financial markets in 2011 - reynolds week 2011

Financial Markets in 2011:

Where are the Stories?

Strictly Financials

Jan. 7, 2011

Strictly Financials 2

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


Gary Trennepohl, Ph.D. President’s Council Professor of Finance - Oklahoma

State University Trustee, Oklahoma Teachers Retirement System Member, OSU Foundation Investment Committee

[email protected]


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?

An Historical Perspective On the Market


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


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

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%



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

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.


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.


Story Ideas

1. What do investment advisors think about the current market?

2. Are investors/advisors investing in international markets?

3. 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!


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.


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.

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.


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.



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


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


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.

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*


(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)


How Can the U.S. Balance The Budget in the future? Federal Budget Spending as a % of GDP

2006 2020e 2035eTotal 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% ? ?



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

Story Ideas

1. Do your readers believe that social security will pay them retirement benefits?

2. Do they favor changes to the system that will insure its survival – (1) increase retirement age, (2) increase taxes, (3) increase taxable wage base?

3. How does social security fit in your retirement planning? Strictly Financials 33

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


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.


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).


*”Taming a Whale Lurking in Pension Financing”, Bruce DealPensions and Investments, August 9, 2010 , p 12.

Two Principal Types Of Pension Plans


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)


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)


Ten Largest Defined Benefit Funds*


$0 $50 $100 $150 $200 $250

Calif. Public Emp.Calif. State Teachers

NY State CommonFla. State Board

NY City RetirementTexas Teachers

Gen. MotorsNY State Teachers

Wisc. Investment Brd.State of New Jersey

Total Assets in Billions of $

* as of Sept. 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)


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”


Funding Levels of Public Plans*


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.



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

Minnesota Teachers Retirement Plan

Minnesota and Colorado Recently Passed Legislation to Modify Benefits for Teachers Plans

1. Motivated to make changes because of projected underfunding.

2. But, changing benefits is very difficult because benefits are viewed as a property right.

3. Greeted by lawsuits immediately after the bills were signed


Story Ideas

1. What is the financial health of pension plans in your area? (Public plans have to provide data.)

2. Are plan administrators considering actions to modify plans? What resistance is expected?

3. What has been the financial performance of the fund over time? Is it competitive with other plans?

4. What is retirement pay for high paid employees?


financial markets in 2011 - reynolds week 2011

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