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Last month, I presented to the National Association of State Treasurers. The room had all 50 State Treasurers, lots of Deputy and Asst Treasurers, and staff. I was realistic about how credit crises unwind over long periods of time.

The prior panel had the major ratings agency reps, and they had discussed Pension Return Assumptions. Given their utter incompetency, it was no surprise the Ratings firms were okay with expected blended returns of 8%.

An audience member asked a question to me about this, and I laughed. I told the Treasurers that the consultants who tell them they should have expected 8% blended returns for the past 5-10 years were dead wrong, and the ones who told them they could expect 8% blended returns for the next 5-10 years were probably high. My joke was to get to 8% required bad math — blended expected returns of 8% requires taking 5% gains in equities and adding 3% gains in bonds (5+3=8).  How often do you get to make a wonky accounting joke to a room full of treasurers?

But, as it turns out, its even worse on the Corporate side: S&P 500 companies pension funds. They currently assume future equity returns of above 10%, according to their own financial statements. As I made clear to the State Treasures, that is an absurd expectation.

Andrew Lapthorne of Société Générale’s Global Quantitative Research group points out how absurd this is:

No-one believes these ridiculous – earnings flattering – pension fund return assumptions, not even US CFOs themselves.

A couple of months ago we highlighted how the implied yield on a traditional balanced portfolio comprising a mix of bonds, equity and cash had fallen to below 3%  less than half of what it was 20 years ago. We suggested (and still do) that with such low yields, generations of investors are facing a potential future income crisis going forward.

Low yields (and as a consequence low returns and annuity rates) is not a new problem. Although particularly compressed now, yields have been depressed for the past decade. However, the consequences being felt today are becoming more acute. Pension entitlements are falling, some companies (AMR, for example) are entering Chapter 11 to help avoid paying them, and endowment mortgages, plus a whole raft of other investment products, are coming up short.

The reality of low yields is the need to save more and spend less. But rather than accept the notion of lower returns and adjust behaviour accordingly, the path of least resistance appears to be total denial…”

We have ultra low yields after 3 years of ZIRP and a market that is precisely where it was 11 years ago. Valuation using forward earnings estimates are at best reasonable, and using trailing 10 year and/or CAPE are subject to potential reversals off of an earnings peak. US equity returns may quote possibly be in the single digits over the coming decade.

Is this the circumstances that lead to 10% plus blended returns for the next decade?

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Source: Quant Quickie, 5 January 2012
Societe Generale – Global Quantitative Research

Category: Investing, Really, really bad calls, Valuation

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

51 Responses to “Not Even Corp Mgmt Believe Their Own Equity Return Assumptions”

  1. Pacioli says:

    Yet the funded status of the relevant pensions resulting from these inputs may not be that far off.

    This is to say that the pension benefits are likely to be curtailed in the future (in some cases massively). Despite the return assumptions probably being unrealistic, the big picture (i.e. funded status) is probably not too far off the mark.

  2. “This is to say that the pension benefits are likely to be curtailed in the future (in some cases massively).”

    In ‘Real’ terms? Bet on it.

    ~~~
    yon QOTD..

    “I place economy among the first and most important republican virtues, and public debt as the greatest of the dangers to be feared. To preserve our independence, we must not let our rulers load us with perpetual debt.”

    -Thomas Jefferson

  3. nofoulsontheplayground says:

    The corporate pension assumptions likely have more to do with massaging quarterly earnings than funding pension funds. The imputed gains are able to be booked to the corporate bottom lines whether they are earned or not.

    Of course, the assumed returns also help corporations keep their pensions “funded” according to accounting requirements regardless of whether they make those numbers.

  4. pdtrader says:

    It’s absolutely astounding that corporate and state treasurers continue to follow models that are not only broken, but which never reflected the market’s realities in the first place.

    As has been said many times before, those who fail to learn from history are doomed to repeat it.

    Boy, I can’t wait for the next round of pension crises…

  5. Global Eyes says:

    In many states pension costs have hijacked the state sales tax to the point of making state pensioners the prime beneficiaries of tax revenue from the states they no longerr liver in!

