Mark Brandon is the Managing Partner of First Sustainable (, a registered investment advisory catering to socially responsible investors. In addition to Socially Responsible Investing (SRI), he may opine on social venturing, microfinance, community investing, clean technology commercialization, sustainability public policy, green products, and, on occasion, University of Texas Longhorn sports.

Wednesday, September 13, 2006

Dueling Viewpoints About the Future of Retirement Savings

While Reading my Sunday Austin American Statesman, I happened to notice two stories that offer two wildly different perspectives on the state of Americans' retirement dilemma. In one story, Pension Plans Go By the Wayside (syndicated), LA Times reporter Jonathan Peterson bemoans the abandonment of the traditional pension plan by large companies. As the story goes, corporations are greedy entities for allowing workers to be responsible for their own retirement. The intimation was that the public is not equipped to handle this responsibility. Yet, on a facing story Long-term 401(k) savers sit on six-figure nest eggs, the Investment Company Institute cites statistics that 401k participants who save for only six years now have an average balance in the six figures. This represents an increase of 50 percent since 1999, despite the most brutal market correction in a generation. Although it is politically popular to berate corporate America for abandoning the traditional pension, for several reasons, it is the correct course of action. However, this opinion also comes with a few qualifiers.

First, let's differentiate the companies who are "abandoning" the pension plan. The first kind, companies such as DuPont (NYSE: DD)and IBM (NYSE: IBM), are halting new participants into their pension plan, slowly buying out the pension so as to guarantee benefits for the current participants, and shifting focus for new participants to the defined contribution (401k and 403b) plans. Nobody is losing out on promised benefits. These companies are wholly different than the companies, such as Bethlehem Steel and United Airlines, who dumped their pension plans onto taxpayers because they over-promised benefits and failed to contribute enough to meet them. Instead, they opted to use bankruptcy laws to turn over their pension obligations to the federally backed Pension Benefit Guarantee Corp, itself a woefully misguided bureaucracy. The latter group rightfully deserve our scorn.

Pensions have become a relic of yesterday's economy for the following reasons:

  1. Over-promised benefits. Taking a cue from our federal government (though still not nearly as brazen), corporate executives have not shown the backbone to either keep a lid on promised benefits or keep contributing enough to meet them. Managements in the auto and airline industries are notorious for buckling under to union pressure to up benefits because someone else will be in charge when the bill comes due.
  2. Employee Turnover. In the postwar "Company Man" era, it was far more common to spend one's entire career at one company. In many cases, the amount of benefit depends on years of service. Since the average adult now changes jobs every 5-6 years, almost nobody is getting the maximum benefit of a pension plan.
  3. Pensions affect a company's earnings. Stay with me on this. GAAP rules require that a company report investment gains or losses on its earnings statements. This not only unfairly ties a company's operating performance to the vagaries of the market, it opens up the plan funds and the earnings reports to manipulation. Verizon (NYSE: VZ)is one company that used investment gains to essentially manufacture earnings. They did so by just changing some basic assumptions on their plan performance. Presto! A quarter with no earnings suddently had bountiful earnings.
  4. Size has become a problem. Despite their much publicized troubles, General Motors (NYSE: GM) has a pension fund about 6 times larger than the market cap of their own company. AND IT IS STILL UNDERFUNDED! Any investment manager knows that size is the enemy of returns.
  5. Lack of Appropriate Allocation. Pension managers make decisions based on their upcoming obligations in the next 10-15 years. This means that they are managing for people in their 50's. If you are in your 20's, 30's, or 40's, you would probably benefit immensely by having a more aggressive allocation, but since you don't, your investment performance will likely underperform.
The 401k data clearly shows that participants can manage effectively, if only they would. Nationwide, only about 17 percent of eligible employees are both participating in their plan, and making the necessary allocations that are appropriate to their age and risk tolerance. This is where the political hand-wringing needs to focus. The problem is entirely fixable if companies and government focused on educating workers to make the right decisions.