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Podcasts from Confluence Investment Management LLC, featuring the periodic Confluence of Ideas series, as well as two bi-weekly series: the Asset Allocation Bi-Weekly and the Bi-Weekly Geopolitical Report (new episodes posted on alternating Mondays).
Welcome to the Confluence Investment Management biweekly asset allocation report for October 28, 2024. I'm Phil Antler. The inflation adjustment for 2025 Social Security benefits has been announced. But do the financial markets even care? Confluence associate market strategist, Daniel Ortworth, joins us today to discuss the impact on markets and portfolios.
Phil Adler:First of all, Daniel, the increase of 2.5% was pretty much telegraphed in advance. Is it fair to say that this annual announcement has zero capacity to surprise the markets?
Daniel Ortwerth:Hi, Phil. 0 market impact might be a touch of an overstatement, but it gets the general direction right. The Social Security Administration determines the annual cost of living adjustment or COLA for the next year based on the consumer price index for urban wage earners and clerical workers. It compares the level of the index in the Q3 of the current year, in this case, 2024, to the level of the index in the Q3 of the previous year, in this case, 2023. The change in the index over those two frames is the primary determinant of the COLA for the next year, in this case, 2025.
Daniel Ortwerth:This means that the information and the method used for the COLA is known public information. Estimates of the number before its release are usually very accurate, and no one is really surprised.
Phil Adler:Well, even if no one is surprised, does this increase probably disappoint recipients who have been used to seeing higher inflation numbers?
Daniel Ortwerth:There probably is some disappointment especially for those who began to receive benefits within only the last 3 or 4 years. The adjustments for 2022 and 2023 were 5.9% and 8.7% respectively, which makes this 2.5% adjustment seem small.
Phil Adler:Well, going back even further, how does this increase compare to prior years?
Daniel Ortwerth:Phil, that's the perfect question to ask if we want to gain an appropriate perspective. The average adjustment for the last 10 years is two point 6%, nearly the same as this year's 2.5%. And I should probably mention that last year's adjustment was 3.2%. So this is the 2nd year of moderating COLAs. A glance over our shoulder at the history of colas reveals that adjustments as high as 5% are actually somewhat rare.
Daniel Ortwerth:The last one of that size was in 2008, accepting 2,022 2023. So the 2 recent years of high colas stand out from the historical norm.
Phil Adler:Looking at it from a different perspective, what's the new average social security monthly benefit and how does that compare to say 10 years ago?
Daniel Ortwerth:The average social security benefit for 2025 is projected to be $1,976 per month. Now let's be clear that this is an average calculation that incorporates all prospective recipients, and those recipients vary across a wide range of benefit levels. Listeners who qualify for a benefit should not take this average as an indication of what they will receive, which could be considerably higher or lower based on their own circumstances. The average is meaningful just as a tool for comparison across years. So to your question, Phil, the average benefit for 20 15, 10 years prior was $1,342.
Daniel Ortwerth:That's $634 less than it will be in 2025.
Phil Adler:Well, there's no getting around the fact that the 2025 increase of 2.5% does seem small compared to those 2 big years that you mentioned. Do you think the lower adjustments of the last couple of years might have any impact on overall consumer confidence?
Daniel Ortwerth:Phil, I think we should begin with a little perspective check. Social Security benefits comprise only about 5% of the total US economy, so most consumers are not directly affected by this announcement. That means we probably should not expect it to have a meaningful impact on overall consumer confidence. Now for those who are affected, the impact on their confidence will probably depend more on their expectations for future inflation. If they think that inflation is moderating as it has been here recently, then they will probably feel reasonably secure.
Daniel Ortwerth:However, if they think that inflation is going to either stay high or get higher after just a brief moderation, then this just might impact their view.
Phil Adler:Daniel, you make it clear in your report this week that the annual social security increase does not anticipate inflation. Instead, it's based on past year price increases. But 2.5% seems a bit low for consumers used to buying groceries and paying rent. Does the calculation the government uses to come up with this number diminish the impact of food and housing costs?
Daniel Ortwerth:Actually, it is the other way around. The consumer price index used to calculate the adjustment includes factors for food and housing costs. In fact, housing inflation has been one of the main reasons why the index has not gone down even more from its early decade highs. This is something economists and we at Confluence have been watching very closely. If the trend of increasing housing costs does not moderate, it could cause the CPI to move higher even if other costs moderate, and this could lead to larger colas in the future.
