April 11, 2011

Is a 4.5 percent rate-of-return realistic?

For Immediate Release: April 11, 2011
Contact: Alan Barber 202-293-5380 x115

Washington DC- Debate over public pension funds continues unabated across the nation. Some have argued that states should assume a risk-free rate of return on pension fund assets, which makes funding shortfalls appear considerably larger. A new calculator from the Center for Economic and Policy Research (CEPR) demonstrates that such a low rate of return is extremely implausible given the sharp drop in the price-to-earnings ratio since the downturn.

The Pension Return Calculator” allows users to manipulate several variables --including nominal rates of return on stocks and GDP growth-- to show price-to-earnings ratios from 1962-2050 in an attempt to achieve a risk-free, 4.5 percent rate of return.

“Most pension funds assume a 10 percent rate of return, the historical average,” said Dean Baker, a co-director of CEPR. “There are practically no plausible scenarios in which stocks will only produce a 4.5 percent rate of return, especially when one considers our current low price-to-earnings ratios.”

The calculator demonstrates that attempts to scale back public pensions based on pessimistic expectations of rates of return are misguided. Barring another downturn of the magnitude of the Great Recession, it is highly unlikely that the rate of returns on public pensions will not be near the historic average.

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