  6. David Merkel says:

    To some degree, I fault the accounting and actuarial professions for this. With life insurance liabilities, you have to have a provision against adverse deviation in your assumptions, not best estimate, much less what we imagine can be achieved.

    In terms of what is allowable in terms of funding methods, and what is permitted in terms of assumptions, it is no surprise that pension plans are underfunded. From a historical standpoint, there was so much pressure to create defined-benefit pension plans that there was a compromise at the very beginning in order to make the current costs affordable for corporations. Thus an unsustainable bargain was made, and for a while, in the 80s and 90s when equity returns were so high it looked like the whole thing would work.

    Remember that in the late 70s and early 80s, like today, had many articles on the unsustainability of defined-benefit pension plans. Unless our society can become more productive without resorting to leverage, we can pretty much guarantee that the promises embedded in defined-benefit pension plans will not be realized, along with most other long-term social insurance schemes.

  7. GeorgeBurnsWasRight says:

    It looks to me that the US has chosen to repeat Japan’s experience for the past couple of decades, except for somewhat better demographics.

  8. sabre_jenn says:

    Compared to the social security “trust fund”, these underfunded pensions look relatively sound.

    An imaginary “fund”, stuffed with IOUs from Congress — but all benefits are actually paid from new contributions. Social Security is a ponzi scheme.

    No one is going to watch over your nest egg for you — not Congress, not the CEOs that own Congress, not the state bureaucrats. If you want your savings to be secure, you have to manage your own savings.

  9. Julia Chestnut says:

    I expect to have to die at my desk. I never had a job that included a fixed-benefit pension: my last job, I started literally the day AFTER the transition to 401(k). How’s that stock market retirement investment working out for me? I think we all know the answer to that question.

    My husband is entitled to a pension. Do I really believe he’ll ever see it? No. They will steal it. That promise will never in a million years be kept.

    Nor do I expect social security to still be paying out when I need it.

    I shall be reverting to the babushka retirement plan when I am too old to work or the corporate mill throws me out with the trash: my children will have to take me in, and I will watch their children and cook meals and clean, and they will resent me and keep a roof over my head. Generations of old women have managed on this plan – it’s got a proven track record. It’s the safety net of the third world, which I fully expect to inhabit by then.

  10. BennyProfane says:

    But, in the end, it’s the taxpayer who backs all of this up, right? (sound familiar?) Wonder how these geniuses would work with their numbers if the PBGC didn’t exist.

  11. dead hobo says:

    I think I understand why defined benefit pension fund managers use unrealistic assumptions. My explanation that follows is about 90% correct; I’m too lazy to look up the precise rules for this.

    Defined benefit plans must accrue the difference between actual returns and expected returns. the 10% would be used to calculate the expected return. The actual return would be subtracted from the expected return and the difference would be a gain or loss. Really significant losses are taken over a period of years and base on a complicated formula. They don’t hit the bottom line all at once. Basically, really big losses get hidden. If a realistic estimate were used for expected returns, then the contribution from the business would have to be much much greater since investment returns couldn’t make up a big part of the required contribution.

    In essence, it’s a minor accounting gimmick but is not really fraud because it’s the FASB standard. Everyone knows it’s a crock, but using realistic numbers would hit profits hard. Think of it as a variation of mark to model.

  12. rd says:

    It must be nice to be a corporate executive with fat paychecks and golden parqachutes so you don’t have to live with your assumpions. I don’t expect to see the accounting rules change to force more realistic pension assumptions because the governments would then have to face their own massive problems, so we are on our own on this.

    For our own financial planning, I have assumed a pessimistic case since 2008 that our portfolio will return only inflation to us over the next decade until we are in our early 60s but then returns will get closer to normal so a 4% withdrawal rate would be safe unlike now.

    This has meant that we are saving in well-diversified (whatever that means these days) accounts about 25% of our gross income in various retirement accounts, so anybody looking for us to stimulate the economy beyond what putting a couple of kids through college is doing is barking up the wrong tree. We have prevented many “unnecessary” costs by not having cable tv or phone dataplan service and by keeping cars for 7-10 years.

