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Cypen & Cypen
JANUARY 27, 2005

Stephen H. Cypen, Esq., Editor

Never Forget - September 11, 2001


The Center for Retirement Research at Boston College has issued a scholarly paper concerning how to handle the risk associated with equity investments when evaluating the financial health of a retirement system. Some argue that retirement plans holding equities can make smaller funding contributions than those invested primarily in bonds. Others say, after accounting for risk, the contribution needed today to fund future pension obligations is the same whether the fund is invested in equities or bonds. The paper concludes that the issue of risk is crucially important when assessing the financial health of retirement plans. Actuaries and economists/accountants generally take quite different approaches. Actuaries usually contend that ongoing healthy entities should be able to reflect higher returns associated with stocks when making their funding decisions. If things turn out badly, the sponsors have resources to adjust contributions and get the plan back on track. But when the sponsor cannot easily make adjustments to offset disappointing returns, or can shift the risk to workers or taxpayers, the higher expected return on equities becomes irrelevant. In such cases, it is appropriate to follow the financial economists and accountants, and discount future pension obligations at a low-risk rate. How nice it would be if treatment of equities in defined benefit plans translated perfectly into recommendations of how to project future balances in private accounts under Social Security. Unfortunately it does not, yet it does yield two useful insights. First, for policy makers, it seems most appropriate to use risk-adjusted returns when comparing alternative reform plans. Assuming bond returns on invested assets produces a stream of income most similar to benefits under the current system and produces the most meaningful comparison. Second, when individuals want to assess their likely outcome under private accounts, those with some flexibility to manage their risk associated with equity investment might assume higher returns. But given that Social Security provides a modest benefit upon which the elderly rely heavily and most people have little ability to manage the risk, ignoring risk in equities is clearly not the right answer. Coming from Alicia Munnell, Director of the Center and a co-author, that’s quite a conclusion.


A Bloomberg News Report indicates that companies in the United States expect increased spending as the economy expands 3% to 4% in the first six months of this year. A little more than half of respondents surveyed forecast growth within that range, and 29% said they expect a rise of only 2% to 3%. Overall, 60% of those surveyed expect to spend more this year, compared with 55% who projected an increase last October. Sixty percent of executives surveyed have the same outlook for growth they had three months ago. Economists surveyed expect gross domestic product to rise 3.6% this year after increasing 4.4% in 2004. The projected pace is faster than the average 3.1% from 1973 to 2003. Thirty-seven percent of survey respondents expect annual wages to rise 2% to 3% this year; 26% see an increase of 3% to 4%.


Every year around this time, we anxiously await release of “The Callan Periodic Table of Investment Returns,” that colorful chart showing annual returns for key indices for the previous twenty years. The following indices are included:

  • S&P 500 -- market-value-weighted index of large capitalization U.S. stocks traded on major exchanges
  • S&P/Barra 500 Growth -- market-value-weighted index of growth style of investing in large cap U.S. stocks
  • S&P/Barra 500 Value -- market-value-weighted index of value style of investing in large cap U.S. stocks; constituents are mutually exclusive to corresponding growth index
  • Russell 2000 -- market-value-weighted index of small capitalization U.S. stocks traded on major exchanges
  • Russell 2000 Growth -- index of growth style of investing in small cap U.S. stocks
  • Russell 2000 Value -- index of value style of investing in small cap U.S. stocks; constituents are not mutually exclusive to corresponding growth index
  • MSCI EAFE -- index of developed stock markets of Europe, Australasia and the Far East
  • Lehman Brothers Aggregate Bond -- index of U.S. government, corporate and mortgage-backed securities with maturities of at least one year

So, what does the chart show (other than diversification is a must)? The Lehman Agg finished last six times and first twice. The Russell 2000 Growth finished last four times and first three times. EAFE finished last seven times and first five times. Russell 2000 Value finished last twice and first five times. For last year, returns ranged from 22.25% (Russell 2000 Value) to 4.34% (Lehman Agg). As usual, a very handy presentation.

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Items in this Newsletter may be excerpts or summaries of original or secondary source material, and may have been reorganized for clarity and brevity. This Newsletter is general in nature and is not intended to provide specific legal or other advice.

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