County Pension System Risks vs 401

B-Daddy B-Daddy 16 Comments


The U-T has a great article on changes in the portfolio mix of the San Diego County employee pension fund.  In 2009, the county fired the fund manager after losses totaling $2 billion in 2008.  Assuming that the fund had about $9 billion at the time, that is a loss of 22%, compared withan an S&P loss of 37% for the same year.  Taken in context that doesn’t seem that bad.  The new fund managers have shifted the mix to include emerging market debt (Russia, Brazil and Mexico) as well as in hedge funds.  I find the 2 basis point (2%) management fee in the new contract to be too high.  Fees are a drag on performance, and frankly, the county should be shooting for something closer to 1%.   Correction: A commenter pointed out that two basis points is .02%, not 2%. I should have checked the math. The fees compare favorably with the Federal Government’s Thrift Savings Plan. I wouldn’t mind hearing from any professional financial planners on this subject.  I am not qualified to say whether the investment strategy is good or not, I just know that above average returns generally do not prevail.

Which brings me to my main arguments for 401 style pensions. Inevitably, these fund managers are going to have a bad year, no matter how well they are doing now, and taxpayers will foot the bill.  The entire system is rigged so that the taxpayer shoulders all the risk, but the fund manager and employee beneficiaries are guaranteed their pay days.  Further, as we have seen with CalPERS pensions, which invested $500 million in green energy in 2010, investments can be influenced by political considerations, again to the detriment of the taxpayers, who are on the hook for losses.

However, under a 401style plan, employees shoulder the risk, but they can adjust their individual pension risk to their personal situation, shifting more to bonds as they approach retirement, for example.  Further, they can protect themselves by managing their own investments and avoiding high fee management firms.  This way taxpayers are protected and employees can be as well.  The counter-argument is that individual employees may not invest wisely, but I think that is changing as financial literacy is more common in the general population.  Should taxpayers take all the risk just because some employees will be foolish?  Further, the union could do an actual service to the employees by providing them with sources of financial advice.

Vocabulary clarification, I use the term 401 style, because government employee defined contribution plans are considered 401(a) plans, not 401(k) which are private sector plans.


Comments 16

  1. It’s 2 bps per quarter, so 8 bps per year. But that’s just what Partridge/Salient skims off the top for picking the managers.

    The bulk of the expenses are in the fees to the overpriced hedge fund and private equity managers Partridge picks.

  2. IMHO Public pension plans vs. 401Ks do resemble the difference between a sports car and the family sedan. Because of the generally lower expenses in pension plans and, more importantly, the fact that the longevity risk (that you have the assets necessary if you live into your late 90s) is spread throughout the pool they tend to be cheaper.

    _HOWEVER_ the problem is government is like a 16 year old driver on a learners permit who is handed the keys without adult supervision. They just have shown themselves near INCAPABLE of operating the vehicle in a way that does not shift the costs to future taxpayers and/or put the taxpayer in the position of shouldering all the risk. 401k style plans rightly get the government out of a line of business that it can’t do well.

  3. I am somewhere near this industry and Erik is right in his post. Nothing is inherently evil about either type of plan. A 401(k) style plan is cleaner, nimble, and easily portable. A pension plan is much easier to screw up by the administrators and harder to screw up by the participants. The opposite is true of a 401(k).

    It is easy to see why the right side would be attracted to a 401(k) style plan because it empowers the individual. I can see why the left likes a pension plan because they have no faith in an individual’s ability to take care of himself and prefer the power of the collective. Oh, and they can steal from it easier to pay for some harebrained program Republicans don’t support anyway. .

    Either plan can be run correctly and well.

    The reality is no matter what plan you have in place, if the wrong people continue to be elected and the wrong decisions continue to be made, bad things will continue to happen. Over and over and over and over…

  4. If one REALLY feels that government should “run the pension plan” —
    “protecting the plan participant” — not leaving much choice to the individual — then a 401k plan can be established with restrictions on what investments can be used.

    For instance, most such plans already limit the choices to mutual funds. No individual stock picking allowed. Further restrictions COULD be imposed as to what KIND of mutual funds could be used.

