For years multiple studies have indicated that many public and private pension plans are woefully underfunded and potentially unable to pay their participants their long awaited lifetime of pension payments.  For 14 years the American Academy of Actuaries and Society of Actuaries were engaged in a task force study to determine the extent of pension projected under-funding.

In the Wall Street Journal article titled, “Covering Up the Pension Crisis” they state:

On Aug. 1, the American Academy of Actuaries and the Society of Actuaries shut down a 14-year-old task force on pension financing when several members were about to publish a paper that found many state and local retirement systems calculate their obligations using overly optimistic future rates of return. The authors want states and municipalities to adopt new valuation standards that would make projecting the cost of future benefits more predictable.

The game pension trustees have been playing for decades is projecting higher future portfolio returns to balance the deficit of current assets to future pension distribution obligations.  Now, if you are younger than 40 years of age and don’t work for a union or the government, you are not likely concerned about bankrupt pension plans.

However, there are some key points to learn about the mistakes made by the pension trustees as your building personal wealth and planning for retirement.

First, the problem that got the trustees in trouble in the first place is “over promising and under delivering”.  Most pension plans were doomed from the start with flawed projections of unrealistic portfolio returns and life expectancy.  Their investments were not providing the net returns they expected (possibly diluted by high fees – another topic to discuss), and their participants were living too long.  Not enough money to pay out benefits for longer periods.  In building personal wealth, it is critical to have a plan.  However, a flawed plan is worse than no plan at all. Trustees based the future growth of their portfolios on what proved to be unrealistic.  Actuaries think in straight line linear terms projecting clean incremental daily gains in portfolio value.  However, investments and economies experience less clean and predictable ebb and flow cycles.  Since 1826 the US has experienced macroeconomic growth and contraction cycles with an average duration of 17 years.  If you are basing a 5 – 10 investment average return it is important to know what macroeconomic cycle you are in and will be retiring.

If your working years were in the last macro growth/expansion cycle from 1982 to 2000 your investment performance in many asset classes including stocks and real estate performed well.  During this cycle the Dow Jones increased 10,647 points for an average annualized compounded return of 15.5% not including dividends.

DJIA 1982 - 2000

DJIA 1982 – 2000

However, in the current macro stagnant/contraction cycle since 2000 the Dow Jones annualized compounded return through August 31, 2016, is 3.3%.

DJIA 2000 - 2016
DJIA 2000 – 2016

Imagine the devastation to 1982 -2000 era retirees expecting to continue earning 15% or even 8% on their investments only to have possibly lost 50% of their portfolio in the 2000 technology bust, the first year of their retirement, and possibly again in the 2008 financial crisis.  Even if the retiree held their stock portfolios through these highly volatile and challenging periods, their reward would most likely still be an investment return significantly less than their original projections. However, the reverse scenario is developing for future retirees in the positive in which as they project very conservative and modest investment returns experienced during this contraction/stagnant cycle, their retirement years may be during the next growth/expansion cycle and enjoying higher returns than expected.

Accountants have a saying,“figures don’t lie, but liars can figure.”  As you develop your financial plan or work with your investment advisors (non-commissioned based I hope), understand that projected returns and investment strategies will differ during growth and contraction macroeconomic cycles.  Ask your advisor how these strategies differ during growth and contraction cycles.  If the answer is, “none”, or worse a blank stare,  you may be creating a flawed plan resulting in the same dilemma at retirement as trustees are now with ill-conceived projections and underfunding.  In sports, strategies change from game to game and team to team.  Some days the team is killing it running at peak performance.  The next game with the same players there’s no energy or enthusiasm.  Cycles exist and understanding them as it pertains to economics and investments is critical for long-term success.  Successful coaches study their opponents, the field conditions, and most importantly understand that their team will fluctuate in performance and plan accordingly.  You need to do the same with your planning.