“…the current [pension] shortfall is attributable to the recent stock market plunge…”
Hmm…first of all, the S&P 500 has doubled from its March 2009 low and is now within 40 points of its all time high (1,565 on Oct. 9, 2007). So we are past the plunge.
Second, the problem of poor returns now stretches back over a decade:
The NASDAQ index peaked at 5132.52 on March 10, 2000. Yesterday (February 28, 2011), nearly 11 years later, it closed at 2782.27, down 45.8%.
The S&P 500 closed at 1,527.46 on March 24, 2000. Yesterday it closed at 1,322.75, down 13.4% over almost 11 years.
The Dow Jones industrial average closed at 11,722.98 on January 14, 2000. Yesterday (Feb 28) it closed at 12,226.34, up 4.3% in 11+ yrs.
Those figures do not include dividends – trivial in the case of NASDAQ, 1-2% for the S&P, 2-3% for the DJIA – but on the other hand, they do not take inflation into account either, and inflation over the last 11 years has averaged well over the rate of dividend returns. Thus the real return on US equities is even less than the figures suggest.
Throughout the last decade the assumed pension return has been 8%. Fortunately some of the pension fund was invested in bonds, which did much better than stocks – but still not 8%.
More generally, there have been multiple 10 and even 25 year periods when nominal stock market returns have amounted to zero (e.g. from 1909 to 1919 the Dow made no net advance; the 1929 peak wasn’t recovered until 1954; and the 1972 high wasn’t surpassed until 1983 – again, no adjustments for inflation).
However, when the good times come – and the 1981-2000 period was among the best – there is an irresistible tendency to think those returns are going to last forever, and to reset pension benefits accordingly.
It is possible that we are now in the midst of a 15-20 year bear market during which consumers, businesses and government at all levels will be deleveraging from the excessive debt taken on in the previous 3 decades. If that turns out to be the case then the assumed return on pension assets should be no higher than the available return on safe long term assets like treasuries (i.e. about 4.5%).
I’m not an expert, and 8% seems high to me. But, Dean Baker (referenced from here, so you can see Will’s comment: http://willbrownsberger.com/index.php/archives/6054 ) makes an argument for 8% assuming dividends and stock prices, and a long-term view.
Part of the problem (I think) is failing to stick to the long-term view when times are good. When the market is running well above 8%, that does not mean that you get to slack off on your investments, because there will surely come a time when it does not run above 8%.
And just as 8% seems high, 4.5% seems overconservative. Something as large as a pension fund ought to be able to take the long view, and get the time-averaged better performance of stocks.
Thanks, Vince and David for continuing this important conversation.
The French stock market lost money through most of the last century. There is no law of nature about long-term equity returns. They depend on political and economic history. So, we should take no particular comfort in trend analysis. Very wise investors differ in their views on what to expect at this moment in history — globalization seems to have pushed down both wages and stock returns; technological advancement may have pushed down wages, but may boost stock returns. It is possible that Main Street and Wall Street will spread further and further apart over the next couple of decades.
For me, the bottom line is that the markets are risky and assuming 8.25%, as we do, puts a lot of risk on future taxpayers. I’d be much more comfortable around 6. Additionally, we should change the rules so that employee contributions adjust themselves if our assumptions are wrong — taxpayers shouldn’t bear all the risk (or carry all the upside). That’s built into my pension reform proposal.
This is the discussion that should be going on as a part of the issue, one Will has been wise to undertake. After much consideration, I come to the discussion with a different perspective, I believe the state should get out of the pension business for new employees going forward which would free individuals to make their own investment assumptions and decisions. With regards to the employees in the system, Will’s concept of adjusting employee contributions depending on return makes emanate sense and any employee who does not want to make additional contributions should be allowed to opt out of the system and roll over to a self directed IRA.
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