    For instance, choices could be limited to index funds, which have annual TOTAL management costs of as little as .08%. I don’t recommend it, but that restricted 401k plan is better than the ALWAYS CORRUPTED government defined benefit (DB) plans.

    Of course, the response to ANY 401k plan by DB plan fans is “What if the the individual loses it all?” Okay — let’s assume that I buy the S&P 500 index fund and lose it all. That would mean the stock markets aggregate value would be zero.

    How on earth could people (still) living in such a destroyed economy (we’re likely talking asteroid collisions or nucs in this case) have government pay for the “guaranteed” DB plans? With WHAT?

  5. The disadvantage of a 401K is not limited to individuals making bad investment decisions. The main problem is that the individual who is approaching retirement or is in retirement has to become increasingly safe with his/her investment options thereby limiting potential returns. With lifespans increasing, it has and will continue to become increasingly difficult to accumulate enough in a 401K to last the 20-25 years the average person will live in retirement. Being the compassionate people we are, our taxpayers will bear the brunt of these shortfalls.

  6. Hypocrisy, that is not true. A pension plan can make good and bad, conservative and aggressive, right and wrong decisions just like someone in a 401(k) style plan can.
    There is no real inherent strength or weakness when you compare 401(k) plans with pension plans (or defined benefit plans with defined contribution plan) when it comes to getting someone to the point of retirement.

    If there is an advantage it would be in favor of a plan that gives the participant a choice because he more easily benefits from wise investments than a pension plan which gives almost no choice. The investor gets more of an advantage of a bull market that drives his account balance up and up.

    Can those choices work against the participant? Yes, but as Richard pointed out, not as easily. If the stock market goes to zero, the world is in trouble. Not just retirement plans. The likelihood of this happening is very, very low.

    I would also have to agree with Richard on the track record of pension plans. Even private company’s plans. Governments and boards screw them up. There is a long history of them getting screwed up. There really is no denying this fact. At least if a person screws up their 401(k), they are the only victim of their mistake. When an elected or appointed board screws up a pension, everyone pays. All those in the pension pay, tax payers pay, insurance companies pay, and on and on and on. The City cannot borrow from individual accounts in a 401(k). This means there is far less potential for malfeasance.

  7. Hypocrisy, you offer one of the many, MANY fallacies common to public employees — the pension should be ALL that is needed to pay for retirement.

    No IRA, no personal savings or investments, no second income savings, no other retirement plans from other work, no paid-off home — and no social security (which many government employees get at least some of).

    While public employees may live that spendthrift life, there is no reason for the rest of us should pay for their “live the moment” lifestyle. And it’s possible that maybe such employees — having a new-found stake in how the economy is going — just might start voting more responsibly about government commitments, deficits and spending.


  8. I’d like to see a management fee where they pay the retirement fund a set percentage if they fail to reach their goals for the year, or at the least, if it is a negative return. Now that would provide an incentive to do well.

  9. Ya know,

    I know that both a 401-K and a DB have the same ability to accumulate an equal amount of wealth at, or at least near, retirement. My point was that a DB plan, because of its unlimited investment horizon, has a much better chance to continue to accumulate wealth after retirement than a 401-K in which the participant has to move money into more conservative investments to protect the principal.

  10. Hypocrisy, that is really just not true. First, a person in a 401(k) doesn’t have to do that. Second, a pension fund doesn’t have an unlimited time horizon either. Comparing the investment time horizon in an individual’s 401(k) and a pension fund is apples and oranges.
    A pension has to stay fairly liquid because of the amount of past employees taking regular distributions. A pension (if run by anyone who knows what the heck they are doing) has to know the demographics of the people in the pension. If the pension is 90% 25 year olds, it is run far more aggressively. If the pension is 90% 55 year olds it is managed far more conservatively with a lot more liquidity.
    Unless it’s not. Then that would be pretty bad. Which goes back to Richard and my point that there is a long history of boards, etc making BAD choices with pensions.

  11. Hypocrisy, as you well know but fail to deal with, EVERY DB pension plan doing well investment-wise then proceeds to do one of two unwise things — sometimes both:

    1. Reduce or even stop contributing funds to the plan during good years

    2. Increase pension benefits — usually retroactively.

    Now, you can pretend that a plan doesn’t HAVE to do that, but just about every govt DB plan on planet Earth has made one or both mistakes. Yet you continue to assert that it’s still a good idea — supposedly with the “right people” in charge.

