Where Investors Should Turn if the Social Security Fund Runs Dry

Last August, the U.S. economy was on the brink of complete collapse.

The U.S. government was hours away from its first-ever default, which would have prevented it from paying all its bills. Veterans, contractors and Social Security recipients were among those at risk of not receiving their hard-earned payments. And the impact of a default would have likely sent financial markets into a downward spiral.

At the 11th hour, however, Congress came to its senses and put aside its partisan bickering just long enough to reach a default-avoiding compromise. The deal raised the debt ceiling by $2.4 trillion and provided for $917 billion in spending cuts over 10 years. But it failed to get to the root of our financial problems.

Nothing Congress did back in August made any meaningful dent in America’s $1.3 trillion deficit. The Office of Management and Budget estimated that the deal cut future deficits by only half a percent. Worse yet, the compromise didn’t address some of the glaring systematic deficiencies that helped put us in this financial mess in the first place.

Last week brought new evidence of one of these lingering systematic deficiencies. Treasury Secretary Tim Geithner announced that the Social Security Fund will begin to run out of money in 2033. That’s three years earlier than previously expected. And it’s a clear sign that the real problems with our system haven’t been addressed.

Bill Gross pointed this out shortly after the August debt deal. The famed bond investor outlined a multi-pronged plan to overhaul Social Security. The plan included such radical reforms as raising the retirement age, reducing benefits and increasing the Social Security tax rate.

While I don’t necessarily agree with all the specifics of Mr. Gross’ recommendations, they are the types of radical suggestions we’ll need if we want to make a meaningful dent in our astronomic deficit. Last-minute debt deals are only temporary Band-Aids for a system that is broken. To truly fix it will require some careful thinking, some tough decisions and – miracle of miracles – some bi-partisan compromises.

But those things aren’t going to happen overnight. The Social Security fund isn’t going to suddenly be replenished in the coming months or even years. If anything, the fund’s life will get shorter. Until last week, Social Security was purported to have been fully funded through at least 2036. Now the year has been reduced to 2033. If that trend continues, Social Security may run out of money a lot sooner than people think.

That’s a scary thought for anyone who plans to retire in the next 15, 20 or even 30 years. When they do retire, will the Social Security checks they’ve been counting on all their lives still be there? Right now, that’s unclear.

The best thing investors can do to combat such uncertainty is to get proactive. Look for investments that will start generating income now, and help build a nest egg of profits that should offer at least some sort of post-retirement cushion even if the Social Security fund dries up.

Right now, the best place for income investors to turn is dividend stocks. As my colleague Chris Preston wrote back in January, dividend payers were the best-performing stocks on the market last year. S&P 500 stocks that paid dividends produced an average return of 1.5% in 2011. Those that didn’t fell 7.5% for the year.

And the higher the dividend yield, the better the stock performed. According to research firm Birinyi Associates, the top 100 stocks in the S&P 500 as ranked by dividend yield returned an average of 3.7% before factoring in their dividends.

For the year, companies listed on the S&P 500 Index paid a combined $240.6 billion in dividends – the largest payout since 2008. Standard & Poor’s is projecting that number to increase to $252 billion this year. With the richest company in the world – Apple (Nasdaq: AAPL) – recently announcing its first-ever dividend, and the second-richest publicly traded company – Exxon (NYSE: XOM) – increasing its dividend to an all-time high, it’s clear that demand for dividends is growing. That means yields should continue to grow, and those stocks that pay dividends should continue to flourish.

At the moment, dividend stocks offer both profitability and security – things Social Security is supposed to provide. But with no guarantees in the Social Security fund, and no real solution to our debt problems in sight, it’s time for investors and future retirees to go on the counterattack.

With short-term interest rates remaining near zero through late 2014, once-reliable bastions of safe income generation such as CDs, money-market accounts and Treasury bonds are no longer generating much income. Dividend stocks are a much more profitable alternative.

Sure, they might not offer the same level of security those other safe havens once did. But with an old stalwart like Social Security no longer safe, dividend stocks are about as close to security as it gets right now.