The Pension Rate-of-Return Fantasy

[akck]

I found this article about pension plan returns:

Andy Kessler: The Pension Rate-of-Return Fantasy - WSJ.com

But, this paragraph caught my attention:

Who wouldn't want 7.5%-8% returns these days? Ten-year U.S. Treasury bonds are paying 1.74%. There is almost zero probability that Calpers will earn 7.5% on its $255 billion anytime soon.

The basic premise here is that with bonds having such a low rate of return (negative real return), there is no way for a standard asset allocation will earn the return expected.

In thinking to our own investment allocation, those keeping a large fixed income percentage will at some point see a hit to their return when rates rise. Has anyone adjusted their asset allocation in preparation for this?

A few years ago, I started to increase my fixed income allocation in preparation for retiring in 5 years. Last year, I began shifting my allocation away from bonds and into dividend producing stocks, figuring appreciation wasn't the goal, just maintaining value. I'm also keeping 1 to 1-1/2 years of cash (or cash equivalents), figuring dividends will provide 1/2 year over that period. When bond rates go up to the point they exceed my dividend return, I'll shift back to a standard bond allocation.

[Fishingmn]

My solution was to stick a bunch of money into rental properties where I now have about 40% of my retirement money. Getting about 9% returns (conservatively) not counting the depreciation writeoffs and appreciation. Nice thing is that if inflation goes up rents go up too.

These aren't for everyone as it does require some work as a landlord (or lower returns to hire it out). Plus, it was easy to find good properties 2 years ago when I started but the lack of properties for sale, increasing prices and glut of investors has made it harder to find good ones (at least in my market).

[heeyy_joe]

I still like preferred stocks. www.quantumonline.com

[W2R]

Quote:

Originally Posted by akck In thinking to our own investment allocation, those keeping a large fixed income percentage will at some point see a hit to their return when rates rise. Has anyone adjusted their asset allocation in preparation for this?

No, but then I tend to be a scaredy-cat in general when it comes to retirement income, so to be honest 2% income from my portffolio seems about right to me, not 7.5%. If there was no inflation and zero return, that would last me 50 years, right? Inflation is a concern too.

Still, I can regard all this with relative equanimity because I have not yet claimed SS. With a paid off house, here in the South I think SS plus my tiny federal pension would be enough for bare bones living expenses. My portfolio is icing on the cake. As for what the future holds, I am watching from the sidelines. Pass the popcorn, please! I hope to be here long enough to see all of this play out, for decades.

P.S. - - if the US defaults on my federal pension and SS, and if my diversified 45:55 investment returns fall apart at the same time, and it stays that way for more than the several years in cash that I have on hand, then we have more troubles than I can even imagine. I am not going to waste my life worrying about that, or about an asteroid hitting me either.

[Midpack]

The article is about public pensions, specifically CA. I doubt there are many retirees (or investors in general) relying substantially on their $ portfolios who are planning on anything like 7.5%, we sure aren't. I use 0-2% real returns, and have for many years. YMMV

I remember when folks were posting articles casually assuming 10%-12% equity returns as a given 10-20 years ago too...

[jebmke]

Quote:

Originally Posted by Midpack The article is about public pensions, specifically CA. I doubt there are many retirees (or investors in general) relying substantially on their $ portfolios who are planning on anything like 7.5%, we sure aren't. I use 0-2% real returns, and have for many years. YMMV I remember when folks were posting articles casually assuming 10% equity returns 10-20 years ago too...

It has been a couple years since I did any projections but I think I used 1% real for my 40/60 allocation.

[pb4uski]

Quote:

Originally Posted by akck .... In thinking to our own investment allocation, those keeping a large fixed income percentage will at some point see a hit to their return when rates rise. Has anyone adjusted their asset allocation in preparation for this?

Sort of. Now mostly in mid duration corporate bonds. My return will likely exceed 7.5% for this year and last, but I don't expect it too last.

[David1961]

Quote:

Originally Posted by akck In thinking to our own investment allocation, those keeping a large fixed income percentage will at some point see a hit to their return when rates rise. Has anyone adjusted their asset allocation in preparation for this?

The only thing I have done is increase my cash a little bit. Plus, most of my bond holdings are short term, so hopefully they will not be affected as much as longer term bonds when rates go up. For the past few years, stocks have more than made up for the lower return of bonds, but that won't last forever.

[braumeister]

Like W2R, I tend to be super-conservative.

All my projections assume 0% real return (just equal to inflation), and I also assume that my pension and Social Security COLAs will be only half of inflation.

Sure, I've been pleasantly surprised so far, but I just can't bring myself to assume any better than that. I've seen several older relatives run out of money in their old age (they were well off when they retired), and that isn't going to happen to me.

[akck]

Quote:

Originally Posted by Midpack The article is about public pensions, specifically CA. I doubt there are many retirees (or investors in general) relying substantially on their $ portfolios who are planning on anything like 7.5%, we sure aren't. I use 0-2% real returns, and have for many years. YMMV I remember when folks were posting articles casually assuming 10%-12% equity returns as a given 10-20 years ago too...

Most of the asset allocation models I've seen were developed with interest rates in the 4-7% range. While most here don't expect 7+% returns, a fixed income allocation with negative real returns will have an effect on your overall return.