Phil Adler:Daniel, without our population aging, is Social Security destined to play a larger and larger role in the overall economy?
Daniel Ortwerth:Yes, Phil. It is. The latest Census Bureau survey indicates that roughly 18% of the US population is currently 65 years or older. According to the Census Bureau projections, that number will increase to 22% 10 years from now. Unless laws are changed altering qualifying retirement ages or benefit levels for qualifiers, this growth in the 65 plus age cohort gives us a rough idea of how the role of social security will grow.
Phil Adler:It's not just inflation. Increasing wages also boost future social security benefits. Well, this doesn't help people who have already retired, but will tomorrow's retirees benefit enough from today's wage increases to beat the inflation curve?
Daniel Ortwerth:This is a very important question, and I'm really glad that you asked. It's important to remember that an individual's own Social Security retirement benefit is not just determined by inflation. The formula for computing an individual's starting benefit is driven in part by his or her wage and salary history. Higher compensation will boost a retiree's initial retirement benefit, which will then be adjusted via the COLA process over time. As average worker productivity increases, average wages and salaries have tended to grow faster than inflation.
Daniel Ortwerth:And as a result, the average Social Security benefit has grown at a higher rate than CPI. Over the last 2 decades, the average Social Security retirement benefit has grown at an average annual rate of 3.5%, which meaningfully exceeds the 2.6 percent annual CPI rate that we mentioned earlier.
Phil Adler:Well, we can't leave the social security discussion without addressing the future and and the fund's solvency, especially since social security plays such a a significant role in the overall economy. According to numbers I saw recently, trust fund reserves are estimated to be depleted in 2034, which would mean only about 80% of scheduled benefits could be paid that year under current law. Do you have, Daniel, a best guess on what the government might do?
Daniel Ortwerth:Phil, your question draws attention to a very, very important point. The first of 2 that I would like to make kinda go together. The Social Security trust fund depletion would not mean that recipients would just stop receiving benefits. The law contains formulae that determine how benefits will change if the fund runs out of money, and that change is not down to 0. The actual change depends on variables such as when the trust fund is depleted, and these estimates change as Social Security tax revenues and payments to beneficiaries change relative to prior projections.
Daniel Ortwerth:The Social Security Administration's most recent report says that the fund is now projected to deplete in 2035, resulting in a 17% reduction in benefit payments. So you see, these numbers rise and fall with circumstances. The second point I want to make is that all of these projections are based on current law, which is subject to change. We all hear the common refrain that lawmakers would not dare to touch any of these benefits for fear of being voted out of office. However, it has happened before.
Daniel Ortwerth:In 1996, the Welfare Reform Act ushered through a Republican Congress and signed into law by a Democrat president eliminated or curtailed a list of benefits. And in 1983, a Democrat congress and Republican president changed the law to raise the ages at which recipients can begin to receive retirement benefits. It might not seem possible or likely
Phil Adler:question with an obvious answer. But I was wondering, perhaps investors might tend to dismiss social security when they calculate asset allocation strategies. How should an investor calculate social security income for asset allocation purposes? Could it be as as guaranteed cash that provides a firm floor and allows remaining assets to be placed in investments with riskier outcomes?
Daniel Ortwerth:There is an expression that we use when teaching this subject, and it is less later. Meaning, that we might be wise to expect less of a benefit than is currently projected and for it to begin at a later age. Let's walk through this a little. Every year, each one of us receives an individualized social security statement that details what we are projected to receive and the age at which we become eligible for those amounts. That statement incorporates key assumptions such as a projection of your own income based on what you've made so far, the age at which you choose to begin to receive benefits, and the continuation of current law.
Daniel Ortwerth:This statement is a good starting point. While it is probably too pessimistic to assume you will get nothing and it might be too optimistic to expect the full amount shown on the statement, the less later idea can help us move from the value shown on the statement to a reasonable prudent assumption. Ultimately, this is a very personal individual decision, and we cannot offer a specific rule or calculation. Each investor should work with his or her adviser to arrive at a decision that seems best.
Phil Adler:Thank you, Daniel. Our discussion today is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security. Our audio engineer is Dane Stoll.
Phil Adler:I'm Phil Adler.