Will Personal SS Accounts Depress Equity Returns?

Opponents of personal accounts often claim that allowing a portion of SS taxes to be invested in the stock market will be at least in part self-defeating in that the extra investments in stocks will reduce the rate of return from stocks going forward. The idea is that prices will quickly appreciate to a relatively large degree, meaning that investments at higher prices in the second and following years will see less and less potential future appreciation.

Proponents of personal accounts, on the other hand, dismiss this concern by noting that the annual increment of stock investment will only likely amount to about 1% of the total market value of stocks.

So who's right?

I'm not willing to hazard a guess, but the argument of the proponents, that the significant factor is the comparison of the annual investment increment to the total market value, is largely invalid.

To see this, consider the following analogy :

We have a tall, cylindrical water tank with an inlet port at the top and an outlet port at the bottom. We add a new inlet port at the top and ask the question :

How does the new inlet port affect the level of the water in the tank?

Before the new inlet port was added, a necessary and sufficient condition for the level of the water in the tank to be stable would be for the volumetric flows through the existing ports to be equal and offsetting.

Any flow through the new inlet port must either cause the water level to rise, or be met by a net new outflow through a combination of the existing ports that offsets it.

This rise in the water level is not dependent on whether the existing water level is 1/4, 1/2 or 3/4 of the tank.

The stock market is similar. A new inflow of cash to the market must raise prices unless and until it is offset by an increase in selling or by a reduction in other buying.

This increase in prices is not directly related to the level of the existing market capitalization.

The rise in prices may well bring forth additional selling from some existing holders, but it may equally well attract new buyers. The likelihood is that new buyers will enter the market and push up prices even before the first SS dollar is invested, due to the near certainty of future substantial and ongoing new demand.

Share this

The problem with the

The problem with the pessimistic analysis is that it's static. Increasing the supply of investment dollars will move us up the demand curve, that is, more IPO's and the like will occur. The 'new' money will increase the capital stock of the economy. I put new in quotes since it does come from somewhere, but where it is now is unproductive, so I'm not sure it's relevant.

I think it will reduce

I think it will reduce returns, but only slightly. When people invest, they naturally choose the best available investment. The more money there is to invest, the worse investments we choose. If we increase the money being invested by 1%, we can expect it to earn a slightly lower rate of return than money that was previously invested, since previous money took the best opportunities.

Wouldn't this hold true for private SS investment? Of course, if the additional amount is small (and 1% is pretty small), the effect will be small too.

There is essentially a one-time windfall to previous stockholders when the private account system is announced (amount depending on how likely it was previously estimated that this would happen). After that, returns are slightly lower. But I don't see why they'd be dramatically lower - there are plenty of good investments available.

Private SS accounts will not

Private SS accounts will not reduce stock returns ... the logic here is incomplete at best. Where do the current SS dollars go? They are in the economy as would be the private account dollars. Please think about the complete system guys. Current SS dollars are used by the government and thus are part of the economy (they spend these dollars). The only change here is that dollars will go into accounts that can flow into US stocks. They also could flow into US bonds, coporate bonds, International Equities, etc. Let's think about the entire economy when reasoning. The use of overly simplistic economic tautologies as the basis for evaluating complex sustems should be left to college econo homework, quizes and exams. In the real world let's graduate to multifacted models.

Patri, I think it will

Patri,

I think it will reduce returns, but only slightly. When people invest, they naturally choose the best available investment. The more money there is to invest, the worse investments we choose. If we increase the money being invested by 1%, we can expect it to earn a slightly lower rate of return than money that was previously invested, since previous money took the best opportunities.

I don't think that this analysis, as good as it is, applies here. It would be correct if you had enough money to buy more than one painting, as you would buy the best painting first, and then the second best, etc.

If you think that IBM is a better stock than Microsoft, the reason that you buy some of both (and some gold for that matter) is not because your individual buying of IBM has driven the price up, nor because IBM has a diminishing subjective marginal utility as you buy more, but because of a need to diversify against an uncertain future.

In the case of personal accounts, it is unlikely that the allowed investment will be much more than $1000 per year and it is also unlikely that anything more risky than a large cap index mutual fund will be allowed. This means that the majority of the money will likely end up buying shares in the 100 or so largest companies in the S&P500.

Thus the fact that most new investors of SS money will not have any idea what makes one stock investment good or bad won't matter, and no advantage would result from actually having any such idea.

Wouldn’t this hold true for private SS investment? Of course, if the additional amount is small (and 1% is pretty small), the effect will be small too.

Not necessarily. If I want to invest as little as a $100 in a stock, the potential price rise can only be limited by someone being willing to sell to me.

There is essentially a one-time windfall to previous stockholders when the private account system is announced (amount depending on how likely it was previously estimated that this would happen). After that, returns are slightly lower. But I don’t see why they’d be dramatically lower - there are plenty of good investments available.

As above, there will not be plenty of good investments available for the SS investments.

Regards, Don