When 2018 comes in as a good year for corporate pension funds, and 2019 isn’t a good year at all, we may wonder if the people who run these funds know what they are doing.
Many people yearn for the good old days where a lot of people had a pension plan, and especially ones which were defined benefit, meaning that when they retire, they will receive a certain amount of money per month for as long as they live, like a life annuity.
Companies moved away from defined benefit plans and away from pensions entirely though, choosing to offer 401(k) retirement accounts where their employers could contribute to the plans as well by matching contributions and the employees were left to manage their own retirement portfolios.
Few people realize how much better this arrangement is. While part of the reason why so many people are disappointed with a 401(k) instead is that they see themselves benefiting less, but they first need to realize that a pension plan only pays out when they can, and we only have to look at Social Security to get a feel for how these things work.
The way the Social Security Trust Fund has been run also sheds light on the real problem behind pension fund management, which is common to both government-run and privately-run pension plans.
Now that so many people have experience deciding about their own retirement investments, rather than just giving this all over to the government or their employer, they can also more readily understand what others that handle their retirement money should be doing, and what would be needed to try to fix the big mess that still lingers and still rings pretty loud.
There are still a lot of pensions out there in the corporate world, and these pensions are underfunded to the tune of hundreds of billions of dollars. This might be a small amount of money compared to the $7 trillion shortfall with government pensions in the U.S., and the $50 trillion that Social Security is behind on, but these corporate shortfalls are still a pretty big chunk of the total assets of a lot of companies.
There is so much of a pension shortfall, not only in the United States but in the world, that some see this as a coming disaster comparable to the subprime mortgage crisis. By 2050, we’re projected to have a pension shortfall worldwide of about $500 trillion, and that is a lot of money indeed, a shocking amount actually.
To put this number in perspective, the U.S. debt is up around $22 trillion these days, and that’s a number that is scaring a lot of people, and not without good reason. The entire value of the U.S. stock and bond market combined is about $70 trillion, and we’re already up to this number these days with our current worldwide pension shortfall.
Pension Shortfalls Have Serious Consequences in the End
The reason why this isn’t as big of a potential crisis as we might think is because pensions can just pay out less if they cannot pay out their entire obligations. This is what Social Security will be doing in a few years.
This will reduce Social Security to a pay as you go pension scheme, which is where we’re headed with just about all of them eventually. This is far from a good thing but it is preferable to this bringing governments down or just conjuring up these shortfalls out of thin air and causing enough hyperinflation to bring the economy itself down.
Company pensions are a little different though as they aren’t the regulators like governments are, they are under their regulation, and the regulations that they are under aren’t so forgiving. Companies already are subject to demands from regulators to contribute additional cash to their pension plans and this may involve billions of dollars and very materially affect a company’s bottom line.
It’s not that they are required to keep their pensions topped up or even anything close to fully funded, and they use some accounting practices to get around all this. The practices involve pushing things forward to quite a degree though and may be widely practiced but this does not mean that the practices are sound enough to protect us against what we need to be protected enough against.
These obligations are long-term ones, so it’s not that unreasonable that we should build in some slack here, but what we don’t want to do is allow companies to set themselves up for failure down the road, and the size of these long-term obligations can, in some cases, can add up to two thirds or more of the entire value of a company.
Certain companies like GM, Ford, GE, and AT&T are particularly at risk for this, mostly due to their bowing to union pressure to come up with pension benefits that were definitely over-generous as it turned out. These 4 companies alone have $300 trillion worth of future pension obligations, out of a total market capitalization of $430 billion. This does sound scary, and we should be scared.
Why the 401(k) Plan Is Such a Great Idea
The coming of the 401(k) did spare us a lot more of this, and this new way of saving for retirement could even be considered a savior for people’s retirement overall, and if we all held pensions instead, we’d be a lot more worse off.
The reason behind the 401(k) claim to glory is the real reason we are in such a mess with pensions, and it’s because we get to manage our own portfolios instead of having our money in a terribly-managed pension plan.
There are some people who mix their 401(k) plans with some bonds, but if you asked anyone whether they thought it was a good idea to invest most of their contributions in treasuries and just keep doing that every year and expect to do well with this, they would at least have a sense of how crazy an idea this would be.
The most we could expect here is to not lose money, as treasuries do not produce a return even worth measuring net of inflation, and they therefore would not get the kind of growth they need to reach people’s retirement goals, or even have the potential to do so.
We might even excuse those behind Social Security for just buying treasuries with all of our money, see the fund die, and blame baby boomers, just because they can do things like this. The voting public has no idea how badly that they are being served by this, and if they can lend the money to the Treasury who holds the strings of Social Security, that’s a great deal for the Treasury, but not for us, and this is our money.
This is what we have done since the program’s inception and we’ll be doing this right to the bitter end, which is only about 10 years away by current projections. Again though, there is some pretty strong bias going on, as they have chosen to take the money for themselves instead of doing something like investing it for us.
We are just entering the period where we have to spend down the principal of the fund to keep benefits as they are, and when this runs out, benefits are going to need to be slashed but we never really will see whose hands the blood is on.
Investing this money would not only have benefited pensioners, it would have created a lot of wealth through its effect on markets as well as with investments placed in the real world.
Surely anyone who had an actual vested interest in the outcome of these investments wouldn’t be choosing to stash away a huge amount of treasuries to provide pensions. This would be eerily similar to the Parable of the Talents, where 3 servants were all given money. Two of them invested theirs and doubled their money, while the third just buried the money in his back yard.
In the end, as the story goes, even what this servant had was taken from him. This sure sounds like the Social Security Fund, but do companies commit this sin as well?
When we look at how corporate pension funds fared in 2018, an interesting story unravels. 2018 was a great year for these funds as far as their ability to reduce their pension shortfalls, which dropped by 15% during the year.
That’s great news, and given that 2019 has been such a great year, we would expect even more good results. The truth is though is that these funds are seeing themselves get in trouble in a year that it would even be hard to imagine screwing up.
This could only mean one thing, that they are very heavily exposed to bonds. Bonds have done fabulously this year though, so that only means one thing, that they are just buying and holding all of these bonds to maturity.
This wouldn’t even be as bad as it is if not for the very low interest rates that we have today and are expected to have for quite some time. This doesn’t really matter much though because even with higher interest rates, bonds don’t really yield much more than inflation and you are just spinning your wheels with this approach anyway.
If the primary goal here is to preserve capital, like it is with elderly people, then we could understand this. Elderly investors just don’t have much of a time horizon at all, and this differs entirely with pension plans, whose horizon is very long.
We need to match our investment strategy with our objectives, and therefore if you are a pension fund with its back against the wall, looking to protect your capital and assure yourself of failure is not a sensible objective at all.
One of the reasons why we have negative yielding bonds in Europe is that pension funds are mandated to buy them regardless of whether it is sane to do or not, and this has caused a lot of traders to ride the backs of them and drive yields even lower. A pension fund buying and holding negative yield bonds is clearly not in the realm of the sane, but chasing paltry yields isn’t much saner.
The real issue with all of this mess is one of a lack of awareness, where if we don’t even realize just how badly these things are run, who will speak against it?
With your own 401(k), you decide all these things, and as lacking as the standard advice out there may be, it at least makes some sense and will at least get you pointed in the right direction toward achieving your retirement goals. That’s the real reason why 401(k) accounts are such a great idea.