| Issue 73 |
Published First Quarter |
January 2005 |
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Quarterly
Letter BACK
In preparing to write
this letter to you each quarter, I review my letters from prior quarters.
It helps my perspective. I recommend that you do the same. In particular,
I’d suggest you read the letters since April 2003 (Muhlenkamp
Memorandum #66).
In Memorandum #66 we explained the methodology
we use in determining fair values for bonds and stocks. Since then,
we’ve maintained that inflation in the U.S. is on the order of 2%. Hence,
we believe that short-term interest rates should move up to a 3% range
and the long-term treasuries (the 30-year) are appropriately priced
to yield about 5%. We also concluded that, on average, common stocks
were/are priced to return about 8%-9%, which we view as fair.
We have further argued that the economy was/is recovering from a “normal
cyclical recession” and that the litany of problems which are featured
on the news would not throw it off track. Much of this has come to pass;
we think the trend continues.
We have been able to benefi t from the uncertainties in the marketplace.
Emotional moves such as we witnessed in 1999 (up) and 2002 (down) often
result in a lot of stocks being mispriced: some priced much too high,
others priced much too low. We’ve been able to benefi t as many of these
stocks have trended toward fair value. The bad news is that we’re finding
fewer and smaller bargains than we did two years ago.
A few months ago, I was asked what it would take to turn me bearish.
I replied, “Give me something to worry about that we aren’t already
worried about.”
In the meantime, the economy continues to expand, interest rates are
doing what they should and our companies continue to do well. We expect
to do well along with them.
— Ron Muhlenkamp
The comments made
by Ron Muhlenkamp in this article are his opinion and are not intended
to be investment advice or a forecast of future events. Copies of past
newsletters are available on our website at www.muhlenkamp.com.
Social
Security by the Numbers
BACK
This essay was originally published in October
1992, updated in July 2000 and January 2005.
In 1992 we published an essay (in Muhlenkamp Memorandum
#24) entitled Social Security by the Numbers. As with all
government programs, we fi nd the numbers much more understandable when
viewed on a per person or per family basis. So we set out to answer
two basic questions: “What did I pay into it?” and “How much can I expect
to get?”
As the topic of Social Security is now on the agenda in Washington D.C.,
it seems like a good time to update the data. This is particularly true
as increasing numbers of people are becoming aware that Social Security,
as presently configured, is unsustainable.
First, the numbers:
1. “What did I pay into it?”
Table 1 shows the maximum Social Security tax
paid by an employee each year since the system started in 1937. Equal
amounts were paid by the employer. If you want the exact numbers for
your account, call the Social Security Administration (SSA) at (800)-772-1213
or visit their website at www.ssa.gov
to get a request form. (Note: It’s unlikely that people paying Social
Security taxes today also paid them in 1937 – 68 years ago – but we
believe it’s useful to print the entire table.)
Our regular readers know
that historic numbers must be adjusted for inflation. This we have done
for you, thus the 1937 contribution of $30 represents $384 in 2004 purchasing
power. Totals for each column are shown at the end of the table.
2. “How much can I expect to get?”
The Social Security website (www.ssa.gov)
states that a single person retiring in 2004 at age 66, who had always
paid in the maximum, would receive $21,924 per year. A married couple
with a non-working spouse (“Family”) would receive $32,880 (see
Table 2). Those who paid less than the maximum would receive less.
It’s interesting to note that the average Social Security wage earner
earned $34,731 in 2003; he and his employer would have paid 2 x 6.20%
or $4,307 in 2003 to Social Security. Table 2
also demonstrates that dividing the maximum annual benefit into the
inflation-adjusted total contribution from employee and employer of
$314,496, an individual retiring today can expect to get all of his/her
money back in 14.3 years, a married couple in 9.6 years. But the life
expectancy of a male age 66 is 16 years, a female is 20 years and these
benefts are promised for life.
The Social Security problem is a result of two inherently incompatible
viewpoints: First, Social Security was established as, and is viewed
as, Social Insurance – a way of providing for those in need. It is a
depression-era program designed to keep older people out of the poor
house. Any discussion of benefits soon becomes a discussion of those
who need the money for subsistence living.
Second, Social Security has come to be viewed as a Pension Plan whereby
“I’m entitled” to benefits because “I paid in all those years.” This
was not the original purpose of the program. In fact, FICA, which is
the heading for your Social Security “contribution” on your W-2 Form,
stands for ’Federal Insurance Contributions Act.’
