When 3% May Be a Bum Number

Three percent is a big number in President Bush's plan for private Social Security investment accounts.

Too big, say some people on both sides of the privatization debate.

The administration's long-term assumption is that money paid into the Social Security trust fund will earn an average of 3% a year, after inflation, on the Treasury bonds the fund owns.

That return also is the "neutral" or "hurdle" rate -- the return investors would have to beat in their private accounts to end up better off than if they simply stuck with regular Social Security benefits, according to the administration's proposal.

The problem is that the current after-inflation, or real, annualized return on Treasury bonds is well below 3%. And some people who spend considerable time thinking about markets say it would be more realistic to assume a return below 3% in the longer term as well.

"Three percent is way too high," said Jeremy Siegel, a finance professor at the University of Pennsylvania and the author of "Stocks for the Long Run," the now-famous 1990s book on investment return expectations.

Bill Gross, one of the world's top bond market authorities and manager of the Newport Beach-based Pimco Total Return fund, says that to earn a 3% real return on a government bond today, "you would have to invest in Mexico or Russia to get that -- not in the United States."

So what if real Treasury returns continue to fall short of 3%? If that's also the hurdle rate for private Social Security accounts, many Americans might be unwilling to take a chance on them, because poor Treasury returns might raise doubts about future returns on stocks and other assets as well.

If you fear that good investment returns in general will be harder to come by in the next decade or two, you might figure it's best to just stick with traditional Social Security benefits, whatever they turn out to be.

Under Bush's plan, workers would be allowed to divert part of their Social Security payroll taxes to private accounts that could invest in broadly diversified stock or bond portfolios.

The trade-off is that workers who opted for private accounts would agree to accept less in traditional Social Security benefits in retirement.

Three percent would be the dividing line: If you earned a real annualized return higher than 3% on your private account, that money plus your reduced traditional benefit would total more than what you'd have if you stayed solely with the traditional benefit program.