The Persistent Pension Fund Doublethink Behind the 7.0% Per Year Projection

Edward Ring

Director, Water and Energy Policy

Edward Ring
January 10, 2013

The Persistent Pension Fund Doublethink Behind the 7.0% Per Year Projection

“Doublethink means the power of holding two contradictory beliefs in one’s mind simultaneously, and accepting both of them.” ― George Orwell, 1984

The two largest public employee pension funds in California, CalPERS and CalSTRS, logged annual returns for their fiscal years ending June 30th, 2012, of 0.14% and 1.8%, respectively. These pension funds employ an official rate of return projection of 7.5% per year. Could “doublethink” account for this continuing failure of high expectations to match cold reality? Because according to generally accepted numerical logic, 7.0% = 1.0% times seven.

There is no variable affecting pension solvency, or explaining why they are woefully underfunded today, more significant than the rate of return. None. Nothing comes close. Not “pension holidays,” not even the retroactively granted benefit enhancements. If pension funds can actually deliver 7.5% returns, on average, for the next 20-30 years, then every other challenge they face is manageable. But they cannot. Here’s why.

The economic growth that fueled stock market appreciation between 1980 and 2008 was based on two factors that cannot be repeated for at least a generation, if ever – debt accumulation and a demographic explosion of baby boomers entering the workforce.


Shown below, courtesy of the U.S. Census Bureau, are two charts, one showing the age distribution of the U.S. population in 1980, and one showing the projected age distribution of the U.S. population in 2030.

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Unlike pension fund return on investment projections, one can quite accurately project the size of America’s aging population 18 years into the future, because these people have already been born and already live here. And the contrast between the age distribution of the United States population in 1980 vs. 2030 is dramatic. In 1980 the percent of Americans over age 65 was 11%. By 2030 the percentage of Americans over age 65 will be 20%.

The fact that there will be twice as many people – as a percentage of the population – selling assets to pay for their retirements, instead of buying assets to save for their retirements, is going to fundamentally shift the dynamics of the investment markets. Another contributing demographic factor may be that the average retirement age will probably be lower in 2030 than it was in 1980, skewing the ratio of sellers to buyers even further. And this same trend will occur throughout the world – more severely in virtually every other developed nation.

This titanic demographic shift to a more aged population, where more people are going to be selling their investments to pay for their retirements, will exert downwards pressure on asset values and returns. But that is only half the story.


The other reason the investment environment has changed is because we are exiting a 30 year cycle of net borrowing and entering an era of deleveraging. The next chart shows the “total credit market debt owed” in the United States. This total consolidates money owed by all borrowers in the U.S. economy; government, consumer, commercial, and financial.

As shown (above), in 1980, total debt in the United States was about $5.0 trillion. By 2012 it had reached $55.0 trillion, an increase of more than ten times. To put this in perspective, it is helpful to compare the amount of debt carried by the U.S. economy to the size of the U.S. gross national product (GDP), since that would be a good indicator of how much money is available to service this debt. The next chart (below), using World Bank data compiled by Google, shows the U.S. GDP growth since 1980:

As shown on the above chart, in 1980, U.S. GDP was not quite $3.0 trillion, whereas by the end of 2011, GDP grew to just over $15.0 trillion. This means that the ratio of debt to GDP in 1980 was 167%, and by 2011 it had grown to 367%. By comparison, on the eve of the great depression in 1929, the ratio of debt to GDP in the U.S. was not quite 300%. It isn’t clear just how much more debt Americans can accumulate. But it is safe to say that debt formation in the U.S. is not going to increase as a percent of GDP at the rate it did between 1980 and 2008. This has negative implications for the broader ability of the market to deliver strong returns on investment.

When debt is accumulating, this means cash is being injected into the economy. From 2nd mortgages to zero percent financing on durable consumer goods, to cities and counties issuing bonds because they enjoy viable credit ratings, all of this cash breathes life into the economy. In the short run – which is this case lasted nearly 30 years – debt financed cash infusions stimulate consumption which in-turn causes corporate profits to increase, elevating their stock prices; it also stimulates investments, bidding the prices up for assets such as real estate, elevating returns to real estate investors. But once debt levels inevitably stabilize, drop, or even just don’t increase as fast anymore, economic growth slows proportionately.

It is important to also note that because interest rates are so low, debt repayments cannot possibly be a source of robust returns on investment. A treasury bill pays 2%; a certificate of deposit or mortgage loan pays 3%; a corporate bond pays 4%. A municipal bond pays 5%, but they are risky and getting riskier. From whence cometh the “risk-free” 7.5% annual return for pension funds? Not from anything relating to the leveling off or pay-down of $55.0 trillion in debt.


A thorough exploration of what these demographic and debt megatrends have done to returns on investment, and what they’re going to do, would require volumes. Instead, just take a look at what has actually happened in the stock markets for the last 12 years, during the same period that CalPERS, CalSTRS, and every other pension fund in the United States claimed they were able to earn a “risk free” rate of return of 7.5%. The next chart shows the three major U.S. stock indexes for the last twelve years:

While one glance at this chart ought to say it all  –  FLAT  –  here are the numbers:

  • The Dow Jones increased from 11,722 in January 2000 to 12,938 in December 2012, an increase of 10.3% over thirteen years, an annual rate of return of 0.76% per year.
  • The NASDAQ decreased from 4,064 in January 2000 to 3,102 in December 2012.
  • The S&P 500 was almost perfectly flat, moving from 1,441 in January 2000 to 1,446 in December 2012.

Perhaps pension fund managers aren’t engaging in “doublethink” when they look at returns of 1.0% and claim they will nonetheless earn returns of 7.0% or more. Maybe they feel the markets are just “taking a breather.” They’d better watch out. The Dow Jones stock index didn’t return to its 1929 high again until 26 years later, in 1956. Not only do we face similar challenges today that we faced then – crippling levels of debt and a slowing global economy – but unlike back then, we are shifting towards a permanently enlarged percentage of our population who will be sellers in the market instead of buyers.

Even if the masters of the universe who manage our public sector pension plans can beat the market and restore their solvency, or even if the market suddenly roars upwards and pushes pension funds back into positive territory on nothing but momentum, questions abound. Because if taxpayer guaranteed public sector pension funds beat the market, it is axiomatic that every other investor in the market will be the reciprocal victims – presumably the private sector taxpayers who also have to save for retirement. And if the market is going to roar, what will help it get there?

If our economic future is challenged by debt and demographic trends as never before, and it is, one thing is certain: We’ll be far more likely to stimulate economic growth through allocating our investments of public dollars into, for example, freeway upgrades to accommodate cars capable of driving on autopilot, than, for example, paying a six-figure pension to a fifty-something retired public servant who wants to buy a vacation cabin on the shores of Lake Tahoe.

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