It's a sad fact of life that humans aren't always very good at making decisions.  What is interesting, though, is that different types of mistakes come up repeatedly, suggesting that some decision-making errors are systematic.  For example, many of us have a bias toward seeking only the information that confirms -- rather than refutes -- what we already believe. 

Here's another example.  It's a question you may know from The Tipping Point: If you take a large piece of paper and fold it in half, then fold it in half again, and again and again until you have folded the original piece of paper in half 50 times, how tall will the stack be? 

As tall as you?  As tall as the building you're in?

The answer is, the stack would reach roughly to the sun.  If you folded the paper in half again, the stack would reach to the sun and back.

This is a useful example to bring up not just because it bears some resemblance to the effects of compound interest, but also because it shows how decision-making errors may lead us to ideas that differ greatly from reality.  

More directly, it may seem reasonable to conclude that personal accounts are too risky given the state of the financial markets.  Two recent think tank papers show in different ways why that conclusion is incorrect.   

First is a paper by Gary Burtless at Brookings.  To be clear, Burtless argues against personal accounts.  Yet the substance of his analysis could just as easily lead to the opposite conclusion.  Keeping in mind that Social Security currently replaces on average less than 40% of earnings, Burtless finds the following for a personal account of 4%:  "The average replacement rate is 40%. For workers retiring after 1945 the replacement rate has averaged 49%." 

In other words, a 4% personal account alone would have replaced on average nearly half of income for those retiring in the last 62 years.  Meanwhile, the 12.4% tax that we've been paying into Social Security replaces only about 40% of income.  How is this an argument against personal accounts?  

It isn't, of course.  As it turns out, Burtless objects to the volatility of personal account returns rather than the size of those returns, which is a bit like saying that a slightly uneven raise for all workers is worse than no raise.

Another problem with the Burtless paper is that he ignores some of the ways in which we might reduce the volatility of returns, such as gradually shifting money away from equities during the course of a worker's contributions.  Thankfully, Andrew Biggs at AEI does use such risk-reducing tools in his historical modeling of personal account returns. 

The conclusion?  Biggs finds that people retiring today would do more than 15% better under a system of 4% personal accounts. 

In his own words:

Opponents of personal retirement accounts as part of a reformed Social Security program have pointed to recent market downturns as self-evident proof that accounts would be a poor policy choice. There are many valid arguments for and against personal accounts, but the simulations herein show that current market conditions do not prove the critics right.

More pointedly, the critics are wrong.  Even when markets are a mess, personal accounts make sense.