When we ask people which is the primary purpose of Social Security,
those over 50 tend to focus on Social Insurance, those under 40 tend
to focus on the Pension Plan, but nearly all believe that both aspects
are important.
But Insurance Plans and Pension Plans are very different concepts using
very different assumptions. A Pension Plan involves setting money aside
over a period of years, investing it to grow its value in real terms
(i.e. versus inflation and eventual taxes) so that assets available
in retirement are a direct result of the
assets set aside and the returns earned on those assets in the interim.
The person receiving the pension can spend more than he put in (in real
purchasing power) only if the invested returns exceed the interim inflation
and the taxes paid upon withdrawal.
An insurance plan is entirely different. In an insurance plan, such
as fire and casualty insurance, those who suffer the loss receive more
than they paid in because those who don’t meet the criteria (i.e.: suffer
the loss) receive nothing. I do not want to collect on my fire insurance,
nor do I feel “entitled” to collect, unless I have a fire. Similarly,
I do not want to “need” Social Security benefits. But they’ve been promised
to me whether I need them or not.
In 1935, when the Social Security Act was passed,
life expectancy was 63 years. Congress set the age at which benefits
began at 65 in the full expectation that more than half the people would
receive no benefits (because they would die before age 65).1
This is how an insurance plan works: a minority receives more than they
paid in because a majority receives less than they paid in.
Back in 1939, there were 40 workers for each retiree, so it was easy
to give a retiree a useful benefit because it was spread among 40 workers.
Referring back to Table 1, we see the rate of
1% on the first $3,000 in annual pay is equal to $30 per year or $384
per year in current dollars, matched by the employer. Sounds like a
valid insurance plan, doesn’t it? And it was, as long as the assumption
held. But as life expectancies improved, the number of workers per retiree
fell to 5:1 in the 1960s and 3:1 in the 1990s. That’s why the contribution
per worker increased by 4 times from 1937 to 1968 and has tripled since.
In 30 years, the expected ratio of 2 workers-to-retiree will require
a 50% increase from today’s workers’ contributions if current promises
are to be kept.
But it’s only a promise.
Social Security has never been run as either a pension plan or as an
insurance plan. It has always been “pay as you go,” a transfer of money
from workers to retirees. One man explained to me that it’s both a pension
plan and an insurance plan, “...except for the fact that there are no
assets, only IOU’s in the trust. The IOU’s in the trust will have to
be paid with increased tax revenue or new taxes.”
Exactly! Social Security has no assets. The benefits promised are simply
a political promise - a political promise to raise taxes, on our children
and our grandchildren.2 But that assumes that our children
will continue to work and continue to hire others, regardless of the
tax rate. But we didn’t.
In the 1970s, when the top tax rate in the U.S. was 70%, we had 10%
unemployment and a stagnant economy because it didn’t pay the most productive
members of our economy to hire other people. So they put their money
into unproductive schemes designed to minimize taxes (tax shelters)
and took time off to play golf. Over the past 20 years, I’ve asked thousands
of people, in groups of a few to a few thousand, how many would continue
to work at a 50% tax rate. In the 1980s, 2-5% of hands were raised.
In the past 8 years, I’ve seen exactly nine hands go up. If we aren’t
willing to work at a 50% tax rate, why do we assume our children will
be willing to work at a 50% tax rate?
The real choice today is not how to save Social Security in its present
form. It can’t be done without driving us to the stagnation of the 1970s.
The real choice is: Would you rather live in the economy of the 1970s
with 10% unemployment and rely on the promise of Social Security? Or
would you rather live in the economy of the 1980s and 1990s and not
need Social Security?
The benefi ts of Social Security can be saved by splitting it into two
parts: a pension plan and an insurance plan.
(1) A pension plan - which allows private accounts the individual owns
and is able to invest for decent returns. While participation in the
private plan can be voluntary, once chosen, the contribution would be
mandatory (people must fund it) and carved out of the Social Security
contribution. These accounts would look much like IRA’s.
(2) An insurance plan - for which the benefi ts are need-based. For
example, anyone with annual income greater than twice the national average,
or assets greater than 20 times that (which at a 5% rate would support
spending at 2x the national average income) would not receive Social
Security. Should their income or assets fall below these levels, they
would once again be eligible for benefits. Today, those levels for an
individual would approximate $70,000 in income or $1.4 million in assets.
