The Portfolio Implications of Adding Social Security Private Account Options to Ongoing Investments

Proposals to allow private accounts under Social Security were introduced long before George Bush was elected President, and support for privatization in some form will survive his administration and the economic downturn that followed. This paper studies the impact that private accounts would have on risk/return investment tradeoffs available to Social Security participants who save and invest on an ongoing basis outside the Social Security system. For such investor/participants, we show that the reduction in total diversifiable risk afforded by traditional Social Security accounts would be more than sufficient in many cases to compensate for the opportunity cost of opting-out of a privatization program if one were enacted. The risk of financing private accounts by diverting mandatory contributions away from guaranteed benefit accounts, on the other hand, would be proportionately higher for those with little or no private savings or investments outside the Social Security system. The paper concludes, therefore, that privatization would lead to imprudent risks being borne by those who can least afford to do so, and would offer no significant advantage to others.