This Social Security Fix Avoids Benefits Cuts

By Markets Fool.com

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With the Social Security trust fund slated to run out of funds by 2034 (thereby necessitating a 25% benefit cut if nothing is done to fix the shortfall), Americans are justifiably worried about the future of Social Security.

Fortunately, there's still time to push the program toward long-term solvency. A number of proposals are out there, which cover several different solution paths (payroll tax increases, decreasing benefits for all Americans or for a group, etc.). But I want to focus on one that I think has some serious possibilities for Social Security and, by extension, Americans' retirement.

This proposal (link opens PDF) came to my attention courtesy of research conducted by the Center for Retirement Research (CRR) at Boston College (variations on this proposal have been around since the '90s), and it involves increasing payroll taxes by 2.62 percentage points in 2016 and investing a portion of the Social Security trust fund in stocks.

Stocks, you say

Yes, stocks. Specifically, CRR's analyses assumed that Social Security increases the percentage of the trust fund reserves invested in stocks by 2.67 percentage points each year until it maxes out at 40%. Currently, the trust fund is 100% invested in Treasury bills, which provides Social Security with tremendous fund stability. That stability comes at a price, though: Treasuries have historically yielded about 0.5% after inflation, while stocks have yielded around 6.5%.

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The researchers ran the potential equity purchases through a Monte Carlo analysis in which they simulated 10,000 possible scenarios for market returns. As you can see, in the vast majority of simulations, the mixed (40% stock) portfolio dramatically outperformed the bond-only portfolio.

Source: Center for Retirement Research.

In fact, by the Social Security trustees' metric of short-term financial adequacy -- a ratio of 1.0, which means that the trust fund has enough money to cover outlays for the year -- the mixed portfolio has a much better record in simulations than the bond-only portfolio.

Source: Center for Retirement Research.

The opportunity to make Social Security solvent over the next 75 years -- thereby avoiding more pain and other difficult fixes (like, for example, cutting benefits) -- is tremendous.

What this means for your retirement savings

You can draw two major conclusions from this discussion. The first -- and obvious -- one is that maybe it would be good public policy for the Social Security trust fund to take on some risk by purchasing stocks.

The second -- and, to me, more important -- is that we're compensated for risk with additional potential returns. If you're still 20 years from retirement and have your entire portfolio in Treasury bills, you may be too conservative in your investments. Sure, you're less likely to lose money, but you're also less likely to make a lot of money over a long period of time. If you're worried about whether you're taking on too little (or too much) risk, here's a good guide to asset allocation, with information that you can apply to your specific circumstances.

This all comes with a caveat: If the Social Security trust fund goes insolvent, chances are pretty good Congress will do something to help. If you go insolvent, you're a lot less likely to get a bailout. So make sure you have enough money to handle most emergencies before you take on the risks of the stock market.

There's another plus to taking on some risk in the stock market: The effect of compounding and time means you'll be less reliant on Social Security when you retire. That's great because Social Security wasn't designed to cover your retirement -- it's supposed to replace around 40% of your pre-retirement income, whereas most financial planners suggest you retire on around 75%-80% of your pre-retirement income. In any case, if you're financially stable at retirement, you can chart your course to a great retirement regardless of what Congress does to the trust fund and to Social Security benefits.

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