    I figure that this savings rate plus one-half of the promised Social Security payments would allow us to live relatively comfortably but without many extras. If we get anything close to the pension plan assumptions, we will be able to retire by age 62 and have a grand time.

  13. Non Sequor says:

    I work as an actuarial analyst on pension plans , primarily in the public sector.

    The 8% return assumption which is typical of a public pension is not expected return over 5-10 years. It is intended to be an expected “long run” return for more than 30 years. There’s some confusion in terminology since what the investment side considers to be long run (5-10 years) is short to medium run for pension actuaries. Short run variation from the assumption is a problem, but it is a manageable one, so long as long run outlook is grounded and adequate funding discipline is maintained.

    Looking at the past century, domestic equity return has averaged about 9%. I haven’t seen as much data on bonds, but they are at some point expected to start offering non negligible real returns. Probably not tomorrow, but some day. On top of your bread and butter domestic equity and bonds you can eke out a little more return with a small asset allocation to riskier asset classes.

    If you study pension funding you see that it works out if the plan hits it’s long run return and maintains an amortization schedule that pays down unfounded liabilities on a time frame that’s reasonable given the remaining lifetime of the plan’s participants.

    As for the expected return in corporate pensions where it’s basically explicitly a single year expected return: that’s all total garbage. The FASB pension rules are an abomination that show no semblance to actuarial principles.

  14. dead hobo says:

    In essence, when you spoke to the pension pros, you were the only one NOT in on the joke.

  15. [...] fund managers need some lessons in basic math.  (Big Picture, [...]

  16. Orange14 says:

    I’m in the lucky 0.1% having recently retired with a fully funded pension and health benefits (and it wasn’t a union job!!). I get to go on the Medicare dole this year as well!!! Kids are finished with college and the house is paid off. That being said, I’m incredulous that anyone in America who is drawing a breath today can vote for anyone of these Republican candidates come November. The country is in bad shape and to leave things up to the Tea Party is a recipe for disaster.

  17. DeDude says:

    That is why all defined benefit plans should be converted to defined contribution plans owned by the employee. The only defined benefit plan should be social security and we should demand that all public employees participate in social security. All the defined contribution plans should be forced to mail out standardized annual statements that use a pessimistic, a realistic, and an optimistic set of assumptions to tell people what they can/should expect to have accumulated by specific ages – and what that would turn into as a life-time annuity. Links should be given for websites that allow people to play with the assumptions. Defined benefit plans are a scam that puts out bigger promises than they can or will fulfill. A lot of public employees are finding that out the hard way these days, as the same politicians who failed to tax sufficiently to fully fund the promises they had given those employees, now are saying that they have to run away from these promises because there is not enough money.

  18. Non Sequor says:

    @Orange14
    That’s great to hear although be wary, unlike pension benefits which are guaranteed (subject to some restrictions) there are no guarantees for retiree health benefits and they can be cut retroactively. Make good use of that coverage but don’t plan your finances assuming it will always be there.

  19. Francois says:

    @David Merkel:
    “To some degree, I fault the accounting and actuarial professions for this.”

    Accountants and actuaries have always been told in no uncertain terms to “get with the program” if they knew what’s good for them. We saw a glaring example of that phenomenon during the financial crisis where the mark-to-BS became the norm in the banking industry, thanks to a compliant CONgress who leaned without mercy of FASB.

  20. BennyProfane says:

    @Non Sequor

    Thank you for telling us how badly your profession has screwed things up.

    To coin a cliche that has been used a lot lately, “In the long run, we are all dead.”

  21. Northeaster says:

    BR,

    I mentioned your National Association of State Treasurers presentation to my State Reps. and State Treasurer (and others), where we have 8.25% ROI expectations. I challenged them to provide any evidence to show that our public pension system was mathematically sound…no replies, from anyone.

  22. dead hobo says:

    http://bcs.wiley.com/he-bcs/Books?action=resource&bcsId=6326&itemId=0470587237&resourceId=24599

    Intermediate Accounting, 14th Edition
    Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield
    March 2011, ©2012

    The link should be the powerpoint slides from chapter 20, taken from the student companion site. This is probably the most complicated chapter in the text, but the slides are pretty good and communicate the material as clearly as it can possibly be communicated.

