Why the Social Security Trust Fund Should Invest in Stocks

As the presidential election battle heats up, neither candidate has offered detailed solutions for one of the biggest problems facing older Americans: fixing Social Security. The program’s reserves are projected to run out in 2034—at that point, Social Security will be able to pay only about 75% of scheduled benefits, according to the most recent trustees report.

Given the size of this shortfall, most of the solutions are painful—some combination of raising payroll taxes and reducing benefits. Which is why the politicians prefer to steer clear of Social Security. But perhaps there’s another way to help shore up the program: allowing the Social Security trust fund to invest in stocks, which can deliver a higher return over time than the current portfolio of U.S. government bonds.

That’s the conclusion of a new study by Boston College’s Center for Retirement Research, which looked at what happens if up to 40% of the trust fund is invested in stocks, with the rest held in bonds. The results were encouraging. With a mixed stock-and-bond portfolio, Social Security is far more likely to stay fully funded over the next 75 years, or 56 years longer than current projections.

The research team—Gary Burtless of Brookings Institution and Anqi Chen, Wenliang Hou, Alicia Munnell and Anthony Webb of Boston College—assumed that up to 40% of trust fund assets were stashed in the stocks in a broad market index. They then compared the possible outcomes of this allocation using historical data, as well as simulations of future returns.

One set of historical simulations assumed a small portion of the Social Security trust fund was invested in stocks starting in 1984, with the allocation gradually increased each year up to the maximum 40%. That starting date was chosen to reflect the impact of 1983 Social Security reforms aimed at building up trust fund reserves.

Another set of simulations put the start date at 1997, which is around the time the notion of putting stocks in Social Security first grabbed the spotlight in Washington. Between 1994 and 1996, at the request of President Bill Clinton, the Social Security Advisory Council studied several proposals for equity investing, both inside the trust fund as well as by adding individual investment accounts—the so-called privatization option. But the idea was controversial, and Congress did not move forward on these proposals. (The Boston College study focused only on equity investments within the trust fund.)

Both sets of historical simulations found that adding stocks dramatically improved trust fund solvency. If the stock investment started in 1984, the trust fund's assets would have grown to $3.8 trillion by last year, which was one-third higher than its actual holdings of $2.8 trillion. If stock investing began in 1997, the trust fund would have reached $3.4 trillion.

These results might seem a bit counter-intuitive. After all, stocks are far riskier than bonds. And over the past few decades, numerous bear markets—and a major financial crisis—have devastated many portfolios. But even after running the numbers using longer and shorter phase-in periods, as well as higher equity allocations, the researchers found that adding stocks would have consistently boosted trust fund solvency, thanks to their strong recent performance.

Of course, historical returns may not mean much if stocks deliver below-average gains in the future, as many forecasters predict. What might happen if Social Security were to start investing in stocks this year? To find out, the researchers ran simulations using different equity returns, with the median set at 6.78% a year.

They also assumed that the Social Security payroll tax, currently 12.4%, was increased by enough to eliminate the program's deficit, or 2.62 percentage points, because equity investments alone would only extend the exhaustion date into the 2040s. "Equity investing is only tested as part of a potential package of reforms to improve long-run solvency," says study co-author Anqi Chen.

Again, the results favored stocks. At the median return, the trust fund would stay solvent over the next 75 years. Only 11% of the simulations resulted in trust fund exhaustion. It was also extremely unlikely that the mixed portfolio would be depleted under market conditions that would not also deplete the bond-only portfolio—that happened in only 3.6% of the 10,000 simulations.

Beyond the risk of losses, however, there are other concerns about holding stocks in the Social Security trust fund. Critics have argued that the massive cash flows into stocks from Social Security would eventually mean the program would hold a major share of the market. That, in turn, could skew the flow of capital in the economy.

Read next: How Would Social Security Fare Under Trump or Clinton?

But the researchers argue those fears are overblown. Their numbers show that if Social Security had begun investing in equities in 1984 or 1997, it would own less than 10% of the market today. The same holds true in simulations of future stock investing. They also say the investments could be structured to avoid government interference in capital markets—the federal Thrift Savings Plan, for example, has operated successfully by investing in index funds.

That's the theory, anyway. But don't expect a Social Security stock fix to see reality anytime soon. Neither Donald Trump or Hillary Clinton have backed the idea. Clinton, who has proposed expanding Social Security, has instead suggested raising taxes on higher earners. Trump has offered few specifics about his plans, although the GOP platform hints at using “the power of markets to create wealth and to help secure the future of our Social Security system.”

Still, whenever Washington finally gets serious about Social Security reform, the notion of holding stocks in the trust fund, or perhaps even privatization, may grab the spotlight again.