What Will You Do If Your Pension Fund Isn’t There For You?
Drained pension fund has retired New York union workers pinching pennies to survive, as doom looms for reserves across U.S.*
-New York Daily News, Sunday, February 26, 2017 (link to article below)
This is a very serious situation – not in its singularity, but commonality. We, as a society, experienced a fantastic unprecedented growth period in our securities markets, and in our capitalist system for roughly twenty years, 1980 – 2000… “The Roaring Twenty”.
During that period, it seemed the rise in the stock markets would never end. It seemed we were on our way to financial nirvana. Corporations viewed record sales, year after year, as a signal to increase capacity. Individuals viewed it all as a reason to get that boat, buy that second home, expand… And municipalities, unions, states, the various government bodies made promises based on the same mindset.
This expansion of capacity (with resultant leverage) created a “bloated infrastructure” .
Promises that were made were often in the form of future pensions. Why would that be a problem?
“Arithmetic Average, Straight-Line Projections”.
A basic pension fund approach to financing future liabilities (pensions) works like this: Money is invested, and every year, even as more cash is added, an actuary must sign off on the amount of growth in those investments as it must meet expectations.
In other words, if the money in the pension fund is expected to be $XX dollars at that time, the actuary must see that amount (or more). If there is a shortfall, the pension fund manager, owner, etc. must add $$ to get to the required amount.
The key to this is: How did the fund determine, prior to all of this, what that amount would be in future years?
“The Roaring Twenty” (1980 – 2000) had incredible growth, with limited volatility in comparison to the volatility we’ve experienced since 2000. During that 20-year period, we became accustomed to hearing “10% gains” or more…it became “normal” to assume that kind of success and growth would continue.
In negotiating future pensions, promises were made utilizing “average growth” from that period in history (at least partly) and extrapolating that into future numbers with “Straight-Line Projections”.
Do you remember hearing that some union (in years past), negotiating for benefits, managed to get a promise of 7% increases in pensions, or funding? That seems a common number… The fund would expect annual growth of 7%, and needed that (or more) to meet future retirement liabilities.
Whatever the number promised, volatility was largely ignored. People tend to hear “average” and assume that means an average of gains/losses, over time, are the same as consistent numbers. Therein lies a large part of the problem.** (link to more complete explanation below).
If the manager (with a municipality as an example) is not accustomed to crunching performance numbers, and thinks “Well, we have to see a 7% gain to make our numbers, but there was no gain this year. That means we have to see 14% next year, to get an average 7%”. That is incorrect…it means that in year two, you have to see a gain of 14.49%, and if there is no gain in year two, a gain of 22.5%, not 21%, in the next; compounding is required! That’s still just addressing average “changes”, not “actual returns”. ** (please read the explanation, link below)
The volatility we’ve experienced in the stock markets since 2000 has created enormous gaps in the results for many funds. The fund has to recover from any drops, and has to pay out (retirement liabilities) even when the markets go down, thereby adding to the obstacles in recovery. A decreasing employee membership would certainly exacerbate the problem.
Oh, and we haven’t seen an average of 7% annual growth in the stock markets since 2000, either. If we had, as of the end of 2016, the Dow average would have been above 33,000, and the S&P would have exceeded 3,800. As of the end of 2016, they were 19,762 and 2,238 respectively.
What does all of this mean?
1) This isn’t a positive for the economy as consumerism/spending has to be effected. It certainly isn’t good for the retirees in question.
2) Expect more of these articles; there are many pension funds in, or near, trouble.
3) Investigate your own pension structure. If you have someone/something controlling it, what are the promises, how are they being met?
4) You should examine your own approach to retirement planning. Have you been using “straight-line projections”, based on historic averages to create your expectations? If you are invested in an inherently volatile series of instruments (i.e. stocks and mutual funds), be certain you aren’t just hearing “the average returns are…” in your determination of success to date. Do the work to see where you are.
Look for a consistent-earnings/growth vehicle; try to avoid volatility. Whole Life insurance could make sense for those that qualify, and understand the structure.
Consider the concept of a “private pension”. Ensure that what you use, and how it performs, provides additional consistency in comparison to the stock market. If your only approach is to use 401(k)’s and IRA’s, you have work to do.
In the backseat of his car, Tim Chmil stashes what he refers to as his new retirement fund — bags and bags of recyclable bottles and cans.
8% isn’t always 8%…in fact, rarely! Arithmetic Averages are Deceiving
“Arithmetic Average” and “Straight-Line Projections” — frequently applied to investment gains, losses and marketing by Wall Street investment advisors.
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