Linda Lutton on Bush tax cut

Great Debates
261

1.35% expense ratio translates to 33% over 30 years. So, what exactly are we supposed to conclude from this (other than that “as much as 30%” of money in privatized plans could go to paying such fees)?

Yes, Americans have chosen to put their money into equity funds. They have also chosen to generally broadly support SS despite a very well-financed disinformation campaign by people who are far from disinterested parties.

So, you are supporting the privatization of SS out of concern for the lower-middle and middle class? Well, that’s what 401K plans are for…And, I would be happy to endorse some sort of additional plan that provided, say, government matching contributions into retirement savings accounts (say, even a 2-to-1 match up to some level) for people below a certain income, funded by slight increases in the tax rates of the top brackets for example. But I am guessing that such ways of providing greater opportunity for these people to invest in the market might become less appealing to you if it didn’t involve trashing a government program in the process!

262

We’re suppposed to conclude that a 1.35% expense ratio is still a good value. Trillions of dollars of invested money speak louder than words.

BTW 1.35% over 30 years isn’t 33%. At simple interest, it would be 40.5%. However, compound interest is more appropriate. At compound interest, 1.33% for 30 years is 49%.

Q. Why are investors voluntarily putting trillions of their dollars into mutual funds with a 30-year 49% expenses ratio?

A. Stocks have appreciated 10% per year on average over the last 100 years. 10% compounded for 30 years adds up to a gain of 1645%! After subtracting 49% overhead, this is a net gain of 1596%

In other words, after expenses $1 grows to $17.

263

Albert Einstein said of compound interest:

The above example shows why.

264

december: In other words, after expenses $1 grows to $17.

If you’re lucky in your investments. One of the points of Social Security is that not all your retirement income should depend on being lucky in your investments.

265

Please re-read my post. Not, “if you’re lucky,” but rather, “if you have normal, average results.” BTW averaged over a thirty year period your chances are quite good of having normal results.

I grant that you would do worse if you were unlucky. Then $1 might only grow to as little as $14 or $12 or even $10. :frowning:

OTOH if you’re unlucky at Social Security, they’ll move the retirement age up to 75 and you’ll die at age 74 1/2 wihtout collecting a penny.

266

Boy, we seem to be switching sides here on the numbers! Now you are arguing it is bigger than me. But, I think you are doing it wrong. The point is that this is not positive interest…it is negative interest (i.e., depreciation). Basically, imagine putting $100 in the bank and then removing 1.35% each year. The correct formula is (1-x) = (1-0.0135)^N. Here, x is the fraction that has disappeared after 30 years (.335 in this case) and N is the number of years. What you are computing is (1+x) = (1+0.0135)^N which is appropriate for positive interest.

How many times do we have to go over this point again and again? One can’t just compare the rate of appreciation with that of SS because SS is a pay-as-you-go system. The question is rather what additional costs you incur vs. what additional money might come into the system as a whole. I think that much earlier in the thread, people [Tejota and CyberPundit] argued why it was unlikely that privatizing would really lead to much additional amount of money in the system. On the other hand, we know of these additional expenses there will be.

267

Exactly, and still a good deal as evidenced by all the money invested in mutual funds.

Yes, I was doing it wrong. Your formula is correct if the investment never grows or declines.

With normal investment results, the right approach is to compound the annual return after deducting each year’s expenses. Assuming the long-term average 10% return, the formula becomes: (1 + .10 - .0135)^30 = 12.04. In other words, the net return is 1104%.

Yes, it’s literally true that overhead expense will be there whether the investment goes up or not. So, even though one would expectg the stock investment to be incredibly more lucrative, it might be prudent to invest only a portion of one’s SS contribution. That’s why you should support Bush’s plan.

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december: So, even though one would expectg the stock investment to be incredibly more lucrative, it might be prudent to invest only a portion of one’s SS contribution. That’s why you should support Bush’s plan.

