iStockphoto/Kenneth Mellott

With the stock market crash, many have pointed to the safety and security of Social Security relative to 401(k) plans and the idea of adding personal accounts to Social Security. There is certainly merit to these arguments, and having a diversified portfolio of safe and risky investments makes sense.

At the same time, it's worth checking into how Social Security's investments have done over time. Surplus taxes paid into Social Security are invested in the Old Age, Survivors and Disability Trust Funds (OASDI), which hold special-issue government bonds whose interest rates are based on average Treasury bond interest rates at the time. The idea here is investments which provide safe, if modest, returns for the long-term.

But not many people have considered how modest. Effective annual interest rates on the trust funds are available through the Social Security actuaries' web site (see here). To calculate real returns I subtracted the annual rate of growth of the consumer price index (CPI), available here. A couple charts tell an interesting story. First is a fairly conventional comparison: how did the trust funds' returns compare to a mixed portfolio of 50 percent stocks and 50 percent bonds? The first chart shows average annual returns by decade and shows a couple interesting things. First, the mixed portfolio returns exceeded the trust fund's returns in all decades except for the truncated 2000-2008 period, by an average of around 2.9 percent. Second, both the stock-bond portfolio and the trust funds lost money in two decades, although only the trust funds had a truly terrible decade, losing 3.5 percent annually during the 1940s.

The second chart shows a running average return on the trust funds, beginning in 1940. The return value for each year represents the average of returns from 1940 through that years. Here's something I found pretty interesting: from the program's inception through 1986, the average annual return on the trust funds was negative. To repeat, through the first four and one half decades, the trust fund's investments lost money on average each year. Following 1986 the running average of annual returns was positive, but barely so: even extending through 2008, the average annual return on trust fund investments, adjusted for inflation, was only 1.38 percent above inflation. These returns are safe, to be sure, but far lower than the 4.4 percent real annual return on the stock-bond portfolio.

So here's a question: if the trust fund's returns have been so low, how did Social Security manage to pay such high benefit returns to early retirees? (The benefit return is a function of taxes paid and benefits received, with the trust fund's investment return having an only indirect effect on benefits.) We've talked here several times about the high returns paid to early retirees; here's a chart showing average annual returns paid to beneficiaries. The answer is that while a sustainable Social Security program would have built up a significant trust fund balance over time to help pay future benefits, the trust fund balance was kept very low and the extra funds paid out as benefits. When Social Security was begun, the idea was for it to become a "funded program" carrying a large trust fund balance. Congress soon acted to delay scheduled tax increases and move up the payment of benefits, in addition to making benefits more generous. (Lesson: past Congresses were pretty much like present ones in terms of catering to current voters over future ones.) High benefits were paid, at the expense of the trust fund balance that could help the system fund itself in perpetuity. This was, in effect, like eating your seed corn: things look good in the short-term, but you don't have the means necessary to keep things going for the long run

Andrew G. Biggs is a resident scholar at AEI.