It’s the Net Result That Matters

It’s been a tough five years for teachers.

As the financial crisis rolled through the economy, everyone looked around for someone to blame or bear the cost of downsizing. The private sector looked for a culprit in the profit centers from the housing boom, namely the banks and financial firms. The public sector, where tax revenue fell like a rock, looked at their largest employment expense, typically in education.

There are many teachers. They tend to have decent retirement plans and healthcare. And since private sector wages have been stagnant or falling for a decade, teachers also have comparable salaries to private sector workers.

And that’s where the fight starts…

Florida governor, Rick Scott, froze teachers’ pay in an effort to control costs.

So far, so good.

Then he went on to attack the rising cost of healthcare and pensions by increasing the amount teachers had to pay to keep the same benefits.

On paper, it can certainly be said that teachers retained their salary but had to pay more for the same benefits. On different paper – meaning one’s paycheck – teachers are pretty certain they got a pay cut. They keep the same job, they keep the same benefits, but their paycheck is smaller.

The same thing is going on with the Fed and pension funds.

Private pension funds are having great years… sort of.

There is no doubt that the multi-year run up in bond and equity prices, driven by the Federal Reserve, has given pension funds a huge boost in returns. With such force behind you, how can you lose?

Oh, I know how… look at what else the Fed is doing.

Yes, it’s true that pension funds are boasting great investment returns. In fact, the 100 largest private pension funds just earned a whopping 1.78% in April alone. But, at the same time, the funding status of pensions fell, meaning they have even less money required to pay all of their pension payments over time.

The reason for this drop in funding, from 82.8% of what they need to 81.2% of what they need, is because the discount rate for their liabilities has changed. Stick with me on this one…

The discount rate is the interest rate used to figure out what all future payments are worth today. Put another way, the discount rate is the interest rate used to figure out how much you need to invest today to meet an obligation in the future. The lower the discount rate, the more you need to invest today.

Given that the Fed has held long-term interest rates low for almost half a decade, the discount rate for pensions keeps falling, so the amount of money they need to sock away today to pay pensions in the future keeps going higher.

What the Fed provides with one hand (better returns), it takes away with the other (higher required contributions from the employers).

So what does this mean?

It means that companies have to write big fat checks to their pension funds to cover the shortfalls. So the same companies have less money to spend on research and development, or dividends, or capital investment, or anything else. All of this is courtesy of the Fed.

Net, net, thanks for nothing, Ben.

Rodney

P.S. Given the circumstances with pensions, don’t get too cozy with dividend stocks. Yes, they have provided a handsome return in the last few years, but their costs are shooting higher as pension costs and other costs rise too. One logical place to cut, in order to pay such costs, is dividends. This is yet another reason that the days of simply buying and holding are behind us!

 

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Categories: Markets

About Author

Rodney Johnson works closely with Harry Dent to study how people spend their money as they go through predictable stages of life, how that spending drives our economy and how you can use this information to invest successfully in any market. Rodney began his career in financial services on Wall Street in the 1980s with Thomson McKinnon and then Prudential Securities. He started working on projects with Harry in the mid-1990s. He’s a regular guest on several radio programs such as America’s Wealth Management, Savvy Investor Radio, and has been featured on CNBC, Fox News and Fox Business’s “America’s Nightly Scorecard, where he discusses economic trends ranging from the price of oil to the direction of the U.S. economy. He holds degrees from Georgetown University and Southern Methodist University.