Going round in circles again. As has been pointed out many times, there are also reasons why we could expect the stock investment to be only somewhat more lucrative, or even only marginally more lucrative. Moreover, the “prudence” of such a plan does not depend only on the gross estimates of comparative rates of return. As I said in an earlier post, you tell me in detail what the Bush plan “will entail in terms of creating and managing privatized accounts, projected rates of return and the specific assumptions underlying the projections, projected levels of risk and the specific assumptions underlying the projections, projected strategies for funding transition costs, expected impact on SS’s redistributive effect, expected impact on non-retirement benefits, strategies for account transfer and annuity conversion, and relation to current economic and demographic projections”, and I’ll tell you whether I think I should support it or not. But you can’t expect me just to take your word for it that it’s worth supporting.

269

Re: the 1.35% figure: there are some 13,000 mutual funds to choose from. Many of them are research-intensive, concentrate on Microcap or international stocks (which are far more expensive funds to run), trade heavily, concentrate narrowly on individual sectors, deliberately run high risks, attract “hot money,” or have assets of only a few million or tens of millions of dollars under management. None of the above would be appropriate for Social Security.

The 1.35% number is simply a red herring.

It’s already been established that we can run large funds with no sales charges at around 10 basis points. The bulk of my own retirement money is invested in such a fund.

The 1.35% figure is simply a scare tactics and a result of ‘chicken-little’ thinking. It is simply not a likely figure.

The figure we should be using to calculate risk/reward is 10 basis points, or less.

270

** panzermanpanzerman **, I want to buy a no-load, low expense stock index fund for my new grandson. Can you recommend any?

Thanks

271

What’s a red herring is the loony idea that once substantial funds from SS make it into the market that the returns will be anywhere near their historic norms after that. What you’ll have is a spike up in prices after which they’ll plateau and not do much. That’s the best case scenario. The worst case? That we’ve already had that spike. (the S&P is sitting at greater than a 20 times P/E at this very moment, one and a half years into a bear market. I believe this is unprecedented, but I might be wrong. It’s certainly not normal. But if you think about it, only the oldest boomers have reached even early-retirement age. So the fact that the market is so far above its historic norm is what you would expect, given the demographics.) In which case the best you can hope for is that they’ll plateau at the current price level or maybe just not go down as much as they otherwise would have.
I’ll make you a gentleman’s bet: over the next 10 years, the market will go up less than its historic norm of 10% per year before inflation. I’ll even give you odds. Even if SS is partially privatized, I’m confident my side of the bet will hold.
This privatization idea is just top-of-the-market behavior. Anyone who would have proposed this back in the thirties, when the system was created, would have been sent packing to an asylum. Of course, that would have been the best time to allow SS funds into the market.

272

December:
<<panzermanpanzerman , I want to buy a no-load, low expense stock index fund for my new grandson. Can you recommend any? >>

Well, geez…great question. And the answer is, of course, “it depends.” Understand, I’m not a financial advisor at all.

Here are some things to consider:

Is this a one-shot, one-kill kind of account? Or is this something you plan on making a contribution to every month?

If the latter, my favorite family is the Vanguard Group. Best bets are the Vanguard 500, which tracks the S&P 500, of course, or the Vanguard Total Stock Market Index Fund, which tracks the Wilshire 5000.

The expense ratios are 18 basis points and 20 basis points anyway. VTSMX, of course, has more exposure to mid- and small-cap stocks, so will be somewhat more diverse.

The portfolio manager for both, Gus Sauter, head of indexing at Vanguard, is a whiz at minimizing real expenses, though. He’s historically managed to use options and sampling strategies at the margin to squeeze out a few basis points at the margin and minimize trading costs, so he’s actually historically trailed the indexes by an amount less than the expense ratios.

Try to keep at least 10,000 in the fund, though, if you can, to avoid the annual 15 dollar fee, I think it is, that Vanguard charges. There are other ways to avoid the minimum, though, if you have lots of money invested elsewhere within Vanguard.

