RE: Questions for Sam Beard:"Investor's License"

["Steven H. Johnson" <cdempro@erols.com>]

Michael Jones piece on stock market risk is an interesting one.

He argues for private accounts being invested in index funds, which
have very low fees and basically avoid the volatility that comes
along with picking individual stocks.  Entirely valid points.
Can't disagree at all.

But there's another dimension of risk that his analysis doesn't
address.

It's a form that's often called "market risk," but which could just
as easily be called "cohort risk".  Not every cohort retires under
similar market conditions.

Had a private account system been in effect for the past century,
cohorts which retired right at the cusp of the market's best year
would have come out three times better than cohorts which retired
right at the end of the market's worst prolonged slump.  And this
assumes precisely identical investing strategies, with equal
percentages of payroll invested fully in an S&P500 index fund for
both cohorts.

The two-tier approach to privatization is not well-designed to deal
with that sort of variability.  A base level benefit, established
as a flat rate for everyone, does nothing to cushion the unlucky
cohorts against the accidents of when they happen to have been born
and when, therefore, they happen to retire.  It's my impression
that this is the approach Sam Beard suggests.

The Feldstein formula is better able to deal with "cohort risk."
Feldstein suggests, for every annuity dollar one receives from his
or her PRA, reducing the Social Security benefit by seventy-five
cents.  I'd go ninety cents, but the idea is the same.  Cohorts
that retire at market peaks, and do well with their annuities,
would have their Social SEcurity benefits reduced by more, while
cohorts which retire at the end of market crashes, and have relatively
anemic annuities, would have their basic Social SEcurity benefits
reduced by much less.

The cohort risk issue is extremely real.  No privatization solution
that ignores it has a ghost of a chance.  You think the notch baby
issue caused a political firestorm? Imagine the firestorm that
would be generated if Cohort A had annuity payments three times
higher than Cohort B, simply as a result of the workings of cohort
risk.  Set up private accounts without any mechanism for dealing
with cohort risk? Can't do it.

To quote that well-known Saturday night satirist Dana Carvey,
"wouldn't be prudent."

-Steve Johnson.