Pension Pitfalls

by: Roger Nusbaum

Summary

Japan’s Government Pension & Investment Fund (the public pension) had investment losses of $50 billion for the year ending in March against an asset base of $1.4 trillion.

If you’re thinking that loss seems manageable, yes it probably is, but the context of an individual taking a small loss in a given year is not the same.

It isn’t that easy for a pension plan that has to pay out to thousands (or more) of plan participants.

By Roger Nusbaum, AdvisorShares ETF Strategist

The other day I stumbled across an item via Seeking Alpha that Japan's Government Pension & Investment Fund (the public pension) had investment losses of $50 billion for the year ending in March against an asset base of $1.4 trillion. The losses were attributed to a rising yen and falling equity prices in Japan.

If you're thinking that loss seems manageable, yes it probably is, but the context of an individual taking a small loss in a given year is not the same as a large pension fund. If the equity market goes down 20% during one year within a bear market and a retiree's portfolio does something vaguely similar, anywhere from 15-25% down, and that is stress inducing (which would be reasonable), then that retiree can figure out how to (maybe) take a smaller withdrawal until some portion of the decline is clawed back.

It isn't that easy for a pension plan that has to pay out to thousands (or more) of plan participants. Pensioners are beholden to the pension manager's ability to generate returns that are sufficient to meet all obligations. Part of the modeling for a pension are assumptions of what future returns will be for equities, fixed income and other asset classes that the pension might invest in.

When those assumptions are met then everything is just fine, but when they are not met there can be problems. Earlier in the recovery from the crisis, the idea of return assumptions including yields from the bond market that no longer existed became a mainstream talking point. Fast forward to 2016 and yields are lower, which makes the threat even worse. Barron's noted that just 6% of sovereign debt now trades with a yield above 2%.

Repeated for emphasis, pensioners are beholden to the pension manager's ability to generate returns that are sufficient to meet all obligations. While this might seem like common sense to people interested enough in investing to seek out blog content, I recently had a conversation about this with someone who needs to make a decision about how to take his pension or whether to take the buyout, and I had the sense that the reliance on market returns was not a consideration for his decision.

Any retirement plan, including one dependent on successful pension results, needs to have the risks to that plan spelled out to have a better chance of mitigating the consequences of those risks should they materialize.

Now an update on tiny houses on wheels which aren't actually legal in too many places. I've written about tiny and small houses for a few years now with the idea being they could be a way to meaningfully downsize such that a couple without a large retirement nest egg could sell an average priced home that was hopefully paid off at time of retirement for $225,000 (about the average home price in America), go all in for a tiny or small home for $75,000 and boost their small nest egg by a relatively large amount.

The tiny house idea is more of a millennial thing in response to younger people wanting/needing to have smaller financial footprints and live a certain lifestyle which includes hitching the tiny house onto a pickup truck and hitting the road, hence the wheels that are on true tiny houses. The linked article gives a decent idea of the zoning issues, even if not a complete list.

We've watched a few of the various tiny house TV shows that are on, and one thing I have noticed is how often the people who actually intend to take their tiny house on the road have a very new-looking Ford F-250 or similar ¾-ton pickup truck. The average weight of a tiny house on a trailer is 10,000 lbs so a ½ truck won't really cut it. Three-quarter-ton trucks are often more expensive than the houses they will be towing. A look at used ¾-ton trucks on cars.com within 200 miles of where I live start at just under $60,000. They bottom out under $10,000, but at that price point they have a lot of miles -- really a lot. There was a 1997 for $9800 that had 280,000 miles on it. At $20,000 you can find kind of newer trucks with a lot of miles (a 2012 with 123,000 miles) or older trucks with lower mileage (a 2005 with just 48,000 miles).

Where the goal really is about a smaller dwelling to save money and have more flexibility, I would argue it would make more sense to build a small house on a foundation, and by small I mean 300-500 square feet which, based on the above linked article, is not too small per building codes. Renting an RV for the occasional road trip is pretty reasonable and $20,000 might buy a vehicle with a little less wear and tear.

A very small house will not be the solution for a lot of people, but can be viable for some and a difference-maker for people who get to retirement age well short of the amount they need.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: To the extent that this content includes references to securities, those references do not constitute an offer or solicitation to buy, sell or hold such security. AdvisorShares is a sponsor of actively managed exchange-traded funds (ETFs) and holds positions in all of its ETFs. This document should not be considered investment advice and the information contain within should not be relied upon in assessing whether or not to invest in any products mentioned. Investment in securities carries a high degree of risk which may result in investors losing all of their invested capital. Please keep in mind that a company’s past financial performance, including the performance of its share price, does not guarantee future results. To learn more about the risks with actively managed ETFs visit our website AdvisorShares.com. AdvisorShares is an SEC registered RIA, which advises to actively managed exchange traded funds (Active ETFs). The article has been written by Roger Nusbaum, AdvisorShares ETF Strategist. We are not receiving compensation for this article, and have no business relationship with any company whose stock is mentioned in this article.