Monday, January 03, 2005

If you wouldn't buy it, sell it

A well known issue in behavioral economics is the observation that investors tend to hang-on to low preforming stocks for too long, while selling winners too quickly. The idea seems to be that a low performing stock will turn around someday, and then can be sold for a smaller loss, or maybe even a gain.

U Chicago behavioral economist, Dick Thaler has a rule of thumb for how to think about stocks and their prices: "if you wouldn't buy it, sell it". In other words, if you would not buy a stock at a given price, and you own some of that stock, then you should sell it. Don't hang on to losers.

Today I did two things I usually don't do. Firstly, I picked up a copy of the New York Times, an excerable publication that I find poorly written (too long winded), short on facts, and sloppy in its analysis. The back page had a long article about how Social Security was OK and should not be changed, but I skipped it because I think the current social security system is a loser. (Note, I don't know if the Bush plan will end up being a loser too, or not). Secondly, I went to talking points memo where, surprise, Josh as adding echoes to the chamber by praising that same article and saying the American Academy of Actuaries agrees too. No actual arguments, just assertions. *Yawn*.

In the spirit of letting your losers go, let's think about what a pension scheme would look like if one were to design it from scratch today.

1) People would be forced to save through their working lives. I know, I know, it's wrong to force people to save, but hey, people are also (irrationally) bad at saving. If you really want, I would let people opt out of this if they wanted. But the default ought to be "you save, unless you opt out" instead of what exists right now, i.e. "you don't save, unless you opt in."

2) People's forced savings should be put into a passively managed, massively indexed fund. Index it to Wilshire 5000, bonds, international instruments, etc. The object is largest diversification, lowest cost.

3) When people retire, they can tap their forced savings fund--it should probably act as some sort of annuity so the money comes in installments. Third party options to take the cash out as a lump sum will probably spring up, but this should not be the default.

4) People can retire when they want, but not before a certain age, like 70 (I'm not sure about this one).

5) Poor old people should get welfare. I'm not sure if the money poor old people get for being poor should be any different from the money poor young people get for being poor, because being poor is being poor. I don't know welfare law well, but I believe that under Clinton your benefits get cut if you don't go back to work. Clearly, this should not apply to old people.

6) When your fund runs out, you start qualifying for poor old-person welfare.

7) Poor old person welfare should be paid out of general tax revenues.

Now let's compare this to the current system.

1) People are currently taxed through their working lives though FICA. FICA is a tax because money is taken from you for government services which you may or may not receive in the future, depending on what happens. You can't rely on social security. You can rely, however, on whatever pool your forced savings have built up which means this is not a tax, it is just defered consumption. Taxes retard economic growth and make us all poorer. Defered consumption does not.

2) People's savings payouts are currently determined by the whim of Congress and the pressure the electorate puts on it for lower taxes. The "social security fund" is just spent out of current government revenue, and so is just part of general government spending. Capital accumulated in a forced savingd account would go to work in actual, real financial markets, filtering down to real companies making real investment. This is probably a good thing, although it is not clear how good.

3&4) The current structure makes people retire too early. Today's "old" are really "old young" by their physical fitness level. They can still work, so they should. If they really want to hit the golf course early, that's fine, but it should come out of their pocket.

5) Currently, all old people get welfare, poor and rich. Also, all young people get taxed to supply this, poor and rich. This means that poor young people are being taxed to pay rich old people to pay golf. I understand why Republicans might think this is a good idea, but I don't know why Democrats are in support of it.

6) Currently, you get old-person welfare no matter how much money you have. Again, a transfer from the poor to the rich.

7) FICA is a regressive tax structure because it caps out at some level of salary ($80,000 or something). And it only comes out of wages, avoiding consumption, capital gains, etc. So, poor wage earners pay for social security, instead of rich capitalist people, like Teresa Heinz Kerry and George Soros. Why the Democrats seem so attached to the status quo, I don't know.

It is quite possible that Bush's plan won't hit any of the features I've laid out in my wish-list, and his proposal may be worse than what exists now. But what exists now is not what anyone would have come up with if they were starting from scratch today. Remember -- let your losers go.

My plan fixes the redistributive and incentive problems the current system has, and makes it more progressive. It also reduces the government's liabilities by reneging on promises to pay rich people social security, and it would raise taxes on rich people who currently cap FICA out. OK. As the conservative (cling to the past) NYTimes and Josh Marshall point out, the problem is a fiscal imbalance one, which means a solution has to involve some mix of cutting benefits and increasing taxes. But why fight cutting benefits when rich people are getting benefits they don't need? And why raise taxes when you can cut benefits to rich people (that they don't need) first?

The current social security system is un-Democratic in that it is quite regressive, moving money from young, poor people to less-young, rich people. It also happens to be broken. An opportunity has appeared to fix this, and instead of weighing in with appropriate, redistributive suggestions, the Democratic party seems to be denying a problem even exists. This is a missed opportunity, and it's sad. I guess extreme consevatism is what happens when you are the party out of power.

Jane Galt has related thoughts here
Arnold Kling has related thoughts here


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