There are other great firms, though. Fidelity offers versions of both indexes. The Fidelity Spartan Total Market fund has a somewhat higher expense ratio than Vanguard’s (25 basis points, I believe.) T. Rowe Price offers 500 index fund, as does USAA and TIAA-CREF. Each will come in at 18 points or thereabouts, and all will take great care of you.

If you’re a fan of annuities in your own personal account, I’d lean toward TIAA-CREF. If you’re a veteran, USAA will probably do you a little better. So it depends on the context, and it depends on where you have your own money. I’d pay an extra basis point or two to have everything on one account statement.
Another thing I’d look into is using a Section 529 plan, which provides powerful tax advantages if the money is used for higher education. Education IRAs can now be used for secondary and grammar school-related expenses, too, starting in 2002.

To find out more about 529s, check out http://www.savingforcollege.com.

The California plan, administered by TIAA CREF, is excellent. (You don’t have to be a Californian to participate.) Other great plans are run by Vanguard and Fidelity.

You don’t get to choose your fund, in this case, but you can pick your state. And the tax advantages of these plans will more than offset a few basis points in expenses.

The limit for Education IRA’s is going up as well, from 500 per year to $2000, and starting in 2002, I believe you can do both an Education IRA and a Section 529 at the same time. (Don’t do both before 2002, though, because the old tax law will screw you with a penalty.)

In a nutshell–and check this carefully with a pro, because I am definitely not a professional advisor, Education IRAs are nondeductible, but money can be withdrawn tax free for all educational-related expenses–tuition at private grammar schools, a new computer, books, etc. Unused money rolls over to the kid, but he gets taxed at HIS (hopefully lower) rate, not at yours.

With a 529, though, contribution limits are MUCH higher, and you remain in control of the money. The kid can’t blow it on beer and drugs when he’s 18. You can usually reclaim the money for yourself if you need to. Money grows tax free as long as its in the plan. When it’s withdrawn for college related expenses, it’s taxed at the KID’S rate, not yours.

So not only the fund you choose, but the type of account you put it in, is very important.

If it’s a one-shot investment on your part, and you aren’t making regular contributions, consider an ETF, such as Vanguard’s Total Stock Market Index ETF, which will have substantially lower expenses than even its index fund. You might put that within an Education IRA and get the best of both worlds. :slight_smile:

If you plan to make regular contributions, though, and dollar cost average in, than the ETF makes less sense because it costs money to do a transaction with those.

Hope this helps!

273

pantom <<What you’ll have is a spike up in prices after which they’ll plateau and not do much. That’s the best case scenario.>>

Why? How can you be so sure?

<<<I’ll make you a gentleman’s bet: over the next 10 years, the market will go up less than its historic norm of 10% per year before inflation. I’ll even give you odds.>>>

You might have a point if we were only talking about 10 years. I agree with you that stock prices absent a P/E expansion (which we’ve seen since 1992) that prices will tend to expand at the same pace corporate earnings + dividends expands. That would take you to maybe 7-8% annually.

Wanna read some good stuff on this very idea, check out the first couple of chapters of John C. Bogles’ “Investing: the First 50 Years.”

Two points:

1.) I’ll take 7-8%, or even 6%, over the current return on social security contributions over the next 10 years any day of the week–especially since that 6% is mine–if I die, my children get it passed on to them, and maybe they won’t have any need for Social Security)

2.) Who the flip is talking about a 10-year horizon, anyway? We’re talking about a 40 year horizon.

<<<This privatization idea is just top-of-the-market behavior. Anyone who would have proposed this back in the thirties, when the system was created, would have been sent packing to an asylum.>>>

<g> Of course, that’s just ‘bottom-of-the-market’ behavior.

But historically, when you’ve got investors dollar cost averaging over a 40 year working career, whether he starts at a market top or bottom doesn’t matter nearly so much.

And by dollar cost averaging, even if we assume the market indexes return 6%, the real world investor should realize somewhere more than that.

