Social Security Rate of Return

I recently analyzed the rate of return on social security. Now for most people, this isn't really interesting. But as a business person interested in numbers and investing, I care how much of my money is being paid in, and how much of it I'm getting back, and at what rate of return (particularly if it's a negative rate of return).

The formula for benefits used to be very opaque. Nowaday, if you're good at math and patient, you can calculate your expected benefits at home. The formula makes inflation adjustments and takes the 35 highest wage earning years and averages them to determine your "average annual wages." Then the government creates three "wage zones" with differing benefits levels. For "average annual wages" from $0 to $9,132 social security will payout benefits equal to 90% of that per year. Above that, from $9,133 to $55,033, benefits drop to 33%, and from $55,034 to $106,000, the benefit drops to 15%. This means that the more you pay in, the worse (by far) your benfits becomes. Above $106,000 there is no required pay-in to social security. (The raw formula is available at here or more clearly here.)

Here's the graph that shows exactly what this means for you and how much you pay in:

Note the points where the graph bends is where you see a different "wage zone" start/end.









There's lots of ways to look at the money paid into social security. I don't like to think of it as giving the government money and hoping they take care of me. Instead, I prefer to think of it as a forced government retirement plan which, after that money is paid in, has a rate of return. I calculate this ROI the way a bank does with an amortized loan. A bank loans me money and I pay principal plus some interest rate. That's how these investments work.

My Rate of Return

If you click into this graph (I can't get the silly thing to display any better inside this blog), note the highlighted column. This is the rate of return I receive on my social security pay-ins!



Note that for the first 9k, it's ok (4.8%), after that, it's actually highly negative (-13.7%), and not shown is above 55k (remember the other bend point?), the rate of return is substantially worse: -25.5%.

Can this ROI number be different? Definately. For example, this ROI assumes you are a 31 yr old male (me) who lives to an average life expectancy of 76 years old (actuary tables). However, since I have my grandparents genetics, which are ridiculous for longevity, I may well live much longer. The effect of this is a better rate of return. Which makes sense. After I hit the retirement age, the amount paid in is fixed. However, my pay-out amounts depend on how long I live. If I die early, I get screwed, if I live longer, I get more checks from the government, increasing my ROI! Which leads to...

Rate of Return by Expected "Live to" Age

This is a table shows the rate of return depending on how long you live. It breaks into wage zones and then how long you expect to live.





The ROI on wages less than $9,132 is pretty good, particularly as you age. But one has to live until almost 90 before any money paid in on the second wage zone even has a rate of return above zero. For wages paid in the last zone (above $55,033), your return is so negative that you will not see a zero ROI until you're very old (115 years old).

The Short in Six Sentences
Social Security is a government required retirement plan. Benefit payouts are calculated using three wage zones with three different benefits rates. Calculating the rate of return on your investment (the money paid into social security) depends on how long you live and which wage zone you're in. The formula provides that: The less you pay in, the better the ROI; the longer you live, the better the ROI. For the wage zones where most people fall, the rate of return is negative, or substantially negative.

Postscript: I am not writing this to thrash social security. My intention is to look at the formula and analyze the numbers objectively and see if there are ways to optimize for my retirement.

Postscript #2: Later, I will add a few more article exploring how if you and your spouse run a business together, the way to increase your Social Security ROI (based on a wrinkle in the payout formula not discussed yet), at what age do you "break-even" (get all your principal back with no interest) , and other details related to this retirement plan.

If you're automobile shopping, read this

I've been researching auto safety related to accidents (I had a friend total 2 cars in 8 days.... lol). I decided to see what data I could learn about risks related to cars. I'm sharing because I don't want people I care about to die. :)

The highest risk factor of dying ages 1-34 is automobile related accidents (source, Forbes). Which means when I go to protect my family, the safety of the car is the top things I can do to protect my famdam.

All cars have to pass a basic Highway safety (NHTSA) test. Beyond that basic test, there is an enormous difference in safety. Not like 30-40%, like multiples, like 21x. After statistical balancing: 232 dead with a dangerous car, only 13 with a safe car.