    This will explain why small loses are taken immediately, big losses are taken over time, and certainly confuse everyone.

  23. Frank_Keegan says:

    What nobody knows for sure yet is who the joke ultimately will be on. State and local officials just assume it will be on taxpayers, who can be forced to continue funding folly forever. That can change abruptly, as history shows. The fact is that to get their 8% assumption from 2006 through 2036, public pensions will have to perform beyond any 30-year period in history. It’s looking more and more as if historic investment performance is made in the coming decades, it will be more likely through record lows. No matter, they will merely keep taxing the hopeless, beleaguered, dwindling number of private sector workers who will docilely labor unto death, right? Based on Q3 ’11 performance, the latest report available, how much does each of us now owe on this public pension crisis? Take a look:
    http://watchdog.org/12634/commentary-happy-new-year-suckers-pay-up-your-share-of-public-pension-crisis-now-424500/

  24. decius says:

    Would love to read the analysis on low yields and their impact on traditional portfolios that Andrew Lapthorne refers to in the quoted text, but I’ve got no idea how to get access to it. Is there an equivalent writeup somewhere?

    While 8% yields are obviously laughable in the current environment, what individual investors have been told to do is the same thing we’ve always been told to do – just wait – it will change. Lapthorne seems to be saying no, it won’t. Its time for new basic assumptions.

    If individual investors should remake their personal savings assumptions based on a 3% long term yield going forward, well, its hard to overstate how important and useful that information is. If its accurate, it should be the dominant meme. Those of us were not born early enough to have a corporate pension are responsible for our own equity return assumptions.

  25. tom brakke says:

    As I wrote in my post the other day, it should be standard practice for there to be a haircut off of even a reasonable estimate of future returns: http://researchpuzzle.com/blog/2012/01/03/the-haircut/.

    To use unrealistic returns with no haircut is really malpractice, and there are lots of enablers that are supporting that misguided approach.

  26. tippet523 says:

    I just plugged in a lifetime annuity with NML and 1,000,000 provided lifetime income of 49,000 a year.

    This is considerably lower than 8.25%. None of the consultants who say 8.25% have to produce that kind of return. They would be out fo business very quickly

  27. Non Sequor says:

    @BennyProfane

    Bare with me here a moment.

    Imagine your on a rocket to another planet. Periodically hazards knock you off course but by constantly keeping track of your position and velocity and through careful use of fuel you maintain a trajectory toward your goal. Now, whether you like it or not, before you start that trip, you need a reasonable estimate of the rate at which you will have to burn fuel to make it to your destination.

    When you’re taking a long trip it’s unavoidable that you have to make long term plans about variables which can vary wildly in the short term. It’s an inherent part of the problem. Retirement planning has this problem. An individual planning for retirement independently has to either implicitly or explicitly assume some rate of return for their money over the remainder of their 40+ year working lifetime and a pension plan has to consider this parameter over the remaining lifetime of participants in various stages of their lives.

    I agree that nothing lasts forever and longterm thinking can’t ignore the short term, but when you are dealing with objectives that are many years in the future, the longterm parameters have to be given the heaviest consideration.

  28. AHodge says:

    nice, real nice, brilliant
    back in the day, people saved and invested to get the cash flow from those investments.
    that cash flow isnt going to be that different than dollar GDP growth over the cycle–say 5-6% now
    you get more only by
    1 levering and underpaying the debtholders
    2 getting in really great sectors
    3 investing overseas-if its booming and you know the risks (not)

    its more than the state treasurers buying their own bullshit
    this is the standard “big lie” intoned by all CPA s stock analysts etc etc as to earning going up double digits
    so stock prices will average up double digits
    all pensions can realize those big bogies
    return on equity overall or for your own compny targetcan be 12-15%

  29. Non Sequor,

    I appreciate the Orthodoxy of your POV, though, you may care to read some of..

    Disciplined Minds: A Critical Look at Salaried Professionals and the Soul-Battering System That Shapes Their Lives
    January 5th, 2012

    Be warned: If you are having difficulties with maintaining appearances at work, this book won’t make it any easier.

