Author: A.T.

Quite a few of you responded to the two comments on Social Security a couple of weeks ago. One of the best and most straightforward questions came from James Griffin:

I wonder if you could give us some FACTS about how the current trust fund (ha!) is invested. I had thought the Gov issued some special IOU’s paying about 1%. However, some pundit stated in a recent news column that the fund was making 8%. At 8% we should be rolling in it? Yes? What is the real rate, if any?

There is good news, bad news, and good news — all of it rather important to understand.

The good news: Yes, Social Security is finally salting away some money as “reserves” for the looming Baby Boom generation. That money — about $70 billion this year alone — is invested in “special” Treasury securities of varying maturities that are actually special only in one important respect: the Trust Fund can redeem them “at par” — 100 cents on the dollar — any time it wants, to pay benefits. (That’s a nice feature. If you or I wanted to cash in long-term bonds early, at a time when interest rates had risen, we’d lose money, because they’d be selling at a discount.) As of the most recent annual report, issued in April 1996, the average interest being earned on the accumulated reserve was 7.8%. Since then, new funds have been invested at somewhat lower rates, because interest rates have fallen, so when the new report comes out in a few weeks, the average interest rate being earned by the whole pot might have slipped to around 7.5%.

I know that in a world of huge increases in the stock market each year, 7.5% must seem paltry, but actually — historically — it ain’t hay. The more typical, long-term return that can be expected from the stock market (dividends plus price appreciation) is around 9% or 10%, and there have been long periods when it’s been lower. (Did you know, for example, that the market was no higher in 1978 than it had been 14 years earlier?)

The bad news is that what you may have heard is true: when politicians talk about “balancing the budget” in 2002 (or whenever), they are including as “revenue” the excess Social Security taxes being set aside as reserves for the future. In other words, that money is being double counted. In 2002, if the budget does indeed “balance,” as Democrats and Republicans are using the term, it will still be in deficit by a projected $96 billion. (That’s the excess Social Security expects to collect in 2002 to augment its reserve.) So it won’t be balanced at all.

One can certainly get a bit hot under the collar at the lack of candor on this issue. I’m frankly surprised more hasn’t been made of it, except that I guess neither party feels it can convincingly blame the other for sweeping this under the rug.

The good news about the bad news is that impossibly large as these numbers are, viewed in context they’re actually not so bad. I know you’ll find that hard to believe, but bear with me a minute.

Let’s say we pretend to have a balanced budget but that, in fact, after being honest about Social Security, we’re actually running a $100 billion deficit, adding that much, year after year, to the national debt. Sounds awful.

But let’s say, also, that at the same time the economy is growing 5% a year — 2.5% inflation plus 2.5% real growth. What does that mean?

Well, it means that our national debt, $5.25 trillion or so now, would be growing by just under 2% a year ($100 billion is about 2% of $5 trillion), while the economy as a whole would be growing at 5%. And what does that mean?

Imagine a home you bought for $100,000 appreciating at 5% a year while the $80,000 mortgage you took to buy it grew at 2%. After 20 years, the home would be worth $265,000, while the mortgage would have grown to $119,000.

Naturally, it would be nice to have a house with no mortgage at all. But it’s a lot less nerve-wracking to have a $119,000 mortgage on a $265,000 home, I should think, than an $80,000 mortgage on a $100,000 home.

Run this out yet another 20 years and the home’s value is up to $703,000, while the mortgage is $177,000. A century later (just for the fun of it) — since one might imagine the U.S. economy really might be around a century from now, growing 5% a year, just as it was around a century ago — this hypothetical house would have grown in value to an astonishing $92 million, while the mortgage would be barely $1 million.

Really, when you think about it, so long as the debt is growing slower than the economy as a whole, it’s shrinking relative to the economy as a whole.

At the end of World War II, the National Debt was well over 120% as large as the Gross National Product (140% is the number that sticks in my mind). Then it got down as low as 30% or 40% (forgive me for not having the precise numbers at hand). Today it’s climbed back toward 70% . . . which is actually fairly low compared to most other nations. But the main thing is this: until recently, the annual budget deficit was so large, especially when reported honestly, without double-counting Social Security reserves, that the National Debt was actually growing faster than the economy as a whole. Big trouble. Lately, and even after admitting that the Social Security “reserves” should really not be counted as “revenue,” the National Debt has been growing slower than the economy as a whole. So we’ve begun the long, gradual process of shrinking the debt again.

