Global Pension Crisis: Unfunded Liabilities and How We Can Fill the Gap

CHAPTER 4

Money Matters

ERISA not only set out stringent protective rules for establishing and administering and controlling pensions, but it actually “created” the modern money management industry governed by the principles of what is called Modern Portfolio Theory such that pension savings might have a chance of keeping pace with the visible growing need. I would like to take a moment to review what we in “the biz” call MPT.

ENTER MODERN PORTFOLIO THEORY

If you need to understand why this is important, just consider the equation 15/35/50 where for every $15 you put into retirement savings (presumably over a 40 year retirement lifecycle), you should accumulate $35 in compounding before retirement and an added $50 postretirement, assuming you drawdown at 60 percent of your preretirement income. This is actually quite logical if you stop to consider the compounding math and the timeframes involved in retirement cycles. And the funny point is that this assumes an investment return of only 5 percent, and if we raised that to 10 percent, almost 99 percent of the value comes from compound return earnings. The point is simply that how your money is invested is far more important than the amount you save (actually somewhere between 6 and 100 times more important). And, in addition, it only gets more important in the later periods once the retirement pool is accumulated. Thus, pensions must rely heavily on their investment schemes to succeed in providing retirement income security.