    For you, apparently we live on some DIFFERENT planet — perhaps where the Big Rock Candy Mountain can be found.

    You try, you REALLY try, to sound reasonable. But you just sound foolish.

    And, being anonymous yet apparently sane, logically are likely hiding that you are a self-interested beneficiary of the one of the nation’s many govt Ponzi schemes. In short, you lack credibility.

  12. If you are afraid that employees can’t keep from spending the money quickly upon retirement, you can take away some of their freedom by REQUIRING they take such life 401k savings and buy an annuity, perhaps with a modest COL annual bump built in.

    To buy such an annuity, very low rates of internal return have to be assumed, so surely you’d want to somehow have government guarantee a higher rate of return than any prudent insurance company would offer (once again, transferring the potential unfunded liability to taxpayers). Ultimately this would just another variation of trying to get something for nothing for employees.

  13. Richard,

    You are correct and I will even add a #3 – providing early retirement options that are far more generous than what would be actuarially neutral. And all three of those problems could be eliminated by passing laws that make them illegal.

    I have yet to read you refute my point that a retiree cannot hope to earn as much after retirement in an individual account as he/she could if his money had been put into a DB.

    Ya Know,

    Since you believe that a retired person need not necessarily change to more conservative investment options, please explain what a person who retired in 2003 would have done had they lost nearly half of their investment in 2008? How would they have ever recovered while still withdrawing money to supplement their Social Security check (assuming they get Social Security)?

    Ya Know and Richard,

    Tell me if you honestly believe that the taxpayers will not be forced to help retirees who either made bad investment decisions or had the misfortune to plan their retirement around a long-term bear market.

  14. Hypocrisy,

    You say in response to Rider: “I have yet to read you refute my point that a retiree cannot hope to earn as much after retirement in an individual account as he/she could if his money had been put into a DB.”

    There is no limit to the amount a retiree can earn in her 401k plan. There is also no limit to the amount that could be lost. It all depends on the investment decisions each individual makes for himself or herself. The important point is that the retiree assumes the risk of a rising or falling market, instead of the taxpayer.

    Moreover, if defined benefit plans were really the best investment decision, then you would expect to see employees (especially unionized employees) band together and voluntarily agree to invest the defined contributions they receive into their own defined benefit pension plan among themselves. The fact that we have not seen that is evidence that they are not.

    You also say: “Tell me if you honestly believe that the taxpayers will not be forced to help retirees who either made bad investment decisions or had the misfortune to plan their retirement around a long-term bear market.”

    There are many things that the government does everyday that defy belief. For example:

    * Wasting billions of dollars every year to prosecute and incarcerate millions of non-violent Americans who use drugs defies belief.

    * Granting a minimum of 120 years of Copyright protection defies belief.

    * Running a $1+ trillion budget deficit for four consecutive years defies belief.

    * Giving Al-Qaeda linked jihadists in Libya access to almost 20,000 shoulder fire anti-aircraft missiles defies belief.

    * Printing $85 billion a month to buy back Treasury debt and mortgage backed securities defies belief.

    ….but asking a person to accept responsibility for the natural consequences of his or her investment decisions. No, that actually sounds credible.

  15. Hypocrisy, you are not having a real conversation here. You are cherry picking and comparing a plan’s best case scenario with another kind of plan’s worst case scenario. I can show you a scenario where a person who stuffs their cash under their mattress makes out better than a participant in a pension whose union thug leaders steal all their money or the poorly run company they work for goes out of business.

    So should we all just stuff our mattress because union leaders are all criminals?

    Your bias leads me to believe you have some sort of vested interest. Which is fine, but I am not interested in your dishonesty on a public forum in order to make your case. As I stated before, neither kind of plan is inherently evil. This is absolutely true. A 401(k) style plan is harder for government/boards to screw up and steal. This is absolutely true and possibly…this is your aversion to it?

    In any case, I’ve added my two cents and am done. You are not being honest and the crap you are full of is showing right through your “argument”.

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