That’s good.

Is it important to be “leaning against the wind” and, in all but recession years, have the debt gradually shrink relative to the size of the overall economy? I think so. Must it ever be paid off in full? Not really. Lots of healthy enterprises have some debt. Unless the U.S. economy is going to close up shop one day, it is perpetual, and can perpetually have some debt on its books.

So: it’s reasonable to be concerned and vigilant, but not necessary to panic. The sky is not falling.

Writes management consultant Jonathan Rotenberg (founder at 13 of the Boston Computer Society), who finds himself dating another management consultant from a competing firm:

“Two management consultants dating can be scary. We never argue; we just have facilitated conversations guided by conceptual frameworks.”

Whatever form your relationship, or future relationship, takes: Happy Valentine’s Day!

(And answer me this: shouldn’t cupidity have more to do with love than love of money?)

“A full service broker told me that the discount brokers make more on the spread than full service brokers. Therefore, the $18 to $40 price quoted is not the real price. Could you please comment.” — Barbara

Ah, just the sort of unbiased, straight-shooting selfless advice some full-service brokers are famous for.

I don’t want to appear to be shilling for Ceres, because I’m not. My own accounts are in three places: at a deep-discount brokerage owned by the same parent as Ceres, at one of the large discounters of the considerably more expensive Schwab or Fidelity variety, and at a well-known, full-service broker who gives me a big discount but still costs far more than a deep discounter. I’ve had a personal relationship there for 25 years, long before there were discounters of any kind. If I were starting from scratch, I might well have an account at Ceres or one of the other really-deep discount brokers and might well not have an account at a full-service broker.

But while it may — or may not — be true that some firms will occasionally do better in terms of “price improvement” than a deep discounter would, I’ve never seen anything that convinces me this is true. I could be wrong, but I believe the price advantages of deep discounters are dramatic.

And in a related issue, thanks to the S.E.C. in these last few Clinton years, some really important changes have been made to help split some of the hairs that were costing us investors a lot of dough. “Spreads” are being shrunk, and the basic “eighth” that used to dominate all trading is giving way to finer measurements that narrow transaction costs as well.

The transaction costs of trading — especially in a tax-sheltered account where taxes are not an issue — have plummeted since I opened my first full-service account, and even in the last several years since I opened my first deep-discount account. America’s transaction machine has become more efficient. We are getting a better deal.

Then again, if you believe as I do in buying and selling relatively infrequently, there comes a point where the difference in price makes very little difference. To someone who trades in and out all day, the difference between $15 or $50 (let alone $300) is huge. To someone who buys $25,000 of a stock and holds it three years, who cares?

Today is Lincoln’s birthday, even though for economy’s sake it has been averaged into February 22, Washington’s birthday, to produce the glorious long weekend I hope you’re about to enjoy. (They were, as you know, the eight-and-a-halfth president, and their birthday is, on average, the 17th.)

“You can fool some of the people all of the time, and all of the people some of the time,” said Abe, who never tried to fool anyone. “But you can’t fool all of the people ALL of the time,”

To which my friend and consumer advocate Jason Adkins — disheartened by the kind of election victories big-money can buy, like that of the sugar growers in Florida last November — appends, sadly: “but you don’t have to.”

(Indeed, if you look at the success the tobacco companies have had so far resisting efforts to restrict their promotion of cigarettes to kids and their parents around the world, one might conclude that sometimes you don’t have to fool ANYONE to get your way. You just need a lot of money.)

“Propagandists, from Shakespeare to Jacqueline Susann, have been telling the unrich that money doesn’t buy happiness. The unrich, not being immune to spasms of common sense, sometimes wonder about this.” — Anthony Haden-Guest

You absolutely don’t need money to be happy, and having money absolutely won’t guarantee that you are happy.

But it sure helps.

You knew this of course, but I find any excuse I can to trot out Anthony’s delicious quote.

What could spook this great bull market? Here’s a contrary thought: a capital gains tax cut. Sure it would be great news for investors. But putting aside all the questions of whether it’s a good idea, whether it’s fair, and so on, I want to contribute just one small idea to the ongoing debate: If you do cut it, cut it gradually.

Think about it. Say the capital gains rate were — bang — cut in half. Millions would have an immediate reason to sell; no one would have an immediate reason to buy. Don’t you own something you think is kind of toppy, but hate to sell because of taxes? Or even if you don’t, don’t you fear others do? Might a lot of them not want to sell — fast, before others do and drive down the price — as soon as the lower rate takes effect?

