Social Security as investment club makes pros nervous

The Insider

Your Money

February 13, 2005|By BILL BARNHART

The debate over Social Security reform has exposed a little secret among professional money managers: They're not sure what they're doing, either.

President Bush proposes that workers be allowed to divert part of their Social Security insurance premiums into private accounts, to be invested in professionally managed stock and bond funds.

Workers naturally are wary. Perhaps coincidentally, the pros who would be asked to manage the money are having an anxiety attack as well.

Rules of thumb that governed investing for decades are being questioned in the wake of the Nasdaq bubble and the widespread forecast of flat stock and bond markets for the next several years.

A gathering of investment graybeards in Pasadena, Calif., last week punctured many assumptions about long-term investing, in general, and private accounts for Social Security dollars, in particular. Here are some highlights:

Robert D. Arnott, editor of the Financial Analysts Journal, whose 60th anniversary was the occasion for the conference, said equity index funds, expected to be a primary vehicle for investing private account dollars, are seriously flawed.

Most stock indexes, including the benchmark Standard & Poor's 500 index, weight their components according to the market value of the stock. In recent years, faddish technology stocks have dominated the index.

"They are large and they don't deserve to be," Arnott said. Investors chase market momentum rather than save safely for retirement.

Arnott proposed weighting stock indexes by other criteria - a company's earnings, its cash flow, number of employees (human capital).

John C. Bogle, the leading critic of mutual fund practices, said the cost of investing through professional intermediaries is a crucial issue, not an incidental matter hardly to be mentioned in the Social Security debate.

"Fifty percent or more of the returns on stocks can be consumed in the cost of the system," he said. Over time, investment costs compound to cancel the potential gains for owning stocks, he said.

"The investment community has a vested interest in ignoring this message," Bogle said.

The Nasdaq bubble proved that company financial reports were unreliable as a basis for investing, said Abby Joseph Cohen, a partner at Goldman Sachs.

Often criticized for her optimism during the late 1990s, Cohen acknowledged, "We assumed the earnings we were getting from the companies were correct."

Government economic data, widely used in planning investment strategies, often is misstated. "We assume data is correct, and sometimes we push it too far," Cohen said.

Many investors rely on reports of past investment returns, but "you're not looking at anything that has substance associated with it," said Gary P. Brinson, a private investor and author of investment concepts. "Trying to use that data for predictive purposes is ridiculous."

Most assumptions about future investment returns in the stock market are inflated, he added.

Every profession engages in bouts of introspection and self-doubt at regular intervals. It's good to see investment gurus undergoing that process now.

Bill Barnhart is a columnist for the Chicago Tribune, a Tribune Publishing newspaper. E-mail him at

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