For the multi-millionaire who reads this and fears that I’m cutting
off your benefits, you’re right. But consider that you’re now paying
income tax on these benefits at a 28-35% rate and can expect your estate
to pay tax on the remainder at 30-48%. So the dollar which is promised
to you will become $0.65 – $0.72 after income taxes, and $0.33 - $0.50
after estate taxes. Under my plan, the promise is more likely to be
kept should you actually need Social Security.
— Ron Muhlenkamp
1 I’ve been told by a man who was
in his late 20s in 1937 that the reason Congress made all the wage earners
eligible was that they feared that benefits based on need would be considered
welfare and they wanted to avoid the stigma of welfare. (This implies
that there is no stigma to welfare if everyone is on it.) The fact that
benefits have been promised to everybody who paid in may help explain
why some have come to view Social Security as a pension plan.
2 In Fleming vs. Nestor (1960) the Supreme Court ruled that
Americans have no property right to the money we’ve paid in Social Security
taxes.
The information in this essay represents the opinions of Ron Muhlenkamp,
is subject to change, and any forecasts made cannot be guaranteed.
Social Security
Revisited BACK
This essay was originally published in December 2000, updated in
January 2005.
In the prior essay (Social Security
by the Numbers,) we looked at Social Security from the point
of view of the individual, specifically, “How much did I pay into it?”
and “What can I expect to get out of it?” Our essay resulted in a number
of comments and questions. In order to address these questions, we need
to review Social Security in the aggregate, i.e. what does the whole
program look like?
In Chart 1 we’ve plotted the following for each
year since 1940:
1. The number of dollars workers paid into the program in taxes.
2. The number of dollars retirees received from the program in benefi
ts.
3. The resulting assets in the “trust fund.”
As you can see, the program currently looks pretty good. There is close
to $1.2 trillion in the trust fund, roughly three years worth of benefits.
This looks impressive until you realize that most people receive benefits
for 20 years, not three.
Most of you know that we don’t like to make projections, but in the
case of Social Security, it’s pretty easy.
The benefi ts to be paid out each year will equal the number of retirees
multiplied by the benefi ts promised to them.
The taxes paid in each year will equal the number of eligible workers,
multiplied by the employment rate, multiplied by the withholding rate
on their salaries up to a stated level.
Since nearly all the future retirees are already in the workforce and
nearly all the eligible workers for the next 20 years have already been
born, it’s fairly easy to project the taxes, benefits and assets for
the next 20-40 years. In fact, our projections look just like the projections
of the Social Security Administration (SSA). The projections are included
in Chart 2.
Chart 2 shows why today’s retirees over the age of 65 don’t have
a problem; there will be sizable assets in the program for the next
30 years.
But Chart 2 also shows why the children of today’s
retirees, 30-40 year-olds, do have a problem: the program runs out of
money in 2035.
Why has the program worked so far? When the Social Security program
was initiated in 1937, the average life expectancy in the U.S. was less
than 65 years. Eligibility for benefi ts was set at age 65 in the expectation
that fewer than half of the workers would collect Social Security (because
they wouldn’t live long enough). Furthermore, when the program started,
there were a lot of workers paying into the program and few receiving
benefits.
In 1945, the ratio of workers-to-retirees was over 40 to 1; in 1950,
over 16 to 1; and in 1960, the ratio was 5 to 1.
Today, the worker-to retiree ratio is a little over 3 to 1. As the worker-to-retiree
ratio fell, the SSA found it necessary to raise the tax rate from 2%
in 1937-1949 (1% employee + 1% employer) to 6% by 1960 to 12.4% in 1990.
The 12.4% rate remains today.
Furthermore, the SSA found it necessary to raise the level of wages
on which the tax is paid from $3,000 in 1937 ($38,400 in 2004 inflation-adjusted
dollars) to $87,900 in 2004.
We’ve plotted the applicable tax rate on Chart 3.
We’ve also marked the years when the combination of tax rate and rate
base first pushed the top payer over the levels of 2, 4, 6, 8 and 10
thousand dollars (all numbers inflation-adjusted). Note that Chart
4 is a continuation of Chart 3, simply with a change in scale.
