The Current State of the Beveridge Curve
Preponing Public Expenditure

Once Again, Gross Innumeracy at the Washington Post: Why Oh Why Can't We Have a Better Press Corps?

Dean Baker reads the Washington Post these days so we don't have to. He notices that nobody at the Post appears to know that stocks pay dividends.

He misses one thing: The *Post" claims that "Eighty-eight of the 126 largest public pension plans assume a [nominal] rate of return exceeding 8 percent a year."

It lies.

Only 31 of the pension plans in the Boston College CRR database assume a nominal rate of return in excess of 8% per year. The highest assumed rate of return is 8.5% per year. 38 pension plans assume a rate of return of less than 8% per year. 57 assume a rate of return of 8% per year.

Dean Baker writes:

Public Pensions and Arithmetic Problems at Fox on 15th (a.k.a. The Washington Post) | Beat the Press: The Post made yet another effort to attack public sector employees today in an editorial (this one is on its editorial page) that criticized the rate of return assumptions used by public pension plans. It tells readers that:

Eighty-eight of the 126 largest public pension plans assume a [nominal] rate of return exceeding 8 percent a year, according to the Wall Street Journal. By way of comparison, the S&P 500 achieved a compound average [nominal] annual growth rate of 5.69 percent over the past 20 years.

Okay, get your calculators out boys and girls. If I look up the value of the S&P 500 for March 1991 I get 375.22. The S&P closed yesterday at 1313.8. This gives a compounded annual rate of return of 6.46 percent. 

But wait, we have to share a little secret with the folks who write editorials for the Washington Post: stocks pay dividends. Dividends are typically paid out quarterly and usually average 3-4 percent of the stock price. If we add in dividend yields, then we would get an average return over the last 20 years in the 9-10 percent range that is assumed by pension funds in their analysis. 

Of course returns going forward will depend on the current ratio of stock prices to corporate earnings. This is around 15 today (measured against trend earnings) compared to about 20 in 1991, suggesting that the prospects going forward over the next 20 years are likely better than they were back in 1991.

It is especially ironic to see this misplaced warnings about excessive stock return assumptions in the Washington Post. This is a paper that for years featured the columns of James K. Glassman, the co-author of Dow 36,000. At the time, it had no room in the paper for those of us who tried to warn of the risks of the stock bubble.

Note that the source is not the Wall Street Journal but rather Alicia Munnell's Center for Retirement Research at Boston College.

An equity price-trend earnings ratio of 15 suggests, at current inflation rates, a forward long-term nominal rate of return on equities of 9% per year. If we anticipate a forward equity return premium of 4% per year, then a portfolio of 3/4 equities and 1/4 debt would be projected to yield a 8% per year nominal return.

Thus 8% per year nominal does not seem to me to be a bad number to use as a central case for pension planning.