Financial Markets in 2011 - Reynolds Week 2011

Financial Markets in 2011: Where are the Stories? Strictly Financials Jan. 7, 2011

Donald W. Reynolds National Center For Business Journalism At Arizona State University Strictly Financials

Gary Trennepohl, Ph.D. President’s Council Professor of Finance - Oklahoma State University Trustee, Oklahoma Teachers Retirement System Member, OSU Foundation Investment Committee [email_address] Strictly Financials

Topics for 2011 Can anyone predict the markets? Did the markets really change in 2008? Will Social Security be your security? Will the coming crisis in public pension plans affect your community? Strictly Financials

An Historical Perspective On the Market Strictly Financials

Strictly Financials

Predicting the Market Is Not for the Faint of Heart

In 2008, It Seemed That Markets Had a Mind of Their Own Oct. 6, Global markets plummet, Dow Jones down 800 at one point Oct. 13, Dow up 936 points Oct. 15, Dow down 733 amid fears over economy’s problems Oct. 28, Dow up 889 Strictly Financials

2008 Market Summary Dow at 11,782.25 on Aug. 11 Dow at 7,773.71 on Oct. 10 34 percent decrease in two months Dow at 9,325.01 on Oct. 31 20.9 percent decrease as of Oct. 31 Strictly Financials

What about the Decade Of 2000 to 2010? Many news sources have reported that the “’00s” were the lost decade for returns, but it depends on which numbers you choose. S&P 500 - .4% DJIA + 2.5% Small Cap + 6.2% World Index + 1.3% Brazil +21.0% U.S. T-Bonds + 8.3% Strictly Financials

Strictly Financials

Strictly Financials *Matt Moran, CBOE seminar, Oct. 29, 2010

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So, What Does This Data Tell Us? First, remember when people say “this time is different” - it is never different. Markets over and under correct, but they revert to the mean of their long term values. Periods of over performance will be followed by periods of underperformance, etc. Diversification is a key strategy for investing. Strictly Financials

Did the Markets Really Change in 2008? Probably not, but technology is driving changes in the way the market operates. The globalization of markets will bring profound changes in investment strategies for U.S. investors . Strictly Financials

Story Ideas What do investment advisors think about the current market? Are investors/advisors investing in international markets? Can bonds really go any higher in price?

Will Social Security Be Your Security?

Social Security and Medicare: The Looming Political Crisis Social Security (taxes paid on income to $106,800) Provides retirement benefits for a worker and his/her spouse to the second death Provides disability benefits to injured workers regardless of age Provides survivor benefits to widows and eligible children to age 19 (or 22). Medicare (tax paid on total income) Provides hospital insurance at age 65 and above Don’t forget to register before you turn 65! Strictly Financials

FAQs regarding the SSA How much can I earn and still receive benefits? After reaching full retirement age (FRA), your SS benefits will not be reduced, but… If your income is over $44,000 (joint) 85% of benefits will be taxable. At what age should I start taking Soc Sec benefits – 62 years, 66 years/FRA, 70 years. Also, keep in mind that SSA and Medicare are independent decisions. You have to sign up for Medicare at 65 but you don’t have to start drawing SS benefits. Strictly Financials

Social Security Myth 1 “ There’s a lockbox that keeps and invests the FICA taxes you pay.” – Not really Taxes paid by current workers are used to pay the benefits of current retirees. You don’t have an individual account with your money in it, just a ledger balance at the SSA. Surpluses are deposited in the “Social Security Trust Fund,” which then buys non-marketable US Government bonds. In reality, this goes directly to fund the Federal deficit. Strictly Financials

Current Status of Social Security Trust Fund (from the 2010 Social Security Trustees Report) In 2010 Social Security costs exceeded income from payroll taxes for the first time Recession reduced payrolls Baby boomers started to retire (we already know this – they’ve been around for 65 years) After 2012-14 costs will exceed income and interest payments from trust fund will be needed to fund payments. After 2025 taxes and interest will be insufficient and the trust funds will have to be used to fund benefits . Strictly Financials

What About the Trust Fund? In 2037 the trust fund will be exhausted But, yearly payroll taxes could still pay about 78% of current benefits. Assuming no new legislation, the “replacement rate”, (Soc. Security benefits/pre-retirement earnings), would drop from 41% today to 36% in 2036 to 29% in 2037. If payroll taxes were immediately raised by 1.92% (ie. .96% each for worker and employer), the 41% benefit level could be maintained to 2086. Strictly Financials

Social Security Myth 2 “ I don’t count on Social Security because it will be broke when I retire” – Not True. This is a legal obligation of the U.S. Government, they really cannot choose not to pay. Do you really think the government can renege on its promise to pay you benefits that you have already paid for? What if your employer decided they were not going to pay your retirement benefits that you had been promised? A politically explosive issue Strictly Financials

What Should Congress Do? Increase retirement age? Originally set at 65 in 1935, but life expectancy has dramatically increased. Increase income tax on SS benefits? Currently, if your taxable income exceeds $44,000 (joint), 85% of SS benefits become taxable. Uncap the wage level for payroll taxes? Just like Medicare taxes are uncapped Increase the payroll tax? By 1.96% total as shown earlier Strictly Financials

What About Medicare and the New Healthcare Legislation? The real economic issue is spending on healthcare. Future Social Security benefits/costs can be mathematically determined so it becomes a political problem to solve; medical costs cannot be estimated with any accuracy. Strictly Financials

Did You Know That … Nearly 50% of the U.S. population is receiving some type of government benefits – Social Security, Medicare, Medicaid, unemployment insurance or food stamps.* About 45% of adults pay no federal income taxes at all.* The U.S. will take in $2.2 trillion in tax revenues this year (2010) and spend $3.5 trillion* Strictly Financials (William Falk, The Week, Oct 1, 2010)

