Question Of The Month – January , 2009

How Secure Is Your Pension?

Roger Lowenstein, in his book, “While America Aged”, says that we are “sitting on a retirement time bomb.  The urgent problem he says is that “America’s private companies and state and local governments share a financial challenge that makes today’s economic downturn seem small by comparison.” 

The problem is the pensions they fund.  “They’ve made promises to their employees – in the form of retirement pensions and health benefits—that they simply can’t afford to keep.”  And this is a problem for local and state governments.  Pension and health care obligations could ultimately become a much heavier burden for taxpayers than they are for shareholders of companies like GM.  GM had to pay $55 billion into worker pension plans from 1991 t0 2006 and during that same period paid only $13 billion in dividends to its shareholders. 

Lowenstein tells us that municipalities and states across the country are virtually insolvent because they are hundreds of billions of dollars behind in pension payments.  “They are so underfunded.” 

Lowenstein tells us that in addition of GM, San Diego’s municipal workers were also granted generous pension benefits.  The City skimped on their contributions to the pension fund while hiding the underfunding from the public and the result was near bankruptcy for the city.  Its pension fund was $1.7 billion in the hole by 2005, a debt that is equivalent to $6,000 for every family of four in the city. 

Lowenstein additional example is the New York City public transit system and the benefits they provide to the workers.  The city has failed to fund its pension benefits adequately.  Lowenstein states that “From 2000 to 2005, the pension bill for the city subway and bus systems soared tenfold.  The subway workers gave some concessions but the city still faces high liabilities. 

And in addition, the Pension Benefit Guarantee Corporation, the federal government agency that protects the pensions of 44 million workers in case their employers can’t make the promised payments.  PBGC faces a liability of more than $14 billion as it pays off the benefits of more than 1.3 billion people whose plans have failed.  Jim Jubak, in his journal for money central.msn.com, states that in order to meet its obligations, PBGC will take on more risk.  It will double the percentage of its portfolio ---45% ---that it puts into stocks and an additional 10% will go into alternative investments, including hedge funds.

Lowenstein states that “Most decision makers behaved like credit card abusers who charged to the limit and made only the minimum payments.”  “States should require that every dollar of pension benefits be funded as the benefit is accrued.  If the system were stripped of the illusion that pensions are “free,” lawmakers would presumably make wiser choices.”  He adds “The most effective remedy – in pensions, health care and even in Social Security – is to banish the credit card.  Benefits should not be charged to a future generation; they should be paid for now.” 

How secure is your pension?  A good place to begin to find out is to ask that question and perhaps others of the employer or agency which handles your pension plan.  And be sure to pay attention to the information they pass along to you.  And don’t be afraid to ask those questions.  It’s your retirement that pension will be funding. 

                     Quote Of The Month

“No doubt stocks will come back.  People who held on to their investments after Black Monday in 1929 and through the Great Depression did recover their money but it took about 25 years.  No one can accurately predict whether the current financial funk will be as dire or last as long.”   Consumer Reports, February 2009

Evaluating mutual fund performance would appear to be a fairly straightforward exercise in numbers. A return of 10% is better than 5%, but not as good as a return of 15%. Similarly, a loss of 5%, while not ideal, is preferable to losing 10%.  

But while it's helpful to regularly monitor the absolute numbers, the truth is that they only begin to tell the story of whether a mutual fund is indeed performing well. A thorough analysis should also examine how a mutual fund has performed relative to its benchmark.  Dictionary.com tells us that a benchmark is designed to “measure a rival’s product according to specific standards in order to compare it to and improve one’s own product.”

Compare Apples with Apples --- A benchmark index gives investors a point of reference for making an "apples to apples" comparison of a fund's characteristics or performance.

One of the best-known benchmarks is the Standard & Poor's® 500 Index. Because the S&P 500® Index is composed almost entirely of large-cap domestic stocks it is a common performance measure for equity-oriented growth funds, including asset allocation and balanced funds.

However, while the S&P 500 might be an appropriate benchmark for many mutual funds, it wouldn't be a good comparison for a fund that specializes in companies with a small-market capitalization. For a so-called small-cap fund, the Russell 2000® Index might serve as a better yardstick.

Another example --- comparing a foreign stock fund with the S&P 500 does not indicate how the fund has done relative to foreign stock markets. The MSCI EAFE® Index might be a better benchmark for a diversified international equity fund. The Lehman Brothers Aggregate Bond Index, which measures the overall bond market, may be a suitable benchmark for U.S. investment-grade fixed-income funds.

With so many different fund objectives and benchmarks, how can you know which index provides the best comparison? The fund's prospectus and semiannual reports are a start.

After reviewing this information about your funds, you may ask yourself, "How concerned should I be if my fund's performance is different from its benchmark?" It's unlikely that any fund's performance is going to exactly match that of a given index. Even index funds that are designed to mirror a particular benchmark will show slight performance variations from their target.

Benchmarking has become even more important because of the increasing number and variety of mutual funds available. There are many different investment styles and objectives among mutual funds.  You wouldn't expect them all to perform the same.  However, your selection of a mutual fund should be based on more than just its performance against a benchmark.  A benchmark index is a good place to start. 

Benchmarking can also help you understand that negative returns may not always signal underperformance.  It's important to understand that a mutual fund may be down a lot, but still outperforming the benchmark against which it is judged.  No one likes to lose money, but if you consider the mutual fund's performance in this context, you may decide that, in reality, it is still okay.

 Benchmarking Mutual Funds

Let’s look at one example:  for this exercise, we will be benchmarking a large-company growth fund against the average return for large company growth funds and the S&P 500 Index over the past 1, 3, 5, and 10 years.  First, you will need to know the returns from your large-company growth fund.  Let us say that you own the Janus Fund (JANSX) --- a lot of investors do.

With the assistance of the Kiplinger Mutual Fund Report for 2007, we find the annualized returns for the Janus Fund through 2007:

1 year:  15.2%   3 years:  9.8%     5 years:  12.8%     10 years:  5.5% Total Expense Ratio: 0.90

Here are the category average returns of the Large Company Growth Fund through 2007:

1 year:  13.6%    3 years:  10.4%     5 years:  11.2%     10 years:  5.3%

Also, from Kiplinger, here are the annualized returns of the S&P 500 Stock Index through 2007:

1 year:  5.5%    3 years:  8.6%     5 years:   12.8%     10 years:  5.9% 

Total Expense Ratio:  0.15

From this benchmarking exercise, you will see that your Janus Fund outperformed the average annualized returns for large-company-growth funds during the past one, five and then year periods.  It outperformed the S&P 500 Index during the past one, and three year periods.

You need to be comfortable that the funds you’ve chosen are appropriate for your personal risk tolerance, time horizon, and investment objectives.  Then, monitoring your funds’ performance over time and comparing them to appropriate benchmarks ­ not just to the overall stock market ­ will help you judge whether they are meeting your objectives. 

There are a good number of sites on the internet that allow you to benchmark mutual funds against one another.  One site you can start with is morningstar.com.