Wall Street and professional investors such as pension funds tend to be smug about how sophisticated they are in comparison to mom-and-pop investors.
We ordinary folk buy high, sell low, chase fads, and generally do poorly — or so goes the conventional thinking from our investment “betters.” What they don’t say is that more often than not, they fall prey to the same weaknesses as the rest of us and only occasionally do better than ordinary investors who buy index funds and simply sit there and do nothing.
But rather than focus on how individuals can do better than the “smart” money by buying and holding, let’s talk about another foible of professional investors: investment assumptions. Specifically, I’m referring to the assumptions made by pension funds about their future returns.
It’s true that “real” pensions — the kind where after working for 25 or 30 years for one employer you receive a monthly check for the rest of your life — are fading away. Most corporations either have stopped offering a defined benefit plan (the more precise term for what we call a pension), frozen their plan, and/or offered their plan participants an annuity from a life insurance company in its place. Still, pensions remain alive and are quite important in the public sector, and millions of teachers, police officers, firefighters, and other state and municipal employees are plan participants.