    Via: Disciplined Minds: A Critical Look at Salaried Professionals and the Soul-Battering System That Shapes Their Lives by Jeff Schmidt:

    For understanding the professional, the concept of “ideology” will emerge as much more useful than that of “skill.” But what is ideology, exactly? Ideology is thought that justifies action, including routine day-to-day activity. It is your ideology that determines your gut reaction to something done, say, by the president (you feel it is right or wrong), by protesters (you feel it is justified or unjustified), by your boss (you feel it is fair or unfair), by a coworker (you feel it is reasonable or unreasonable) and so on. More importantly, your ideology justifies your own actions to yourself. Economics may bring you back to your employer day after day, but it is ideology that makes that activity feel like a reasonable or unreasonable way to spend your life.

    Work in general is becoming more and more ideological, and so is the workforce that does it. As technology has made production easier, employment has shifted from factories to offices, where work revolves around inherently ideological activities, such as design, analysis, writing, accounting, marketing and other creative tasks. Of course, ideology has been a workplace issue all along: Employers have always scrutinized the attitudes and values of the people they hire, to protect themselves from unionists, radicals and others whose “bad attitude” would undermine workplace discipline. Today, however, for a relatively small but rapidly growing fraction of jobs, employers will carefully assess your attitude for an additional reason: its crucial role in the work itself. On these jobs, which are in every field, from journalism and architecture to education and commercial art, your view of the world threatens to affect not only the quantity and quality of what you produce, but also the very nature of the product. These jobs require strict adherence to an assigned point of view; and so a prerequisite for employment is the willingness and ability to exercise what I call ideological discipline…”
    http://cryptogon.com/?p=26816

    it may assist you in being able to see ‘other’ than that which is expected..

  30. Arequipa01 says:

    Asking a guy whose moniker is ‘Benny Profane’ to ‘bare with me’ is just begging to get a pair of stretched-out tighty-whiteys tossed in your face.

    BEAR- as in furry animal or to be indulgent, endure…

    otherwise, fine argument, I suppose, for an actuarial…

  31. theexpertisin says:

    They have to prop up the 8% assumption. The herds of public pension recipients want premium returns and a middle-aged retirement date for minimum payments into the system. And the states need the 8% assumption to claim thety have sufficient assets in the system to pay the benefits.

    Taxpayers=screwed.

  32. Non Sequor says:

    @Mark E Hoffer

    I work not because I need the money but because I need something to do and being influenced by my job is something I willingly accept because it’s fun to be a champion of principles you believe in I find the good in where I work and I see the bad and I try to drive it out. That’s fun.

    Do I have everything right? Hell no, ive studied enough math to understand that isn’t possible

  33. Iamthe50percent says:

    Dedude – ALL federal employees DO participate in Social Security and have since the mid 1980′s.

  34. AHodge says:

    Dear non Sequor
    while i have great respect for actuaries
    your 9% per year for a century is pure moonshine
    Bernstein and other statistically literate have debunked these flawed reported index returns with all kinds of selection bias, beloved by salesmen and repeated endlessly
    i can do this right here– what is 9% growth compounded for a century?
    i dont have my growth rate calculator
    but on extended rule of 72, a dollar doubles every 8 years
    a dollar a century ago at 9% per year would be worth roughly $6144 now
    or about 6000X
    not a believable number??

  35. Gunboat says:

    There’s too much focus on the next ten years in the pension debate. These liabilities are amortized over a max 30 years per accounting rules, but the liability is even longer than that. For most state pension systems, the pensioner has to work 25+ years to qualify for a full pension. Typically that employee lives for another 15 years in retirement. So we are looking at a 40 liability, not ten.

  36. NoKidding says:

    @AHodge,

    If he’s who he says he is, there is no surprise in calculating compound interest.

    I think 9% per year is perfectly believable, in nominal terms.

    Picking the last 10-year period as a baseline is as foolish as picking 1990-2000.

    If there were not some form of inflation event in the next two decades, I would be shocked ito a coma.