274

As you know, but seem to keep ignoring. past performance is no gurantee of future performance. Certainly, there is no real chance to know how the market will do in any specific year, but you seem quite confident that the long term average will be around the same time as it has been in the past.

But remember, past performance blah blah blah…

In order to make some kind of guess about what the future holds, you have to look at factors that we know affect the market, and how they can be expected to turn out over the next 50 years.

Now, there’s a lot we don’t know, but there are a few things we can guess at. And most of these things are tending to depress the market.

  1. The same population bulge that is going to cause problems for SS revenues vs. benefits. Is going to result in
    a labor shortage over the next 50 years. IMO This is NOT going to be good for the market as a whole.

  2. If a significant fraction of SS funds is put into the capital market, this will be more capital than the market can usefully absorb. This will result in the cost of capital going up, and returns going down.

Now, if we leave SS funds out of the capital markets, then your projections about future returns might actually work out. (though I doubt it because of the future tight labor market), but if you DO plan do pour much of the SS funds into the markets, then they will change the market.

The one thing I think you can count on is that if you privatize SS (or even if you don’t but put 20% if SS funds into the market), then that amount of extra money into the markets, will have a large effect on the markets’ behavior.

Really? Then I guess you haven’t done your homework. The T-bills that the current SS surplus are put into are credited with 6-7% interest.

tj

275

Actually, the 6-7% cerdit going to T-bills is not the right comparison. The right comparison is the interest assumption that makes the Present Value of one’s SS contributions equal to the PV of one’s benefits, after accounting for mortality. This inherent interest rate will depend on how future benefits turn out.

Given the demographics, it’s a good bet that benefits won’t turn out that well, but I confess I haven’t done any calculation, nor do I have the data to do so. This requires a pretty complex model. I suppose some actuary may be looking at various scenarios.

276

True enough, although in this model, the return on investment is going to vary wildly depending on your income level and how early you retire and how long you live (and even more wildly if you die early or are disabled).

Determining a typical number is just about meaningless because the deviation is so large only a relatively small group of people will be typical. You end up comparing private rates of return with SS ranges of rates of return and associated incomes/probabilities.

And, of course, you will find that SS is a poor rate of return for the rich and a good rate for the poor. It would be interesting to know at what income level does SS rate of return equals the private rate of return. Does anyone have this number?

But that’s the real point isn’t it? Privatization of SS is really a back-door attempt to remove the income-redistributive effect of SS. Only the administration isn’t honest enough to tell us that and and defend that idea on its own merit.

277

[hijack]

I just have to say that every time I see this thread I do a double-take, 'cause my sister’s name is… Lynda Lutton. All I keep thinking is, “What the Hell is she on about now?”

:smiley:

That’s all.

[/hijack]

Esprix

278

In principle a mean rate of return could be calculated by averaging over all these groups. I assume the social security actuaries have the data to do this.

The difference in rate of return may be less than you think. The rich live longer than the poor, so they have more years to collect benefits.

That’s an interesting thought. I really don’t know if partial privatization would result in reducing income redistribution. I suppose it depends the exact structure.

Of course, privatization would most likely make everyone who particpated richer. In particular, those who die before retirement or soon after would have a fund of investments built up to pass on to their heirs. It seems like too much envy to reject a program that helps the poor because it helps the rich even more.

279

Pure, unadulterated, nonsense. The only way everyone could win is if privatization could somehow cause a growth in the total wealth of the nation. The only problem is, it can’t. (you already agreed to this in this very thread).

280

Most of what I said has been backed up by tejota, so no reason to go over that ground again.
Just one thing. This priceless gem:

Ever heard of P/E contraction? That’s what happens in bear markets. I know that a lot of you are too young to know what happens in a bear market, so let me spell it out for you.

c-o-n-t-r-a-c-t-i-o-n.

Got that?

I’ve got another piece of news for you: earnings can go down.

And yet another one: so can dividends. In fact, they can even stop paying them, if it comes to that.

That’s what I mean by top-of-the-market behavior. In your mind you can’t even fathom something like P/E contraction.