I’m still mostly on a blog sabbatical, but here is a good article I saw this weekend related to one of my pet topics: PERS. The author is John Mauldin, who is a deep thinker on financial topics.
The article attacks the 8% investment assumption that Mississippi and many other states follow. It contains a great explanation of why it’s a problem when the assumption is not met:
To illustrate the effect that investment return has on supplying funds for retirement benefits, consider the following example. Assume for simplicity that the time horizon is thirty years. That’s about the amount of time from the first dollar of wages to the first dollar of retirement. It’s also about the time from the last dollar of wages to the last dollar of retirement. Clearly there are other considerations including wage gains and retirement benefit adjustments, yet thirty years provides a representative example.
One dollar grows to just over $3 after thirty years of investment returns at 4%. But, the same dollar grows to more than $10 after thirty years when returns are 8%. That is more than three times the assets to pay retirement benefits. Investment return does not change the amount paid in retirement benefits, it only changes the amount of funds provided by investment returns. The difference must be provided through additional contributions.
And this bombshell:
All in, depending upon the relative mix of investments that are used, the blended rate of return will more likely be 3% to 5% instead of the 7.5% to 8% currently assumed by most state pension plans.
The result is an ongoing gap of near 4% annually that will cause an ever-widening shortfall for state pension plans. The problem is not a gap created by a unique event in 2008, but rather it is the result of an environment that started about a decade ago.
That gap, moreover, will not move at glacial pace presenting a subtle 4% shift each year. Rather, with the force of an earthquake, periodic market declines will reveal large chasms. Subsequent surges may cure much of the hole until the next plunge. Yet over time, the gap will never seem to close and will attract excuses for why it is widening. Hope will spring eternal as the ship slowly succumbs to drowning waters.