For many months we have recommended that investors lower their long-term return assumptions. Very simply, when asset prices are high, we can expect future returns to be lower than average. Conversely, when asset prices are low, we can expect long-term returns to be higher than average. This is axiomatic.
We are not alone in these assumptions. According to Heather Gillers of The Wall Street Journal, CALPERS, the giant California retirement fund, has lowered its long-term return target to 6.8%. The very bright people who run the fund know that they need to further lower their expectations for the next 20 years to 6.2%, but public officials throughout the state “urged the board not to further lower the rate.” Those officials know that they do not have enough money to meet the promises that they have made to their retirees.*
Cornered by political exigencies, the board has instead chosen to permanently increase risk through the use of leverage (borrowing). In a world with a surplus of irony, these shortfalls, which are hardly unique to California, coincide with a tsunami of federal money.
We all should view the CALPERS situation as a cautionary tale. We are not the same as public-employee retirement plans in the most important of ways. We do not have a time horizon that stretches to infinity, but rather the biblical “threescore years and ten.” We do not have money permanently coming into our accounts every month, but can anticipate a time when funds regularly go out of our accounts. Unless we are tech CEOs and the like, we cannot borrow against our holdings until we die.
Instead, we need to remember the fundamentals. If we are young and funding our retirement plans, we should stay reasonably aggressive, since market declines will benefit us as systematic buyers. If we are approaching the point where we will be using our assets to fund our lifestyles, we should cut back on risk. If we are already at the stage where we are systematic sellers, we should not be caught up in FOMO, the fear of missing out.
Many people will retire now that the market is high. Among them will be those who have only known the positive impact of systematic buying, primarily in employer-sponsored retirement plans. They may be fooled into overly-high return assumptions and excessively risky asset allocations. We should take the example provided to us by the folks at CALPERS and adopt a realistic view of the future.
At Treasure Coast Financial Planning, we have the many decades of experience that are necessary to be as disciplined as the CALPERS board. We are happy to help you avoid the mistake that public officials are making, which is to try to make up through risk what we have failed to achieve through planning. They may pull it off, but that will only be because they have the luxury of unlimited time.
* Gillers, H. "Retirement Fund Giant CALPERS Votes to Use Leverage, More Alternative Assets: U.S. pensions are hundreds of billions of dollars short of what they expect to need to pay public worker retirement benefits". The Wall Street Journal, Online, Markets | Finance. Nov. 16, 2021.