Pensions still dream of 8% returns
Despite the financial crisis, plan managers run on past expecations. Is a time bomb ticking?
More than 100 U.S. public pension plans still have an 8% median expected return on their investments, The Wall Street Journal reports. That's unchanged from 2001.
Hmmm. Let's bring in this little thing called reality: The median annualized return of public pension plans was a meager 3.9% over the past decade. The 10-year Treasury note is at 2.75%. Inflation is at 1%, and deflation is a very real threat.
Where do 8% returns come from? It's not just public plans that boast these numbers; pension plans at S&P 500 companies are also banking on 8%.
"The concern is that the reluctance to plan for smaller gains will understate the scale of the potential time bomb facing America's government and corporate pension plans," Reilly writes.
So how are governments handling this imminent crisis? Some are starting to cut back their forecasts. New York state, for example, plans to trim the expected return rate for its pension system to 7.5% from 8%.
Pension managers say they aren't changing their expectations just because of a little short-term economic chaos. After all, returns have surpassed 10% annually for decades.
The real question -- one that managers don't seem ready to ask -- is whether the latest financial crisis has permanently changed our investing expectations. Will we ever return to the gung-ho returns of the past?
The turbulent market is taking a bite out of these returns, for sure. But Reilly writes that plummeting bond yields are also wreaking havoc on fixed-income portfolios at many plans. Lower inflation means funds can't count on economic growth to help meet their 8% goals.
Why can't these pension plans just slash rates to a more realistic 5% or so? Because doing so would immediately create huge budget shortfalls. In Colorado, Reilly writes, one study found that dropping the return rate to 6.5% caused the deficit to shoot up to $34 billion from $23 billion. And no one wants that.
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The brightest minds at top university endowments were unable to match the returns of a rather boring portfolio of stocks and bonds.
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