New Cato Study: Private Investments Yield More Than Social Security

November 3, 2003

Opponents of Social Security private accounts have taken to arguing that the current system will provide higher rates of return for retirees than individual accounts. According to a new study by the Cato Institute, those opponents are wrong. Private accounts would yield a much greater return for investors than the existing Social Security scheme.

In "The Better Deal: Estimating Rates of Return under a System of Individual Accounts," Michael Tanner, director of Cato's Project on Social Security Choice, finds that private accounts can be reasonably expected to yield a return of at least 4.6 percent a year. Social Security is estimated to have a 2 percent return.

Tanner asserts that critics use flawed reasoning when figuring that Social Security yields more than individual accounts. They claim that the Social Security Administration's estimate of a 6.5 percent return on equities is too high. But, according to Tanner, that estimate is reasonable and may even be too low when compared to historical equity returns. Opponents further argue that comparisons should give the risks of private accounts more weight. Tanner counters that investors reduce risk by diversifying their portfolios. The 4.6 percent expected return rate comes from an account consisting of 50 percent stocks, 30 percent corporate bonds, and 20 percent government bonds.

Finally, opponents argue that making the transition to a system of individual accounts would cost too much and drive down the return rate. However, according to Tanner, "Financing a transition through reduced government spending would not reduce returns." It is possible, after all, for the government to cut spending elsewhere to make payments to those who are already largely vested in the current Social Security program.

Tanner says that a fair comparison of individual accounts to the current system would show that private investments provide significantly higher rates of return, "which means that the vast majority of younger workers would be better off switching to such a system."

"Given the other advantages of individual accounts, such as inheritability, ownership, and equity, Social Security reform based on private capital investment is clearly superior to the current Social Security system," Tanner writes.

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