Also, starting in 1984, the SSA started cutting the value of retiree
benefits. In 1984 they started taxing benefits; they started taxing
50% of the benefit and now tax 85% of the benefi t. More recently, they’ve
been raising the retirement age.
I was born in 1944; the age for me to qualify for full Social Security
benefits is 66 years, not 65. If you were born in 1960, the age at which
you will qualify for full benefi ts is 67 years, not 65.
Social Security benefi ts are calculated as a percentage of your qualifying
pay prior to retirement. Currently, benefi ts are calculated at 90%
of the first $627 of his/her average indexed monthly earnings; plus
32% of his/her average indexed monthly earnings over $627 and through
$3,799; plus 15% of his/her average indexed monthly earnings over $3,779.
Since the average wage earner today earns roughly $34,731 per year ($2,894
monthly), the average retiree is promised benefits a little over 45%
of their pay. See Table 1 for details.
Three people each paying 12% in taxes can support one person taking
36% out in benefi ts. (Note that in 1960, five people each paying 6%
in taxes could support one person taking 30% out in benefits.) The problem
is that the ratio of workers toretiree will decline to just 2:1 by 2030.
At that point, the two workers would each have to pay 18% of their pay
(nearly a 50% increase) into Social Security in order for one retiree
to receive 36%. Some people believe this is a viable solution. I don’t.
In the 1970s, I saw what happens when people are pushed into ever-higher
tax brackets. At some point, they quit work. Even if the employees want
to work – if the employer quits, the employees are out of work.
A second solution is to cut benefits. (In fact, I’ve suggested cutting
the benefits of millionaires, but there aren’t enough millionaires to
solve the problem.) Many retirees believe that their benefits can’t
be cut. They believe they’re entitled to the promised benefts. But the
Supreme Court (Fleming vs. Nestor, 1960) has ruled that we’re not entitled
to the promised benefits. Some retirees were shocked when Medicare tripled
the amount (from $10 to $30) of the co-pay for prescribed drugs. Folks,
the rules on Social Security are set by the same people who make the
rules on Medicare. If they believe it is necessary, they will cut your
benefits.
But there is a third way to make Social Security viable for the next
generation.
If a part of the taxes used to build the trust fund for the next 30
years could be invested to earn a reasonable rate of return, we could
alleviate the problem. Some have suggested allowing people to invest
part of their Social Security taxes in a Personal Social Security account.
To me, a Personal Social Security account sounds a lot like an IRA (call
it a PSA). So I took a look at my IRA to see how it has done.
Note: Within the above illustration, performance is net of all fees.
Click here to see
quarter-ending standardized returns for the Muhlenkamp Fund.
Chart 5 is a plot of my personal IRA from 1980
through 2004. The bottom line is the total dollars I’ve paid in, 24-years
multiplied by $2,000 per year is equal to $48,000. The middle lines
are calculated: they show the assets I’d have if I’d earned 2%, 6%,
or 9% per year. The top line is what my account has actually done. Chart
6 simply extends Chart 5 out another 20 years
to show a typical working lifespan of 44 years.
The Social Security Administration recently sent me a statement which
said my promised benefit upon retirement is $21,924 per year. The IRS
says my life expectancy at age 66 is 16 years. So the SSA expects to
pay me $350,784 over my retirement years. We’ve marked that on Chart
6.
Alternatively, an annuity which promised me $21,924 for 16 years, would
cost $240,000 at the start, if we assume an interest rate of 5%. We’ve
marked that on Chart 6.
You’ll note that at contributions of $2,000 per year, the return has
to be 6% or greater to reach $350,000 in 44 years but that it reaches
$240,000 in 37 years. I’ve exceeded $240,000 in 24 years. The amazing
thing is that the $2,000 per year that I put into my IRA is less than
30% of what I’ve paid into Social Security in the same period of time.
It’s also less than 25% of what I’ve paid into Social Security to date.
So just by earning a reasonable return on my investment (it’s been invested
first in the Windsor Fund and later in the Muhlenkamp Fund), I will
be able to fund an amount equal to my promised Social Security benefits
with only 30% of the Social Security taxes. This makes 70% of my Social
Security taxes available to someone else.
From the above data I reach several conclusions:
1. The 65+ year olds don’t have a problem, their children do.
2. Using Personal Security Accounts for a part of the taxes can help
alleviate the problem.
