Social Security, our nation's most treasured social program that's responsible for keeping more than 15 million seniors each month out of poverty, is in some pretty big trouble.
The clock is ticking
As you've probably heard by now, the annually released Social Security Board of Trustees report has predicted that the program would begin expending more money than it's bringing in very soon. The 2018 report incorrectly called for this to happen last year, but the passage of the Tax Cuts and Jobs Act appears to have staved off the inevitable, for at least one more year. However, the first three months of the year have not been as promising, with $9 billion in net cash outflows from the Social Security Trust Fund.
With more money leaving the fund than is being collected, it's only a matter of time before the $2.89 trillion in net cash surpluses that Social Security has built up since its inception is gone. According to the Trustees, the year 2034 is pegged as the asset reserve exhaustion date, assuming Congress fails to act by generating more revenue, cutting long-term expenditures, or enacting some combination of the two. In short, in order to keep the program solvent, a 21% across-the-board benefit cut may be 15 years (or less) away.
To say there have been countless proposals to fix Social Security's estimate $13.2 trillion cash shortfall between 2034 and 2092 would be an understatement. But rarely, if ever, do these proposals cross party lines and attempt to find a middle ground, which is why so many introduced reform bills are dead on arrival in the House or Senate.
Should Social Security invest in the stock market?
However, one suggestion that consistently crops up is the idea of investing Social Security's asset reserves into the stock market. To be clear, this doesn't mean giving each individual access to an account with their payroll tax earnings to invest. This is known as a partial privatization of Social Security, and the idea was shot down during the mid-2000s. Rather, since the program is a social investment in future generations of retired workers, investing in the stock market would involve the federal government buying a basket of stocks with some or all of the money currently held in the program's asset reserves.
Why invest in the stock market, you ask? The simple answer is that it tends to perform very well over the long run, and it's returned an average of 7% a year historically, inclusive of dividend reinvestment, and when adjusted for inflation. That's far and away higher than the 2.85% average yield that Social Security's asset reserves are bringing in via special-issue bonds and certificates of indebtedness right now. By law, the Social Security Administration is required to invest in these special-issue income-generating financial instruments with the program's annual net cash surplus.
Additionally, it's possible that pouring nearly $2.9 trillion into the stock market could send the broader market to new highs. We've seen what more than $4 trillion in bond-buying by the Federal Reserve did to bond yields over the past decade, and the effect could be similar for equities if the federal government began buying stocks with Social Security's asset reserves.
Here's why bonds are the better investment choice for Social Security
But as intriguing an idea as this might seem, there are four very good reasons keeping Social Security Trust funds out of the stock market is a good idea.
First, even though some folks find this to be a highly unpopular opinion, investing this excess cash into the stock market instead of bonds would remove $2.89 trillion worth of borrowing capacity for the federal government. To be crystal clear, Congress hasn't stolen a dime from Social Security, and they are paying interest into the program every year. Paying this money back wouldn't put the program on better footing and would, almost certainly, make things worse. But the big issue with investing in the stock market is that it would now cause the federal government to seek out $2.9 trillion in new borrowing capacity, which is a lot to ask.
Second, I'd venture to say that the federal government would be incapable of impartially investing $2.89 trillion. There's a strong likelihood that we'd see government money pour into companies that have contracts with the federal government, or businesses that align with the prevailing political party in power. It would be almost impossible for the Social Security Administration to invest this money based on fundamental merits, rather than political preference.
Third, while no investment offers guaranteed returns, special-issue bonds backed by the full faith and credit of the U.S. government are about as close as you're going to get to a safe and predictable investment. Comparatively, there are no guarantees when it comes to investing in the stock market. Sure, the market has done well over time, but predicting its short-term and interim movements are hit-and-miss at best. This is a problem, because the Trustees rely on consistent investment return data to make long-term solvency projections. A few bad years in the market could put a big dent in Social Security's solvency forecast and funding needs.
Fourth and finally, adding a boatload of money to the stock market all at once could distort returns for the foreseeable future. The immediate impact would be positive, but it's unclear if the push higher caused by nearly $2.9 trillion would be sustainable over an extended period of time. In other words, the market would be knocked out its traditional expectation of cash inflows and outflows with such a monstrous investment, and that could lead to added volatility and a departure from the stability that the Trustees rely on when crafting their outlook on the program.
Special-issue bonds may not be flashy, but they get the job done and are expected to generate $804 billion for the program between 2018 and 2027.