  37. rd says:

    AHodge:

    The DJIA was worth a bit over 80 in 1910-1912. It is worth roughly 12,000 now. That is a bit over a 5% compounded return over the past century.

    However, it does not include ANY dividends. I believe that the DJIA has averaged about 4% dividends over the past 100 years.

    So, yes 9% annualized return for the past century is actually reasonable and may be on the low side if it is assumed that the dividends were re-invested and compounded. It does assume that the dollar went in and all dividends and nothing was ever sold which is generally not possible.

    Within that 100 years, there is a lot of variability in the rolling 10 to 30 year periods which are the really critical periods for individual investors who have defined accumulation and payout periods that are of those magnitude. So both Bernstein and the actuaries are right.

    So the real question is whether or not an assumption of 9% for the next 50 to 100 years is reasonable.

  38. DeDude says:

    Iamthe50percent;

    Yes and that is good since Federal employees are a sizable portion of public employees. I think a lot of state workers are also in the SS system, but I have heard of municipalities where they are not part of SS. I am not sure how many workers are still not participating in SS but it is an absolute must in order to shift from defined benefits to defined contribution. You have to give people a predictable piece that will keep them out of poverty no matter what the markets do.

  39. BennyProfane says:

    @Non Sequor

    I have another cliche for you: Past performance doesn’t guarantee future results. The 20th was a pretty good century, even including the depression. Many think, including yours truly, that the 21st won’t be for our stock market. Certainly not the early part, when 73 million Boomers on your spaceship to Mars are in the end game, and cashing out. Those have been the retail investors that have driven the market for the past 30 years, and now they need more than zero on their returns to just eat well in old age. Trust me, pension fund managers, both public and private, are privately freaking out about this little tsunami of pensioneers they have to take care of for the next 30 years, and many are doubling down on the most risky of investments to somehow reach 8%. I don’t think that’s going to end well.

  40. BennyProfane says:

    @Arequipa01

    I see that you are not well read in contemporary literature. Too bad.

  41. AtlasRocked says:

    Good post, BR.

  42. AtlasRocked says:

    @Dedude – what is special about govt ROI? On what fiscal foundation does SS get to create returns that the private market cannot?

  43. Non Sequor says:

    @BennyProfane

    Past performance doesn’t have to guarantee future results, it’s just your starting point for establishing your expected cost which is revised over time. As the outlook changes, you revise your assumptions to maintain your trajectory. A lot of the plans that were at 8% are now at 7.75% or 7.5% and the ones that were at 8.5% are coming down to 8%. That trend will continue if thing stay this nasty and the framework is in place for the plans to survive this transition if they don’t do anything too stupid.

    The stock market has survived retail investor flight before. So long as there is still hope of growth and human progress (and I believe there still is), there’s still going to be risk premiums and a way for a fund to earn a decent return.

  44. howardoark says:

    Most pension plans are only partially indexed against inflation. Who here thinks that we won’t see a few years of 17% inflation over the next few decades? Julia Chestnutt is correct in believing that her husband’s pension will be stolen – though the taxpayers in their 30s trying to raise children probably won’t look on it as theft.

  45. Iamthe50percent says:

    @Everyone who thinks there must be inflation in the next ten years

    How much inflation has there been in Japan for the last twenty years? That’s the path we are following and will follow until the TBTF banks are broken in bankruptcy court and their worthless derivatives are declared worthless. THEN we can start rebuilding the American economy without the Vampire Squid sucking all the blood out.

  46. 873450 says:

    There is still a way 99% of senior citizens eating dogfood living in dumpsters can be blamed on public school teachers.

    Children should not be taught reading and writing, particularly fiction, until after arithmetic is drilled into their heads. Imagination can be a dangerous thing. Imagination got 99% stuck with the wrong side of TBTF’s synthetic CDO forced down its throat.

  47. Arequipa01 says:

    V stands for v^gina?

    “The receptionist, a slim girl who seemed to be all tight – tight underwear, stockings, ligaments, tendons, mouth, a true windup woman – moved precisely among the decks, depositing applications like an automatic card-dealing machine. Six interviewers, he counted. Six to one odds she drew me. Like Russian roulette. Why like that? Would she destroy him, she so frail-looking, such gentle, well-bred legs? She had her head down, studying the application in her hand. She looked up, he saw the eyes, both slanted the same way.

