Lies, Darn Lies, and Statistics- The Intersection of Politics and Investments

Most of us use 401(k) plans or some such defined contribution type plan to save for our retirement. That is – we contribute money from our paycheck, it is invested in the market, and when we retire that is what we live on. If we don’t have enough money in our account when we retire – too bad. We need to reduce our standard of living or find part-time employment while in retirement. It hasn’t always been this way. Up until a few decades ago, many private workers had pensions, provided to them by their company. Now, pensions exist mainly for Government workers. But there is an arcane calculation and that is where Government(s) are setting us all up for some serious pain. A private corporation is required to perform a complex calculation that takes into account the number of workers in the plan, expected retirement age of the work force, the amount of money set aside in the pension plan, and most importantly (and here’s the important point) how much the money in the plan will grow. This is called a pension plan return assumption.

Private corporations are required by law to use a reasonable return assumption in their pension plan and it must be grounded in reality. Generally speaking, companies assume that their pension funds return 6% or 7% or some number like that each year. If the plan performs worse than that, the company literally has to dip into its own pocket to make the plan whole. In case you were wondering, on average the U.S. stock market has returned on average about 7.5% per year (emphasis on the word “average”) since 1929. In summary, any corporation who assumes their pension plan will return 7% per year is probably on safe ground, 5% would be considered a conservative, and 9% would be a very aggressive assumption.

Regulators (mainly the SEC and their friends in the criminal division of the Justice Department) don’t look too kindly on expecting a 9% return on a pension plan and only delivering 4%. Neither do investors in the company. So there are powerful forces making sure that corporations use achievable assumptions in their pension plan.

Here’s the outrageous part. Nearly every Government worker is covered by a pension. Most pensions don’t require the worker to contribute anything. Politicians decide what the benefit level is and the pension fund manager tries to achieve a return that will pay the benefits. Politicians like to award enhanced pension benefits to Government employees – it keeps them happy and by and large doesn’t ‘cost” Government any money. That assumes of course that the pension fund manager can get the right return. Many don’t even come close. Here’s where the outrage should begin.

As an example of exactly how out of control government pension plan assumptions are let’s use the largest public employee pension plan in the country as an example. The California Public Employees Retirement Systems (Calpers) covers a few hundred thousand current and retired California state employees. The politicians of the state of California have promised a pension level to these folks that require the Dow Jones Industrial average to reach a level of 25,000 by THE END OF 2010 to pay all the benefits that have been promised (current level for the Dow Industrial Average is around 10,000). Furthermore, the return assumption of the plan assumes that that very same Dow Jones Industrial Average will reach 595,000 by 2049. Yep. This is where the outrage should begin to build.

California’s state pension obligations have risen 2,000% over the last 10 years and this is a major reason why the State of California is in perpetual financial purgatory every year. And here’s where you should begin to get your pitchfork and your torch ready, when the pension fund manager can’t deliver the return that the politicians promised (and they can’t, won’t and never will be able to), the taxpayers of the state will be asked to make up the difference in the form of increased taxes. So let’s summarize. Taxpayers of the State Of California will have their taxes raised year in and year out, with no real relief in sight, to pay the pension of state workers, while their own 401(k) accounts are down 20%, 30%, even 40%.

While I pick on California, this same story can be told of nearly every city, county, state and even the Federal Government. All told, we could be talking about trillions upon trillions of dollars of taxes that will need to be confiscated from citizens JUST TO PAY RETIREMENT BENEFITS TO GOVERNMENT WORKERS. Does that make you mad? It should.

John Puricelli

John is a Portfolio Manager and Financial Planner for a bank trust department. Prior to his current position, he worked for a Registered Investment Advisor helping high net worth clients navigate the ins and outs of investing. Prior to that he worked for a large, national stock brokerage firm that, sadly, was recently swallowed up in an acquisition. He holds an undergraduate degree in Computer Science (don’t hold that against him) and an MBA from Washington University. He enjoys investing, politics, and all things having to do with the National Football League.