The IIHS is somewhat to safety what Consumer Reports is to reliability. They're a non-profit insurance organization that puts out information related to auto-safety. They analyzed 125,000 accidents that resulted in fatalities. From the safest vehicle to the most dangerous vehicle equally certified by the NHTSA, you are 21x more likely to die in a fatal accident. That's a lot more dead people because they bought the wrong car. Incidently, that vehicle is the Chevy Blazer, 2-door (Autumn had a friend's friend die in an accident in one (http://www.iihs.org/externaldata/srdata/docs/sr4204.pdf)

It's a good study. It's adjusted for sex of the driver (men are 2x more likely, even after making adjustments to die in accidents? roar!) and other driver demographics, it's adjusted for number of vehicles on the road, it uses confidence intervals. And if you stare at the numbers for a bit, you see patterns between automakers (Mitsubishi = death, Toyota = happy face) and brands inside of single automaker (my Avalon is somewhat safer than a Camry, which is somewhat safer than a Corolla).

Incidently, greater mass is a significant increaser of safety (in the rock-papper-sissors of car accidents, large beats small). Intuitive. Although it's interesting to note that trucks are usually much less safe than SUV's. Not intuitive.

The IIHS puts out a search engine for determining the safety of different vehicles during different years: http://www.iihs.org/ratings/default.aspx. It's less useful than the study becase it's much less exact (three categories of good, ave, bad isn't nearly as good as an index, which I like to call the death index, which shows degrees of good->bad which vary enormously).

Based on how I drove in HS, it's a miracle I'm alive right now... but my dad was wise to put me in a huge, heavy car.

Couple last comments:
* night-time driving is 3x riskier per mile driven than day-time driving (ie, be more alert, wear eye glasses)
* for a future car, electronic stability control (ESC) reduces single-vehicle accident risk by 40% and fatality risk by 56% and rollover risk by 80% (IIHS article)

If a loved one is in an accident, it may be a random accident. However, the probability of their safety is not random. It's largely based on the automobile they're inside.

The article with safety index for different cars is at: http://www.iihs.org/externaldata/srdata/docs/sr4204.pdf.

How much does a couch cost?

Imagine a new couch is purchased for $1,000 (not an amazing couch, just an ok one).

This is how a person normally looks at it:
$1,000 Couch

How else is there to look at it?

There's the money that had to be earned in taxes just to have the $1,000 to spend (assuming a 25% tax bracket is $1,000/.75=$334 more)
Cost of $1,000 Couch
$1,000 Couch
$ 334 Extra money earned for fed taxes

Then there's sale tax that goes with the $1,000 purchase (10% in WA).
Cost of $1,000 Couch
$1,000 Couch
$ 334 Extra money earned for fed taxes
$ 100 Sales tax

In total, the $1,000 couch actually cost $1434. That's 43% more than the price tag you see! Everytime! Everything personally purchased comes with a tax makimg it 43% more expensive.

That's not the half of it. How much is that couch worth? If you were forced to sell it used, 6 months to a year later, in great condition, it would be worth about less than half, usually 1/3 of what was paid for it. Meaning the $1,000 couch is worth $334. A loss of $665. (By the way, if you doubt it, try buying something used in the Nickel or Craigslist.)

The poor and middle class come from a perspective that they own a $1,000 couch. Instead, they have a $334 couch for which they spent $1434 (4x more money!).

That's the same as a financial planner guarenteeing a 75% loss on all money invested with him -- and the average person just keeps on spending/investing this same way each year.

I don't advocate foresaking everything material and subsisting on rice and more rice (which one friend took as the point). The point is to ask yourself, how can I do better for myself so I have more money left over: to invest in a Roth, play, not have to work so I can spend extra time with my fam -- anything other than lose it as such.

Why the Rich get Richer and the Poor Poorer

How come people who make more money seem to get rich so MUCH FASTER and the poor just seem to stay poor or worse?

An excerpt from http://en.wikipedia.org/wiki/Wealth_condensation: "Cost of living is typically the same for everyone. In a free market economy, factors contributing to the cost of living will adjust so that poorest members of the society are forced to spend all their income on bare necessities (food, housing, medicine), whereas richer members will have enough excess income that they can save and invest. Thus, in a free-market capitalist economy, both savings and the investment income ...are disproportionally accumulated in hands of wealthiest individuals."

