Thursday, May 26, 2005

Do you invest as well as your pension fund?

By now, it’s pretty clear that defined-benefit pension plans are an endangered species (see this article). Even relatively healthy firms are switching to defined-contribution plans to transfer investment risk to workers.

Is this a good thing? Sure, if the average Joe was equipped to make smart financial decisions. However, there’s a lot of research that suggest the average investor makes plenty of costly mistakes, such as overlooking costs (this piece provides a nice summary). In that regard, traditional company pension funds, which are usually large and managed professionally, may provide better performance.

I took a look at four large pension funds –two for public sector workers (Calpers and NY State Common), and two company funds (IBM’s and GE’s). Over the last ten years, they averaged a 10.2% annual compound return (the range was very narrow: between 9.9% and 10.6%).

It’s not an extraordinary result. A portfolio made up of Vanguard’s S&P 500 and Total Bond Market index funds, split on a 65-35 per cent basis, would’ve delivered basically the same performance.

Yet, one has to wonder how many people actually earned these returns. My bet is that, on average, they would’ve earned a between one and two percent less, simply from paying higher management fees or from excessive trading. So spare a tear for your traditional pension fund, which in most cases offered workers a decent deal.