U.S. Taxpayers by Income (AGI) and Total Income Taxes Paid* ( Tax Foundation, Summary of Latest Federal Individual Income Tax Data , Oct. 6, 2010, for Tax Year 2008) Strictly Financials

How Can the U.S. Balance The Budget in the future? Federal Budget Spending as a % of GDP 2006 2020e 2035e Total Spending 20.1% 24.2% 28.9% Soc. Sec/Medicare/aid 8.3% 12.4% 17.1% Defense 3.9% 3.9% 3.9% Other Spending 6.2% 6.2% 6.2% Net Interest 1.7% 1.7% 1.7% Tax Receipts 18.2% ? ? Deficit 1.9% ? ? Strictly Financials

Information about Social Security Center for Retirement Research at Boston College. http://crr.bc.edu/ List of publications at: http://crr.bc.edu/social_security/social%2520security%3bbriefs.html Strictly Financials

Story Ideas Do your readers believe that social security will pay them retirement benefits? Do they favor changes to the system that will insure its survival – (1) increase retirement age, (2) increase taxes, (3) increase taxable wage base? How does social security fit in your retirement planning? Strictly Financials

Will the Coming Crisis in Public Pension Plans Affect Your Community? Strictly Financials

Some Recent Headlines About Public Pension Plans “ Padded Pensions Add to New York Fiscal Woes” Walsh and Schoenfeld, NY Times, May 21, 2010. “ Studies Show Grim Outlook for Public Plans” Burr, Pension & Investments, Oct. 12, 2010. “ Can the Illinois Pension Catastrophe be Stopped?” Novy-Marx, and Rauh, Chicago Tribune, Aug 13, 2010. “ State Pension Plans Go Broke as Payrolls Expand” Mysak, Bloomberg Opinion, Jun 10, 2010. “ Pension Woes May Deepen Financial Crisis for States Keith, NRP News, Mar 21, 2010. Strictly Financials

Grabbing Headlines* - “ After 30 years of service a police officer in California can retire at 90% of his final compensation. The monthly benefit will increase each year by a 2% cola.” An officer earning $150,000/year will retire earning $140,000/year for the rest of his/her life, for a total benefit of $5.9 million (to age 85). Strictly Financials *”Taming a Whale Lurking in Pension Financing”, Bruce Deal Pensions and Investments, August 9, 2010 , p 12.

Two Principal Types Of Pension Plans Strictly Financials

Defined Benefit Plans Employer assumes obligation to pay retirement benefits defined by formula. Retirement benefits determined by a calculation: eg. = (years service*2%*avg. 3 yr highest salary) Most public plans are of this type. Market risk is carried by the State Sponsor and the investments are professionally managed. No asset available to transfer to heirs. $4,357 billion of assets in DB plans ( as of Sept 30, 2009) Strictly Financials

Defined Contribution Plan Employer only assumes obligation to pay yearly % of salary (eg. 10%) into employee selected investment vehicle (think 401k). Individual bears the market risk and is responsible for selecting investment vehicles. Retirement benefits determined by performance of investment choices. Most newer corporate plans are of this type. Value of assets becomes part of estate that can be transferred to heirs $1,720 billion of assets in DC plans (as of Sept 30, 2009) Strictly Financials

Ten Largest Defined Benefit Funds* Strictly Financials * as of S ept. 30, 2009* from Pensions&Investments, Dec 28 and Feb. 8, 2010)

Typical Pension Plan Sponsors State or Municipal employee plans (almost all are defined benefit plans): Teachers (K-12, community colleges, universities) State employees Firefighters and Police Judges Local Union Plans (usually defined benefit plans) Corporate Plans (may be defined benefit or defined contribution plans) Strictly Financials

Measuring Pension Plan Health Actuaries can project future plan liabilities and income – key factors are: Workforce demographics, Rate of return assumptions, Mortality rates – and we are living longer Size of investment portfolio COLAs – “cost of living allowances (eg. 2% a year) The “present value” of projected pension payments and income to the plan is used to calculate the “funding ratio”: $ projected payments/$ income A funding ratio of at least 80% is considered “safe” Strictly Financials

Funding Levels of Public Plans* Strictly Financials

What the Future Holds In 2008 most plans were over 80% funded, but by 2009 only 36% were. Falling stock market reduced portfolio values Reduced contributions from states as they struggled to balance budgets. Alternatives for State and local government plans- CA, IL, NJ may need to increase contributions to 8-12% of state budgets to keep plans solvent. Most states need to increase contributions an additional 2% of State budget to get funding up to 80%. Experiences of Minnesota and Colorado to change plan benefits. Strictly Financials

Strictly Financials *Source: Marti Zins, Minnesota Teachers Retirement Board Chair, presentation at 88 th NCTR Convention, San Antonio, Texas, Oct .13, 2010 Minnesota Teachers Retirement Plan

Minnesota and Colorado Recently Passed Legislation to Modify Benefits for Teachers Plans Motivated to make changes because of projected underfunding. But, changing benefits is very difficult because benefits are viewed as a property right. Greeted by lawsuits immediately after the bills were signed Strictly Financials

Story Ideas What is the financial health of pension plans in your area? (Public plans have to provide data.) Are plan administrators considering actions to modify plans? What resistance is expected? What has been the financial performance of the fund over time? Is it competitive with other plans? What is retirement pay for high paid employees? Strictly Financials

Financial Markets in 2011 - Reynolds Week 2011

by Reynolds Center for Business Journalism on Jan 07, 2011

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Financial Markets in 2011 - Reynolds Week 2011 — Presentation Transcript