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Is Financial Risk Adequately Accounted for in Social Security Reform Measures?

In most analyses of private accounts funded out of the payroll tax, it is assumed that accounts will earn a rate of return equal to the average market return over some historical period. How that approach fails to take into account important sources of variation (risk) in rates of return is demonstrated in this AARP Public Policy Institute Issue Brief by Thomas Hungerford, a Washington-based economic consultant formerly with American and Johns Hopkins Universities as well as the Government Accountability Office, the Office of Management and Budget, the Social Security Administration, and the Levy Economics Institute.

Hungerford finds that using the constant average rate of return systematically overestimates the account balance at the end of the 40-year period as compared with using actual annual returns, and concludes that financial risks must be considered in the distributional analyses of the impacts of privatization. (8 pages)

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