Preferred stock

Can you spot the bias in this Newsweek poll on Social Security reform?

WASHINGTON (Reuters) - Fifty-six percent of Americans think the stock market is too risky for Social Security funds, according to a Newsweek poll released on Saturday.

The poll signaled a tough sell for President Bush as he promotes his plans to change Social Security and allow workers to shift part of their payroll taxes into private stock and bond accounts.

The 56 percent who were wary of putting retirement money into the stock market contrasted with 36 percent who said such investing was a "necessary risk to improve the rate of return of Social Security funds."

It seems like the poll offered respondents two choices: Either investing Social Secuirty funds in the stock market is "too risky", or else it's a "necessary risk".

Missing is a third option: that investing Social Security funds in the stock market actually avoids risk.

Since stocks provide vastly higher long-term returns than virtually any other investment alternative, investing Social Security funds in the stock market would reduce the biggest risk facing the program -- that there won't be enough funds available to pay benefits to an increasing number of senior citizens.

Chicago research firm Ibbotson Associates studied how four types of investments -- large-company ("large-cap") stocks, small-cap stocks, long-term government bonds, and U.S. Treasury bills -- performed over the 75 years from 1925 to 2000.

If you had invested one dollar in Treasury bills back in 1925, Ibbotson found, you'd have had $17 in 2000. Not bad, huh -- you've gained sixteen times your original investment.

Well, it sounds good until you compare it to the $49 you'd have made investing in government bonds. But even that return pales in comparison to the $2,587 you'd have received from large-company stocks, or the whopping $6,402 from small-company stocks.

In sum, small-company stocks would have made you over 375 times more money than so-called "no-risk" Treasury bills. And bear in mind that the 75-year period studied included both the Great Depression and 1987's "Black Monday" crash. Still feel like "avoiding risk" with the guaranteed return on government bonds and treasuries?

Sure, the stock market can crash. But crashes don't last forever. In fact, they represent excellent buying opportunities for canny, patient investors. As Warren Buffet, perhaps America's most famous and successful stock investor, has said, "Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it."

In his 1997 letter to shareholders in his company, Berkshire Hathaway, Buffet explained the logic behind this saying as follows:

If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef?

Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices?

These questions, of course, answer themselves. But now for the final exam:

If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period?

Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying.

This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.

Of course, Buffet has also said, "Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market."

I doubt that it would be politically feasible for the government to stay in the market after a 50% decline -- even though that would be the best time to plow more funds in.