A Lesson in Pension Return Math

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CalPERS, the giant California state pension fund, says it expects future investment returns of 7.5 percent on its holdings. Andy Kessler says this is “fiction.” He figures 3 percent is more like it. Dean Baker brings the math:

This is a case where Mr. Arithmetic can provide a big hand. Pension funds like Calpers typically invest around 70 percent of their assets in equities, including the money invested in private equity. The expected return on stock is equal to the rate of the economy’s growth, plus the payouts in dividends and share buybacks.

….The long-term growth of nominal GDP is projected at around 4.8 percent, 2.3 percent real growth and 2.5 percent inflation….Companies typically pay out about two-thirds of their earnings as either dividends or share buybacks. With a current ratio of price to trend earnings, the yield is around 7 percent. Two thirds of this yield gives us a payout of 4.7 percent. Adding the two together we get 4.8 + 4.7 = 9.5 percent.

The problem, as near as I can tell, is that Kessler is unaware (?) that pension funds don’t invest their money entirely in treasury bonds and other fixed-income securities. They invest lots of it in equities, which have a higher return. And indeed, if you get Baker’s 9.5 percent return on 70 percent of your holdings and Kessler’s 3 percent on the rest, your average return is….

7.5 percent.

It wouldn’t surprise me in the least if CalPERS is being a wee bit optimistic in its forecasts. Maybe they really ought to be assuming 7.25 percent or something like that. But 3 percent? Give me a break.

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THE BIG PICTURE

You expect the big picture, and it's our job at Mother Jones to give it to you. And right now, so many of the troubles we face are the making not of a virus, but of the quest for profit, political or economic (and not just from the man in the White House who could have offered leadership and comfort but instead gave us bleach).

In "News Is Just Like Waste Management," we unpack what the coronavirus crisis has meant for journalism, including Mother Jones’, and how we can rise to the challenge. If you're able to, this is a critical moment to support our nonprofit journalism with a donation: We've scoured our budget and made the cuts we can without impairing our mission, and we hope to raise $400,000 from our community of online readers to help keep our big reporting projects going because this extraordinary pandemic-plus-election year is no time to pull back.

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