I could be wrong. Maybe no one would look at this sudden change in the rules of the game and want to take advantage of it . . . but when has that ever happened? Or maybe people would be so electrified by the prospect of lower tax rates they would rush to buy more shares. But I think the reaction on the buy side, while positive, would be much more relaxed. What’s the hurry? So you’d have an imbalance: more enthusiasm for selling than buying — and that drives prices down.

Happily, there’s a no-brainer solution. Just phase in the cut gradually. E.g., cut the 28% top rate 2% a year for seven years. Selling would be spread out. (It might peak a little in January of each year, as each new tax cut notched in; but that’s a good month to absorb extra selling, because it already has a bias toward extra buying because of inflows from bonus money and the like.) Some would wait all seven years. Others would grab the 2% right now, now that there’s no longer any prospect of a large immediate tax break. Many would do something in between. Yes, there would be a bit of a bias toward holding on . . . but what’s so bad about that?

So if you DO cut it — and I’m not at all sure we need a drastic cut in the capital gains rate right now, much as I’d enjoy one — cut it gradually. (How about cutting it 1% for eight years, bringing the top rate down from 28% to 20%?)

And while I’ve been writing this mainly in terms of the stock market, don’t think there wouldn’t be an impact on the real estate market, as well — especially investment real estate. A homeowner who sells is generally, though not always, more or less simultaneously a buyer as well. And homeowners already enjoy enormous shelter from capital gains taxes. But with investment real estate, most of which (because of depreciation) sits with large unrealized capital gains, a chance to cash out at 14% instead of 28% might trigger a lot more FOR SALE signs than “Investment Properties Sought” classifieds . . . and thus depress prices.

Because remember: no one says you have to take the cash you get for selling a stock or office building and immediately reinvest it. Yes, you become a potential buyer. But what if instead of immediately buying some different stock or office building, you use the cash to pay down debt? Or to buy municipal bonds? Or to resurface your driveway?

So guys: whatever you do, do it gradually. If not, we may see prices decline even before the tax cut takes effect. (Wouldn’t a lot of people/institutions with money in tax-sheltered accounts, fearing selling when the sharp break in tax rates becomes effective, want to take the precaution of selling first?)

Not a bad time to be a stockbroker, or a real estate broker, though, if the tax barriers to selling are suddenly cut in half. And almost as good a time if the barriers are cut gradually.

Yesterday I argued against privatizing Social Security. Today, a few quick thoughts on the other popular solution to the Social Security problem; namely, why not invest some or all of the Social Security Trust Fund in stocks? After all, everyone knows that over the long run, stocks outperform safer bonds — like all my mentors, I’ve been writing that for 25 years.

Wow.

The idea, I assume, is not to have Uncle Sam picking stocks and trying to outsmart other investors. The idea is to have perhaps 40% of these funds invested in a broad, broad index of the market as a whole.

(Interesting statistic Dan Nachbar kindly found for me: the S&P 500 stocks alone account for about two-thirds of the entire valuation of every New York Stock Exchange, NASDAQ and American Stock Exchange issue. So though an even broader sweep would absolutely be appropriate, it wouldn’t be hard to absorb quite a bit of dough in “just” these 500 stocks.)

Sadly, the Trust Fund is not as large as you might imagine. It’s largely a “pay as you go” kind of retirement system, where all our contributions used to go right back out to our grandparents, with nothing put away for our own retirements.

In the past decade or so, however, we’ve begun collecting more than we need to pay out right now, hoping to build a cushion for when the baby boomers are retired, with too few workers to support them all.

That cushion has been growing fatter and fatter (although not so much as to solve the long-term problem), and it’s all invested in U.S. government bonds. After inflation, the Treasury bonds can be expected to earn barely more than 2%, while stocks have historically outstripped inflation by more like 6%. So, the thinking goes, why not juice up the return on this money?

Clearly, the injection of tens of billions of new capital in the market, if it happens, will have effects. One obvious one: raising stock prices (more demand, same supply, equals higher prices). But nearly as obvious: higher borrowing costs to the Treasury.

It’s true, Social Security allows the Treasury to borrow at “bargain” rates. But it’s our Treasury, our debt being financed. Do we accomplish much by raising our return in our right-hand pocket while raising our borrowing costs in our left? And is this really the time to start thinking about pumping even more money into a stock market already flirting with irrational exuberance?