    “Profane,” she called. Looking at him with a little frown.”

    Preferred Mason & Dixon

  48. bonzo says:

    Not a lot of financial intelligence here. 8% is NOMINAL. Very easy to achieve 8% NOMINAL return if you have 12% inflation and 8% t-bills. Just put everything in t-bills. Of course, that means the pension recipients are screwed to the tune of 4%/year, so that their pension is worth only about 66% of its original value (in REAL terms) after 10 years. Some pension recipients have COLA provisions and courts may rule that these provisions cannot be changed retroactively. Very well. Pull an Argentina and manipulate the CPI. The Republicans have long been trying to move us towards a South America style banana republic, so I wouldn’t be at all surprised to see something like this happen. It will probably also happen in Europe, eventually. Inflation is easier than default and the Europeans are bound to eventually opt for the easier course.

    Japan is sui generis. Highly disciplined, racially and culturally homogeneous, xenophobic, massive net creditor, mercantilist, centrally planned by an elite bureaucracy. A lot different from the US or most of the European countries. Paying off pensions means redistribution of income from young to old. In Japan this was okay, because Japan is like one big family, due to its racial and cultural homogeneity. Either tax the young to pay pensions, or the young have to support their parents using take-home pay. Redistribution is likely to be far more controversial in the United States and most of the European countries.

  49. AHodge says:

    tks for comments
    but the dow is itself subject to selection bias-its an attempt to pick most solid companies
    And you cant own it with all its regular changes cost free
    many of the pump and dumps are dropped out before they go to zero–you should be so lucky.
    And especially early in history
    they statstically switch the base companies in and out before they announce to the world and get mkt kick both ways
    there are also questionable split and reverse split practices
    as for dividends id be amazed if there was a 4% average yield for a century…

    the basic rule is stock returns will trade in line with their operating earnings growth over decades
    if there are embedded capital gains like Japanese zaitech they will eventually turn into capital losses
    operating and total earnings growth will not deviate that much from GDP growth
    otherwise the profit share of GDP would look goofy

    if you learned the wrong lesson from the roughly1980 2000 market boom interest rate collapse period
    that will be too bad for you

  50. AHodge says:

    let me rephrase that.
    if you and the actuaries learned the wrong lesson from 1980-2000, too bad
    if bernstein were still around i doubt he would say he is in agreement w the above
    said to be from actuaries
    you might get the woody allen repeat
    “sir you know nothing of my work”

  51. river says:

    I am a couple days late to this, but I am curious as to this article written by Dean Baker . . .http://www.cepr.net/documents/publications/pensions-2011-02.pdf

    On page 7 of the attached .pdf, we have this:

    “The fourth column projects the nominal return for the pension portfolio as a whole. The calculations assume that two-thirds of pension assets are held in equities or assets that might be expected to give a comparable return, such as hedge funds. It assumes that the other third is invested in long-term Treasury bonds (National Association of State Retirement Administrators 2010, Figure J). It projects an average interest rate of 5.0 percent for 30-year Treasury bonds (roughly a half percentage point higher than the current rate), following CBO’s projection that interest rates will rise back to more normal levels in the next few years.”

    “These assumptions imply an average return of 7.3 percent. While this is somewhat lower than the 8.0 percent return that is commonly assumed by pension funds, it is worth noting that the inflation assumption in this calculation is considerably lower than what most pension funds use in their
    projections. Most pension funds assume an inflation rate of between 2.5 to 3.0 percent, compared to the 2.0 percent inflation assumption in this analysis. This means that the slightly lower assumption on returns would be offset by the lower assumption on costs due to a lower rate of inflation.”

    This article seems to say that the 8% assumptions are just fine, so just curious if I am reading this right or is the difference simply between “real” returns and “nominal” returns, and this article seems to think the 8% is nominal (before inflation adjustment)?

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    BR: BTW, when was the last time the 30 year bond yielded 5%? (Its 3.016% now)