3. We have a fairly short period of time (the next 10-15 years while
the assets in the trust fund are building) to implement the PSA. After
15 years the window closes.
4. Politically, it will probably not happen soon enough unless those
over 65 push for it.
Folks, our politicians know the numbers. They expect to hear complaints
from young workers who know the numbers, but they fear a backlash from
retirees who don’t know the numbers.
And they know that retirees vote in greater percentages than do younger
people. Plus, the problem won’t come to fruition for 30 years, which
is 5 to 15 elections away.
So, in order to solve the problems, it is necessary for retirees to
insist to their congress people that they reform Social Security for
the benefi t of their children and grandchildren.
We welcome your comments and questions.
— Ron Muhlenkamp
Past performance does not guarantee future results. The information
in this article represents the opinions of Ron Muhlenkamp, is subject
to change, and any forecasts made cannot be guaranteed. This article
is not a solicitation of any other funds mentioned.
Management
Fee Breakpoint BACK
For the fiscal year ended December 31, 2004, the Adviser (Muhlenkamp
& Company, Inc.) received management fees of 1% per annum of the
Muhlenkamp Fund’s average daily market value of its net assets. Effective
January 1, 2005, the Fund’s management fee is 1% per annum of the average
daily market value of the Fund’s net assets up to $1 billion and 0.9%
per annum of those net assets in excess of $1 billion.
2004/2005
IRA Contributions BACK
You have until your tax deadline, April 15, 2005 for most individuals,
to fund your IRA for 2004,including Traditional, Roth and Coverdell
Education Savings Accounts.
Starting in 2005, IRA contribution limits have increased: Traditional
and Roth IRA limits are now $4,000 with an additional $500 for “catch-up”
contributions. The limits for other types of retirement accounts have
also increased. If you need more information, IRS Publications 560 and
590 are good sources of information. You can download copies of these
publications at www.irs.gov.
It’s not too early to begin funding your 2005 IRA. Equity returns compounded
over long periods can be truly amazing.
2004
Distributions BACK
An income dividend of $0.10704 was paid on December 29, 2004
to shareholders of record on December 28, 2004. IRS Form 1099-DIV will
be issued during January
2005 to all taxable accounts that received the dividend. There was no
capital gains distribution for the Muhlenkamp Fund for the year ended
December 31, 2004.
EGTRRA
Update BACK
In September of 2004 The Economic Growth and Tax Relief Reconcilliation
Act (EGTRRA) of 2001 was amended. This amendment stipulates mandatory
cashouts of inactive participant accounts in qualified retirement plans
of $5,000 or less. These accounts will automatically be rolled to either
an IRA or individual retirement annuity invested in money market funds,
interest bearing accounts or CDs. This amendment goes into effect as
of March 28, 2005.
If you have an account in a qualified retirement plan in which you are
no longer an active participant, you may want to contact your plan sponsor
to roll over the account to an IRA of your choice.
Important
Reminder BACK
Please note that we cannot process new account applications, additional
investments, account transfers or account redemptions at our Wexford,
Pennsylvania office.
Please send all account correspondence to the following addresss:
Muhlenkamp Fund
c/o U.S. Bancorp Fund Services, LLC
PO Box 701
Milwaukee, WI 53201-0701
Or by overnight mail to:
Muhlenkamp Fund
c/o U.S. Bancorp Fund Services, LLC
615 East Michigan Street
Milwaukee, WI 53202
If your account is set up for telephone transactions, you may also call
(800) 860-3863 to purchase or redeem shares in your account.
Events BACK
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Pittsburgh
Winter Seminar
Visit the “Slide
Show” section of our website to view Ron’s presentation Musings
on Economics and Investing, delivered on Thursday, December 2, 2004.
While there, take time to review Ron’s responses
to frequently asked questions along with audience asked questions
taken at the seminar. |
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Muhlenkamp
& Company, Inc.
Atlanta Seminar 2005
Click
here for more information
Click
here for driving directions to the Atlanta Seminar |
February 1, 2005 |
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In addition to our exhibit activities, both Ron and Tony Muhlenkampwill
be conducting workshops at the upcoming 2nd Annual WorldMoney
Show at the Gaylord Palms Resort inOrlando, FL.
Click the image to Register
or or call (877)935-5520 or (724) 935-5520 and press 4 for more
information. |
February 2-5,
2005 |
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