And what happens to the market when the Baby Boomers pass through to the years when the huge buildup in funds needs to be withdrawn? Might this presage many years of a bad market, as any fool can see tens of millions of retirees coming down the pike? Might this lead people to try to cash out as early as possible to avoid the crush?

Talk about leaving an immoral debt to our kids! This one wouldn’t be a literal debt, just the semi-sure knowledge of a massive, long-term stagnant market at best, or a here-comes-the-Boomer-bulge panic and collapse at worst.

Not that this may not happen, 15 or 20 years from now anyway.

(This raises an intriguing prospect. You don’t want to get the government into the business of trying to manage the stock market. Still, the market might be even less prone to unreasoning panic than it is today if people knew that on steep sell-offs, the Trust Fund might take the opportunity to scoop up an extra $50 billion or $100 billion of securities. And it might even help keep the market from reaching dangerous overvaluations if people knew that the Trust Fund would occasionally “take profits” since it has, after all, no capital gains tax to worry about. But one can see all sorts of potential for political abuse and mismanagement.)

(And then there’s the question of why we should even limit this to the U.S. stock market. Overseas markets, in countries growing faster than we are, may do even better than our own. To the extent the Trust Fund could profit by stepping in to soften some other market’s panic — buying when prices have plunged — it could be a potent force in global economic foreign policy at the same time as it aided the world economy and piled up more loot for retirees. So perhaps a small portion of the investable funds should have the flexibility to go abroad, odd as that may sound at first.)

Bottom line: If Social Security funds are shifted from bonds to stocks, who will buy the Treasuries we no longer do? How high will interest rates have to climb to attract other purchasers?

I think we should table this discussion until, some years from now, the stock market seems extraordinarily depressed. At that point, we might well still decide to scrap the idea — but mere discussion of it could perk up the market, giving Greed a chance, once again, to wrest the reins from Fear. Today, Greed needs no help whatever.

In the meantime, what is the solution? It is this: Trim the CPI in line with more realistic statistics; index the retirement age to increases in life expectancy; reduce benefits for those who don’t need them; and remind everyone that for a really comfortable retirement, they need to fully fund those 401(k)s, IRAs, SEPs and Keoghs.

With all the talk about what’s wrong with Social Security (Medicare’s the real looming crisis), it may be time to debunk the reforms.

The most dramatic suggestion — to privatize the system gradually by moving people into mandatory individual investment accounts — has great surface appeal but some pretty big problems:

• While you’re making the transition, one generation must in effect shoulder the nearly impossible burden of two systems. After all, no one advocates stopping, cold turkey, the payments today’s workers make to today’s retirees.

• What do you do if a person invests poorly? You’d still need a safety net. Indeed, what an incentive to gamble! If you win, you retire in luxury. If you lose, you’re at least assured some poverty-level maintenance program.

• Won’t this leave an awful lot of unsophisticated people prey to all manner of sales pitches, commissions and transaction costs?

• But mainly (to my mind): why should everyone have to save — and live, once retired — as if he or she will live to be 110? Social Security is not just a “pact between generations,” though it is that, with each generation pledging to assist the previous one. (The problem, of course: we now have just 3.3 workers for each retiree, and we’re headed for just 2.) It is also a pact among citizens of the same generation.We all pay in more or less equally (given equal incomes), knowing that those who die earlier than average will have wound up subsidizing those who outlive them. Yet this seems a reasonable deal, because it keeps us from all having to live like paupers at age 65 in case we have to stretch our funds to last 35 or 40 years. (So there’s another reason we’d still need a taxpayer-financed safety net. Would we allow 88-year-olds whose cash has run out to freeze and starve?) Really, smokers should by age 55, say, be excused from further Social Security contributions, since they’re so much less likely to collect as much as nonsmokers. (Not that I’m seriously proposing this. Perversely, it would encourage nonsmoking 55-year-olds either to lie or to take up smoking.)

There’s a reasonable case for going part way, by restoring Social Security more toward the safety-net-of-last-resort bare subsistence sort of thing I believe it was originally intended to be. In other words, with enough warning, you could eliminate benefits to those who don’t need them and cut back somewhat on benefits even to those who do. The savings from this would be used to fund the individual investment accounts people are talking about. But why? Why take that extra step, in effect penalizing people who live longer than average, as tens of millions will?

