I am quoted today in an article on Bloomberg.com about the Connecticut pension fund return assumptions. The article is here: https://www.bloomberg.com/news/articles/2017-07-20/connecticut-sinks-deeper-in-debt-as-pension-returns-lag-target
So why is an 8.5% return assumption delusional?
It's pretty simply really. Assume that your fund is 50% bonds, 50% stocks. Currently 10-year Treasuries are yielding about 2.3%. Let's round that up to say 3% to be generous. Assume an equity risk premium of 5%, and equities will return about 8%. So our hypothetical pension fund is going to earn:
50% bonds + 50% equities = 0.5*3 + 0.5*8 = 5.5%
Even with a tweaking the bonds to 4%, and using a risk premium of say 6%, you are looking at:
0.5*4 + 0.5*10 = 7%
I think 7% is still pretty optimistic, but if we use today's numbers, 8.5% implies stock returns of:
8.5 = 0.5*3 + 0.5*X
Solve for X, ... go ahead, I'll wait.
X = 14%.
So stocks would need to return 14% on average, implying an 11% equity risk premium. That's why it's easy to say that 8.5% or even 8% is delusional.
But just labelling something delusional doesn't really help anyone, and I appreciate this. Unfortunately to ensure a pension fund is fully funded, and meets a realistic return goal, either contributions have to increase, or payouts have to decrease. Both are hard choices and there's no easy fix. Just setting a high return merely kicks the can down the road.