By John C. Bogle, Founder and Former Chairman
The Vanguard Group
July 5, 2000
The following was originally published Mutual Funds magazine.
To the surprise of the pundits, Social Security is becoming a major issue in the 2000 presidential election. Traditionally considered too hot to handle ("the third rail of American politics"), both candidates have presented programs allegedly designed to assure our retired citizens a comfortable government-financed (really, worker-financed) retirement.
Alas, "politics as usual" is in the driver's seat. For neither candidate deals directly with the well-publicized problem at hand: Social Security taxes will fall short of benefits in 2025. Then the (nominal) trust fund will begin to be depleted, to be exhausted by 2037.
Republican George W. Bush would offer each participant in the system the right to divert two percentage points of the present 12.4% Social Security tax into individually-owned stock market accounts. Yet, absent a massive reduction in future benefits, to state the obvious, this diversion of the system's tax receipts would simply bring the day of retribution even closer. While the reduced contributions into the new plan would necessarily reduce the participant's benefits from the existing plan, the Republican candidate doesn't say by how much. An important issue? Yes. While 55% of voters want the opportunity to invest in stocks, only 17% support the Bush proposal if there is any reduction in the present level of benefits.
Democrat Al Gore takes a very different (and surely, more, well, Democratic) track. He also proposes no change in the basic Social Security program, but offers a supplemental retirement plan into which citizens with annual income of less than $100,000 could deposit up to $2,000 a year. The government (i.e., the taxpayers) would provide a generous $3 subsidy for each $1 dollar deposited for incomes up to $30,000, falling to a $0.30 subsidy for incomes of $60,000 to $100,000. While the benefits of the plan are clearly focused on lower-earning families, it is not easy for those families to save anything. Nonetheless, the Gore program is estimated to carry a 10-year cost of $200 billion.
Note that neither candidate has actually dared to touch that third rail—a solution for the coming shortfall. Why the hesitation? Because what is required is tough medicine: Raising Social Security taxes (which would shock wage-earning families) and/or cutting social security benefits (which would shock retired families). Remember the old adage: "you can't get blood out of a turnip."
Truth told, however, those steps could be taken fairly simply by providing a more realistic (i.e., smaller) adjustment for future inflation and gradually raising the retirement age, perhaps by linking it to the rise in our longevity. But the sooner we take these steps, the easier it will be, for the compounding magician best works his miracles over the longest possible horizons.
If we finally muster the courage to work out the Social Security mathematics that will permit the Bush plan or the Gore plan, or some combination of the two, what role might the mutual fund industry play? My conclusion: None. The basic retirement savings of America's families are too important to be entrusted to the mutual fund industry.
Why? Because the costs of offering mutual funds to millions of small accounts making weekly or monthly contributions would be even larger than today's already excessive level of fund costs. Present all-in costs (sales commissions, management fees, operating expenses, portfolio transaction costs, and opportunity costs) total at least 2 ˝% per year; extra fees for the new retirement accounts could easily add another 1%. We can reasonably assume that thousands of mutual funds, perhaps investing hundreds of billions of dollars, will earn the stock market's aggregate return before expenses. Thus, if the market generated a 9% return, the fund owners would earn, after the deduction of expenses, just 5 ˝%—only 60% of the market's return and even less than the current yield on the U.S. Treasury bond!
A far better solution would be the creation of an independent "Social Security Retirement Board," which would run an all-stock market index fund, deciding policy issues such as the extent to which foreign stocks should be included or tobacco stocks excluded and offering almost none of the counterproductive "bells and whistles" funds offer today. No phone calls to check the daily asset value, no switching, one statement per year, and no liquidity until retirement. Result: a simple program, administered at minuscule cost, that could earn virtually 100% of the market's return and provide truly productive long-term results to participants.
Consider the difference: A 25-year old, earning $25,000 per year, with salary growing at 4% and making a contribution of 2% of income until retirement at age 65, would, under my assumptions, accumulate $140,000 in the mutual fund plan, but $320,000 in the Social Security Reserve Board plan. If we decide that we shall focus on the interests, not of the financial services industry, but of the plan participants, the investment of choice for private stock market accounts is obvious.
Note: The opinions expressed in this article do not necessarily represent the views of Vanguard's present management.
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