Privatization explained in simple terms

Dozens of people who are desperately trying to make sense of all the buzz about social security privatization have written to ask if there is an easier way to understand what it all means for an average Joe and Jane in America. We have consolidated all the questions in a few here and as one visitor suggested, we will try to explain Social Security privatization that it would make sense to a six-year old.

Please note, though, that this is not meant to be the most comprehensive analysis, and therefore, we would encourage you to do more research, visit a few more websites, and then make sure that you really understand this issue well so that you can plan for your retirement with all the knowledge that you need. Privatization of Social Security, if it happens, will fundamentally change the lives of Americans.

What is meant by privatization of Social Security? What is the definition?

The term privatization can have a political meaning and that is what is happening right now. There are too many interpretations already. But in simple terms, it means what is not public or commonly held. As is well known, Social Security program is publicly administered by the Federal Government. Privatization means that control will transferred from the government to private hands (to you, but indirectly to American corporations in which you will invest your savings).

Privatization happens when individuals have greater control over how their retirement savings are invested. Most likely, Americans will invest these into stocks (which are again private, or not government, investments) as opposed to typical Social Security investments that by law can be made only into government bonds and other similar "secure" investment instruments.

Is privatization good or bad?

Depends on who you ask. But historical data shows that investments made in the stock market (over the long run, which means decades) produce higher rates of returns than those in government securities and bonds. This applies only to indices, and not to specific stocks. So while some stocks do produce enormous returns, many stocks will simply wipe out your investment. In other words, a passive investment (which means through an index-linked investment like an Exchange Traded Fund or ETF) can produce a higher rate of return than that in a bond or a savings account.

But a high reward comes with huge risk. Stock market can continue to be in a slump for years. If you did not get in at the right time or at the right price, you may not recover from your losses during your life time. There are also many dishonest companies in America (Enron, Worldcom, Tyco, etc.) that often cheat investors. Privatization will attract more crooks on Wall Street whose only aim will be to prey on average Americans who will get a taste of investing for the first time. Investors themselves can make poor choices (e.g. hoping that Internet stocks will continue to rise forever as investors thought in the 90s).

Is it a good idea to put your retirement savings at risk by privatization of Social Security?

Here it is important to understand that not everyone has the same appetite for risk. While younger Americans want to take more risk (as some surveys show) and it is fine to do so since they have many more years to recover if they make poor investment choices, the same people want to have a guaranteed income when they retire, as do the baby boomers and retirees.
Many Americans already invest in the stock market either through a personal online trading account or through their 401(K) plan, but Americans have come to expect that the Social Security is their safest best when it comes to providing them with a steady source of income when they are retired. (Related article: Most Americans oppose privatization of Social Security)

By privatization of Social Security, there is high risk that your income when you are retired can fluctuate and/or disappear completely, but of course some American can get lucky and prosper.

What is the difference between wage and price indexation?

This is a technical point but has a huge impact on what your monthly check will be like. At this time, Social Security benefits are linked to wages. In other words, as wages grow, benefits grow. This makes a lot of sense because this allows retired Americans to maintain a lifestyle that keeps pace with how others are living.

President Bush wants to change that so that Social Security benefits will instead be linked to prices. Or in other words, while wages might go up for everyone else, but if prices stay the same or go down, your Social Security benefits will stay the same or go down. That means that the lifestyle of retired Americans will not be as good as those of working Americans.

I understand that stock market investments produce higher return but I am afraid that I will not have steady income at a time when I am so helpless. Why does Bush wants privatization so bad?

There are several reasons and we have addressed them in our article on why Bush wants to privatize Social Security. In addition to that it may be noted that taking on an issue as big as this, Bush can divert the attention of American people away from the war in Iraq, falling incomes of Americans, lack of jobs, etc. Privatization will also allow the very rich to become even richer basically overnight while most average Americans will have to pray for good luck. Finally, there is a more important conservative agenda being pushed and Social Security is a good target since it will the greatest (the next one was the tax cut in the first Bush term) transfer of wealth from low-income and middle-class Americans to top 1% of Americans (who happen to be the largest contributors to Bush's campaigns and are pushing this agenda through several think tanks, advocacy groups, and lobbyists).

Recommended article: American companies push for privatization of Social Security