State Pension Funds' Woeful Underperformance

The state of Washington scored the highest marks (3.92%) over the last decade for state pension funds with greater than $20 billion in assets, according to a Bloomberg survey.

Sadly, they all woefully underperformed the Vanguard Balanced Index fund (4.79%) over the same period (lost decade?  really?).  An indexed strategy that included small allocations to the Vanguard REIT index fund (10.99% over the decade) and the Vanguard Small Cap Index fund (7.41%) would have blown the state pension funds away by an even higher margin.

As usual, there's more money to be made "selling the system" than there is in the system itself.

Your investments and the debt ceiling

For the past several weeks, there has been much hand-wringing going on over the continuing "debt ceiling deadline."

Yet the excessive amount of political rhetoric can't conceal two obvious conclusions:

1)  It is highly likely that our politicians will renew their own license to print money.  Whether or not they do it by the August 2nd "deadline" is immaterial.

When push comes to shove (ie, when Social Security checks become threatened), they will act to raise the debt limit.  If interest rates rise or if a ratings downgrade happens, it can be attributed to the sorry state of the country's finances, not to the lawmakers' failure to raise the debt ceiling.

2)  The current and future fiscal expectations in the U.S. are what drive the financial markets, not the debt ceiling squabble nor the "debt rating" handed down by the ratings agencies.

The financial markets and the American people are clearly unhappy with our deficit spending and investors "vote" every day based on their actions in the financial markets.

With all of the political posturing going on in D.C., you might be tempted to make changes to your investment portfolio.

My advice is to fight that urge, stay the course, and do nothing.
(assuming you have a sound, diversified portfolio in place that reflects your goals, timeframe, and risk tolerance)

It is most assuredly a losing proposition to attempt to "outsmart" the consensus of the market with knee-jerk reactionary investment changes. As always, the market consensus is constantly processing new information and acting accordingly.

Any "common knowledge" has long since been reflected in security prices and has no hope of being exploited.

The good news is that the debt ceiling is forcing the politicians to confront the ballooning government spending problem sooner rather than later and we can only hope that meaningful progress will be made.

In the meantime, expect high volatility in the markets during the short-term-- markets hate uncertainty and that seems to be what we will have for the foreseeable future.

Here is a recent commentary on this debate that gives a very thoughtful perspective:

 Hysteria and the debt debate

 

 

Fiscal Illusion: 11 strategies for government to squeeze money out of its population

Nearly 100 years ago, the Italian economist, Amilcare Puviani, suggested 11 strategies that a government could use if its goal were to squeeze as much money as possible out of its population:

1)  Use indirect, rather than direct taxes to hide the tax in the price of the goods.

2)  Inflation (via a state-controlled central bank).

3)  Borrowing (to postpone the necessary taxation).

4)  Gift and luxury taxes (wrap the tax in the purchase of a "special" purchase, reducing the "annoyance" of the tax).

5)  Institute "temporary" taxes (and then never repeal them).

6)  Tax unpopular minority groups (ie, the rich, smokers, windfall profit recipients).

7)  Threaten social collapse or withholding of monopoly government services if taxes are reduced.

8)  Collect taxes in small increments (ie, sales tax or income tax withholding).

9)  Create taxes whose amount (and the amount of the programs it funds) and incidence can't be predicted in advance (ie, Medicare).

10)  Extraordinary budget complexity to obfuscate public understanding.

11)  Use generalized expense categories to make assessment of individual components difficult.

The extraordinary cost of tax compliance

Arthur Laffer recently wrote a piece in the Wall Street Journal detailing the huge cost of complying with our income tax code.

While you might disagree with his politics or his solution (I personally support a consumption-based tax rather than a flat income tax as he suggests), it's hard to argue with the incredible inefficiency of our income tax code when it comes to its most basic charge:  effectively collecting revenue.

"Tax compliance employs more workers than Wal-Mart, UPS, McDonald's, IBM and Citigroup combined."

Read the whole WSJ piece, The 30-cent tax premium.

The cost of entitlement

The latest round of health care reform has produced a pair of bills which promise to not only fix the healthcare woes in this country, but to dramatically reduce the deficit at the same time
(the new plan could reduce the deficit by $138 billion over the first 10 years -- $20 billion more than the Senate bill, according to the CBO forecast).

Excuse me for being cynical, but I've heard this song and dance before:

"In 1967, the House Ways and Means Committee predicted that the new Medicare program, launched the previous year, would cost about $12 billion in 1990. Actual Medicare spending in 1990 was $110 billion—off by nearly a factor of 10."

So why were these cost estimates so far off?  The cost of entitlement.

The estimates failed to recognize or account for the behavioral change that occurs in people when they are promised a no-cost benefit.

"Roosevelt described Social Security as a modest offer to 'give some measure of protection to the average citizen and to his family against the loss of a job and against poverty-ridden old age.'

Look what has happened since then. About 35 percent of Americans rely on Social Security for 90 percent or more of their retirement income. ... And Social Security is only one example. Over the years, the federal government has created a number of social insurance programs -- including the Medicare plans for doctors' visits and prescription drugs -- that provide significant taxpayer subsidies to even middle- and upper-income Americans.

We started these programs as a safety net for our hard-luck fellow citizens, and of course that safety net must remain strong. My point is that programs designed to help the needy should not become enshrined as benefits to which all are entitled. Too many of us who can afford to contribute more to our own well-being are jumping into the safety net instead. That approach is not affordable or sustainable. More important, it's not the American way."

--David Walker, Former GAO chief from his book, Comeback America.

The inmates are running the asylum: eight ideas to permanently break Social Security

When I saw this headline, 8 Possible Social Security Benefit Changes, I was naively hopeful that fiscal responsibilty had stealthily infiltrated its way into D.C.

Sadly, I couldn't have been more wrong.  The article gives eight possible "improvements" to the program including:
  • Guaranteeing a minimum benefit
  • Reducing work requirements for eligibility
  • Supplementing benefits for low-income single workers
  • Increasing survivor benefits and
  • Providing longevity insurance
Sorry to be such a wet blanket, but since it's common knowledge that Social Security is on a certain trajectory towards bankruptcy, shouldn't we be looking at how to make good on the existing promises rather than promising even more?

Related (courtesy of Wikipedia):

A Ponzi scheme is a fraudulent investment operation that pays returns to separate investors from their own money or money paid by subsequent investors, rather than from any actual profit earned. The Ponzi scheme usually entices new investors by offering returns other investments cannot guarantee, in the form of short-term returns that are either abnormally high or unusually consistent. The perpetuation of the returns that a Ponzi scheme advertises and pays requires an ever-increasing flow of money from investors to keep the scheme going...  Knowingly entering a Ponzi scheme, even at the last round of the scheme, can be rational economically if government bails out those participating in the Ponzi scheme. If governments use newly created currency to bail out the scheme victims, the newly printed currency will devalue the rest of the currency in circulation, meaning all holders of that currency will suffer inflation to the currency. However, Ponzi schemes cannot last forever.

"He deprives the leaders of the earth of their wisdom, he sends them wandering through a trackless waste.  They grope in darkness with no light.  He makes them stagger like drunkards."

-- Job 12:24-25