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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You just sent an incredible message: that quality journalism doesn't have to answer to advertisers, billionaires, or hedge funds; that newsrooms can eke out an existence thanks primarily to the generosity of its readers. That's so powerful. Especially during what's been called a "media extinction event" when those looking to make a profit from the news pull back, the Mother Jones community steps in.

The months and years ahead won't be easy. Far from it. But there's no one we'd rather face the big challenges with than you, our committed and passionate readers, and our team of fearless reporters who show up every day.

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