After all, there’s still plenty of variety in retirement lifestyles. It’s not as if America becomes a homogenized, socialized society even with today’s rather modest benefit levels. Some retire in splendor; others eke out a life on Social Security alone. If the “safety net” is indeed a bit above bare subsistence . . . well, why not? For one thing, it’s one relatively small concession to a sort of national neighborliness. A social compact. It binds us together. We’re the only advanced country in the world without universal health insurance, and we no longer have the common experience of the draft or of Walter Cronkite every night. Maybe we should keep Social Security.

As usual, I know if I’m missing something here, I can rely on you to point it out.

Tomorrow:Social Security II (the problem with fixing the system by investing its funds in stocks)

I’m not saying you may not do well trying to beat the market, though not trying is often the wisest course. (On average, we can’t all be above average. The more time and money one spends trying to beat the average, the bigger the “handicap” that must be overcome just to do as well as those who don’t try.) Not long ago, I even laid out my top 10 reasons why you might NOT want to invest via low-expense, no-load mutual funds, even though that’s surely the best course for most people.

(Full disclosure: little of my own money is in mutual funds, and none of it in the Vanguard Index funds I’ve so long recommended. For the most part, I enjoy making my own mistakes.)

But there are just so many reminders of this basic fact: that most of the time you’ll do well — or at least better than most people who are trying harder — just “buying the average” via a low-expense index fund.

Latest example? This month’s Smart Money Magazine is emblazoned: THE SEVEN BEST MUTUAL FUNDS FOR 1997.(My first thought: what outfit conducted the focus group that determined “seven” would sell better than “ten?” Or maybe it was just good editorial instinct. We’re tired of “ten.” Ten is a cliché. Ten’s been done — to death. Ten is not particularly lucky. And ten is perhaps a tedious lot of choices to muddle through in these days of instant soup and widespread downsizing.)

So the “seven” part of the deal I was fully in synch with. But the rest? C’mon. The guys at Smart Money are every bit as smart as I am, which means they know as well as I do this is basically just good entertainment, good marketing, part of what makes the world go round. And little more.

To their credit, Smart Money did just what they should as part of this endeavor. Namely, they showed the results of last year’s picks. In a time frame during which the S&P 500 returned 27.85% (this was the benchmark they used), all seven of THE BEST FUNDS FOR ’96 did anywhere from considerably to dramatically worse. Not one of the best came close to the S&P (or, therefore, the Vanguard Index Trust). The best of the seven managed 20.86%, the worst returned less than 1%.

I have no doubt Smart Money’s picks for ’97 won’t have such an awful year relative to the S&P. Who knows: they could even match the S&P or, it’s certainly possible, exceed it. But could they exceed it by enough to bring Smart Money back up to even with the S&P for the two years? My guess is you could buy Smart Money and follow its mutual fund advice forever without meaningfully justifying the price of the magazine on this score, simply because the funds they choose will normally have a bigger expense-ratio handicap, on average, than the low-expense, no-load index funds, and therefore very possibly trail them.

This then raises the issue of, “Well, what if everyone invested only in index funds?” What if no one picked stocks, or funds that picked stocks?

I grant that if that day ever approached, the “inefficiencies” in the market — which are already there and create opportunities for the nimble (see, for example, my comment on spin-offs) — would become so glaring they would provide opportunities even for the lame. Which is why we’ll never get that far. There will always be a balance between people like me willing to try to beat the averages, some succeeding, most failing, and those taking the boring, prudent course.

Everyone has his or her own way of accepting a compliment. “Aw shucks” is good. “Thank you, sugar,” works for a certain sort of recipient. “Thanks for your kind words” is what an older writer once responded to a fan letter I had sent. His response had at once a sort of warmth and yet an arm’s-length formality that I decided to adopt should the occasion ever arise.

“Thank you for your kind words.”

Well, now comes Joseph Conrad — not literally, of course, but in 1920, four years before he died — with a turn of phrase that puts the rest of us to shame. I mean, gee whiz — English wasn’t even his first language. (Born Josef Teodor Konrad Walecz Korzeniowski in Poland in 1857, he wrote everything, including Lord Jim and Heart of Darkness, in English, his second language.)

To a gushing fan he wrote . . .

“I do not know when I shall depart on my last journey, and still less do I know what will be my destination, but you may be sure that if St. Peter shows any reluctance to open the door I shall use your name without scruple.”

Now, that’s a thank-you note.