Looking at real life: If you compare three people's income (100k, 60k, 30k) you'll find that their expenses are not proportionately different. If you earn 100k in income, you might spend 60k in expenses, if you earn 60k, you might spend 50k in expenses, and at 30k, you might spend 29k. Why this is so important is that the first person saves 40k a year, the second person 10k, and the third 1k. This is enormously different. At 100k vs 60k, one is earning just 1.66 times more income, but they're have 4 times more income left over at the end of a year - they're accumulating wealth at 4 times, not 1.66 times. And compare 60k to 30k and the difference is even more staggering: earning 2x more money but having 30x more left over at the end of a year. That is one of the single greatest arguements for the importance of increasing ones income: if you don't, your expenses will eat all your income. Of course, no matter what income you earn, you can still manage to spend it all. But using this example, a 100k earner saves more in 5 years than a 60k earner in 20 years. Add to that fact opportunities to invest and compounded interest in real estate, stocks, or a business.

So the answer: the disparity isn't income. The disparity is money left over after life expenses.

How do you accumulate wealth twice as fast?
While saving money is highly useful, it's hard to trim 10k off your expenses.

The next step: If you're that 60k/yr earner, and if you got a part-time job that made you another $800 a month over the next year (9.6k), while that's only a small increase in income, that's the equivalent accumulating an entire extra year worth of savings (9.6k in addition to the 10k left over at the end of a year).

In parting: If you feel yourself putting up resistence to the idea, do a cost benefit analysis. Is making that extra 9.6k of money harder than working nearly a full year of your life? And, who said you had to work harder? People who accumulate money have the same number of hours in the day as everyone else. In fact, it's quite likely they work less. They are more creative and effective and frequently choose ways to make money that don't correlate to how much time they must spend.

Jared's 2009 Most Favorite Buys

1. Get a smart phone (My fav - iPhone 3GS, $99). Try to get a person to give up their smartphone. It's like asking someone to go back to riding the bus to get around. The iPhone has full internet, helpful apps, email, texting, 3MP pictures... you can listen to music, watch movies, shoot live streaming video. Customer satisfaction for iPhone's is the highest of any smart phone. It's impressive even if it's hampered by ATT.

2. Get a Kindle, $259. The best advertisements are kindle owners - ask them about it and they turn into a long, animated advertisement. I understand people who say they're "old school." But if using the product for 5 minutes converted my very old school father, it'll knock you over, too. It saves money, too -- books are MUCH cheaper and can be bought virutally anywhere (lying in bed, reading on the water, at a restaurant, etc). You can always return it if not convinced.

3. Get a personal cook, $12-15. If you have an undying love for cooking, skip this one. Otherwise, consider how much time you spend going to the groccery store, buying ingredients, cooking, and then cleaning. And spoilage. And eating out. At the end of a day, would you rather do all that, or spend time doing anything else? Estimated cost of homemade meals delivered to home, $12-15 that feeds 2-3. Even having meals 2-3 days a week can make a big difference in stress levels and free time. If you're interested, IM me for suggestions on hiring (I have this down pat).

4. Weigh yourself daily, $0. Write it down on a chart taped to the wall above your scale. This won't by itself make you skinny, but being consistently conscious of your weight is much easier than waking up 25 lbs fatter 2 years later. This is freedom from buying bigger clothes, feeling crappy, and as you age, a ton of health related problems. I'm not saying go for skinny, but I am saying avoiding fat would be cool.

5. Delegate a job, $10. Make it one you really hate. A repetitive one. Cleaning, laundry, shopping, basic errands, picking up poop, whatever? What you really want can generally be delegated to someone competent for $9-$12/hr. I like Craigslist for job postings.

6. Get voicemail transcription, $10-30. If you use your cell phone for your work phone, this is a must! Of the last 900 voicemails I've gotten, I avoided listening to all but 60 of them. Highly accurate computer technology converts your voice messages to emails you can read (the voice message is attached). I've tested all the services and like phonetag.com the best.

7. Get MyWi. $10. It's a hacked iphone app that allows you to make your iPhone a wireless spot. Be anywhere - car, boat, library - turn on this app, and your laptop can connect to the iphone (wirelessly) and use the internet just like at home. Super handy! See iphone.jaredfielding.com for more apps I like.

8. Viper Remote Car Starter (w/iPhone app), $500 installed: This isn't cheap, but if you live in places where it gets to 25 below freezing, being able to warm your car from inside your work building, or inside the mall or movie theater makes winter (and super hot summers) more more enjoyable.