THE BLOG
11/29/2010 10:49 am ET Updated May 25, 2011

Why Joe Klein Is Wrong: Social Security Needs to Invest in Stocks

Time magazine columnist Joe Klein got it wrong when he said that the stock market's slump proves that "privatizing" Social Security was a bad idea. This is like saying that losing your job proves that jobs are a bad idea.

Don't get me wrong, the privatization approach taken by former President George W. Bush would have enriched brokerage firms at the expense of the general public. As is the case with just about everything that happens on Capitol Hill, the idea wasn't inspired by logic but by campaign contributions. Progress for America, a tax exempt group that spent an estimated $20 million promoting privatization, was supported by brokerage firm CEO Charles Schwab, who contributed $50,000 to the group's political arm in 2004 and $75,000 to the Club for Growth, which also lobbied for it.

Trust me, the existence of brokerage accounts that attempt to time the market is evidence that there is no logic in finance. Why? It's not because stocks are dangerous but you can't predict their day-to-day behavior. In the same fashion that lives can be lost when someone shouts "fire" in a crowded theater, fortunes can be lost when investors stampede out of the market. Take the panic following the largest one-day slump in stock market history on October 19, 1987, causing millions of investors to miss out when the S&P 500 turned in a 30%-plus return two years later, one of only 12 calendar years that the market performed that well. Or take the rush-to-the-exits nearly 20 years later in March of 2007, when 401(k) investors moved half a billion dollars out of stock mutual funds, losing out when the S&P 500 closed above 1500 two months later, the longest run of bullishness since 1944.

But while brokerage accounts are reckless that doesn't mean that stocks are risky as long as you take a buy-and-hold approach. As I pointed out in my book America, Welcome to the Poorhouse, over the long haul, everyone needs to own shares of companies that will be worth many multiples of what they were when they first bought them. On the other hand, nobody should own government bonds because they are a long-term investment whose premiums are generally less than the rate of inflation, so you're actually losing money. The proof is in the historical pudding: during the 56 20-year-investment periods from 1945 to 2001, large-company stocks yielded better than 5% returns in all but 19 of them. In contrast, long-term government bonds lost money in all but eight of the holding periods. The other sensible stock market strategy is to "go global." While there is no doubt that the first decade of this century has been the worst on record for the U.S. stock market, mutual funds investing in emerging markets such as Brazil, India, Russia and China have delivered greater than 10% annual returns for the past decade.

Rather than allowing investors to shoot themselves in the foot with brokerage accounts, the best fix for Social Security's shortfall is a combination of tax increases and having the assets managed by a government-sponsored entity that would invest in a mix of stock and money market index funds, as is the case with the Thrift Savings Plan, which covers many government employees.

The failure to fix Social Security demonstrates once again that partisan rhetoric, not logical discourse, takes the upper hand when it comes to addressing serious issues that confront the country.