That formula is one I often cite to show the importance of holding fees down---administrative and investment, and also to demonstrate the significant excess of investment returns of an actuarially funded DB plan over the current PayGo DB Social Security system (actually an oxymoronic term, if ever there was one.)
I also use it to show the much higher administartive and investment fees of DC plans over DB plans (for large systems, not for small; the issue is all about fixed versus variable costs).
Above all, I use it to show the far greater investment returns one gets in a DB system over a DC system---showing one major reason why such a system, actuarially funded, of course, is so much cheaper than converting the current system to a DC plan.
There are other reasons why it is cheaper as well. And plenety of resons why privatizing the system is exactly the wrong thing to do.
For anyone who is interested in moronic acts through history, read Paul Tabor's book, Stupidity, down through the ages.
Or perhaps, if that gets tedious, the book, Why things go Wrong, and What We Can Do About It." , by Dietrick Dorner--a phsycologist who won Germany's highest science prize. Dorner's book is my personal favorite because he shows the thinking process that leads so often to 'solutions' that make problems worse, sometimes catastrophically so.
In my humble opinion, the 'solution' of fixing Social Secuirty's problems--which are real to be sure---by converting it to a defined contribution, Do-It-Yourself plan, would clearly fall in the catastrophic category---right up there with say, the US Congress's decision after the 1929 crash to close our markets to foreign goods in an attempt to keep jobs here,(partly in retaliation to some other countries doing the same thing there) thus bringing on the Great Depression.
When I get home, I will post the seven (or is it eight?) things that would happen if we ever did that insane thing---all bad, some terrible even.
In the meantime, ponder this. Worldwide, Social Security systems are all failing.
In germany and Japan,for example, the two powerful ex-enemies, now our central partners for peace and the two other richest nations on earth, have enormous social Secuirty problems---brought on by PayGo systems. In germany, the head of the second largest bank recently said that i Germany doesnt solve its problems very soon, it wil lbe left with only old people and foreign workers---so keen are the young to leave in large part becasue of rising costs of the German SS system. Naturally, if you leave a PayGo system, the 'costs' rise for everyone else---making it a viscious cycle.
In Japan, the problems are caused alaos by PayGo, and by the highest longevity of any nation on earth. couple that with no private pension system to speak of, very low, negative, even real rates of return on investments and a poliitical/buisness system that is both corrupt and stuck in gear, and you also have the makings of a disaster.
The German representative seemed to have no concept of why and how to fix it---misunderstnding the large assets we have in private pensions for DC plans rather than predominately DB plans.
Both nations are toying with doing the wrong thing.
In Lithuania, the home country of my mother's side of my family, my contact there says the nation is failing to pay even meager pensions, all the while collecting around 26% of pay for the PayGo system.
And so it goes, nearly everywhere.
The few nations that recently converted to DC systems, are already experiencing the paroxisms of pain that often accompany not the birth of something good, but the cancer that will eventually be very difficult to get rid of, and may even kill the patient entirely.
America invented the Defined Benefit pension plan. It is one of the great inventions of the 20th century. Like most inventions, it was not invented by a single person at a single time by by many people over nearly a century, in an evolutionary movement that still has not finsihed its growth and development.
It is a nearly perfect example of the whole being greater than the sum of its parts. You cannot replicate its results by having individuals invest for themselves---its mathematically impossible.
But you have to have all three components in place and working. Not one.
Stay tuned and you will learn all about why.
Our governmnet certainly needs to. So do some of its inventors---even actuaries--pension actauries by God, seem confused and silent too often. Well ,that is another story.
Keep this in mind: There is nothing at all inconsistant with a program being a social program and a financialy and actuarially sound program.
All defined benefit pension systems in the private sector are (to varying degrees).
Calling a program a 'social' program does not obviate the need for putting it also on a sound financial basis. The two are not mutually exclusive. In fact, a national pension system MUST by actuarially sound, otherwise it is doomed from the outset.
An actuarially sound defined benefit pension system is a wonderous thing to behold---a reasonable cost which is a good deal for everyone, even the rich, placing no one at risk, while also being greatly beneficial to the financial markets and the economy as a whole.
Do it wrong and it can be a source of constant unremitting problems, and the most expensive possible way to pay for pensions.
Change it bu using a simplistic solution, and like the Chernobyl disaster, you take a problem and turn it into a disaster.
In the above cited book, the author shows hw this actually happened at Chernobyl, and how it is also happening at many other places in the world, but in different contexts.
We better not set the wrong example here in America with our Social Security system---cause if we do there will be a hundred Social Security Chernobyls around the world.
As I have said before, the US can afford to be stupid for a very long time before it hurts us badly---but other nations can't.
And, as rich as we are, even we might not even be able to afford this mistake.
One last comment. If the richest nation on earth, at the top of its game, cant afford to have a measly national pension system like the current systems benefits are---there is something seriously wrong.
What's more, if we cant solve this relatively easy thing--something we already know a lot about, there is absolutely no hope whatsoever for Medicare---a much needed system that is far harder by many times. So oyu can kiss that one goodbye too.
Then all you rich folks out there better make sure that a strong military is still present to keep the peasants with pitchforks away.
Come to think of it, that's virtually the only federal program that the Cato Institute supports. NOW I see why they like a strong military.
