000.

All these numbers are, technically, correct. However, any statistician can tell you that just because an investment averages 10% over time doesn't mean it always returns 10%. In fact, the stock market's returns have shown many peaks and valleys over the years. The 1990's saw phenomenal market returns, but these were preceded by the very poor performance of the 1970's. And, as most investors can tell you, the past 5 years can hardly be classified as positive.

These peaks and valleys can wreak havoc on personal investors. Consider that same investor, who puts $5,000 into the market, but this time he invested in late 1999. After riding out the roller coaster of the past 5 years, that investor would now have right about what he started with 5 years ago. Even if he manages 10% every year after 2004, he'll only get about $140,000 at retirement. That's a loss of $85,000, or 37%.

There's something to be said for constant, predictable returns. Compounding interest only works if the compounding is done consistently. A poorly-timed downturn can devastate a portfolio. And, unlike statisticians, you can't tell a retiree not to worry because they'll get 10% over the long run. These people don't have the ability to wait a few decades for the law of averages to kick in.

There is something to be said for predictable returns - slow and steady wins the race.