Think and Invest Like a Pension Plan

By Adrian Mastracci

Markets continue to find volatility, creating the traditional wall of worry. Let’s turn to pension plans for some portfolio investing guidance. Investors too can reap benefits from this approach.

Unlike most individuals, pension plans focus first on policies and strategies. Then they attend to making investment selections. They have been following this simple approach for decades.

I summarize some pension plan tactics for consideration:

Think long-term
Pension plan managers are very skilled at long-term thinking. They understand that short-term moves are a normal part of the long investment journey. They think in decades in their quest to deliver pension income to each retiree.

Find your mix
Pension plans routinely review and rebalance their asset mix plan. Investors can also examine the suitability of the mix on a regular basis. Asset combinations like equities, bonds, cash and real estate have the biggest impact on portfolio returns.

Manage risk
Pension plans resist temptations to incur unwanted risks. If a touch of aggressive investing is fitting, limits are placed on these investments. Such as allocating not more than 5% of total portfolio value.

Stick to basics
Pension plans follow time-tested strategies and regimens. They try to ensure that no investment tips the ship or creates lasting portfolio damage. They also implement strategies to deal with gains and losses.

There is no reason that individuals can’t invest like pension plans. Investors can adopt similar strategies to steward their portfolios. Think and invest like a pension plan. That keeps your portfolio delivering for decades.

This is what all investors require. Whether accumulating or spending the retirement nest egg. However, keep in mind that pension plans are not always right. There is something else that every pension member should do. That is, take a keen interest in the financial health of the pension plan. Be on top of it; your retirement depends on it.

A number of pension plans are now underfunded, while others are about to become underfunded. Some pension income benefits may be reduced if those funding levels don’t improve.

Anyone who is a member of a pension plan should take note of this unsettling situation. This includes investors who are still contributing and those now receiving pension benefits.
My own mother is caught up in a pension underfunding predicament.

Pension plans have three sources of funding. They are employer contributions, employee contributions and investment returns. Ongoing low interest rates have been devastating to pension plan returns.

Longer life expectancy places additional demands on pension payouts. Some pension plans may incur problems in paying all the promised benefits. A couple retiring at age 65 could easily receive joint life pension income for 20 to 25 years.

Participating in pension plans means making some irreversible decisions. Notable pension events occur when:

• A choice is presented to join a pension plan, buy back past pension service or retire normally.
• An early retiree is offered the option of staying with the pension plan or transferring the commuted value to a locked-in account.
• Accepting a commuted value shifts responsibility to provide in retirement to the employee’s hands.
• A switch from a defined benefit to a defined contribution pension keeps the employee working longer.

Steady pension income has always been an important part of the retirement puzzle for pension members. Pension reductions can rattle some pillars and assumptions of retirement planning.

Investors should consider what could happen to the retirement plan if the expected pension was reduced, say by 10% to 30%. Some key questions entail how would you make up the potential retirement income shortfall, how much more investment capital would you require and if there is sufficient time to accumulate your additional funding.

Dependable pension income is the most important part of the retirement planning puzzle for many. Every pension plan member, retired or not, is advised to annually check financial footing with the pension administrator.

No doubt, some retirement plans will face difficult choices. Long-term income adjustments may be necessary. There are no easy answers, even for pension plans that are rock solid today. Be sensible and don’t assume that your pension is iron clad forever.

Warren Buffett once that if a business does well, the stock eventually follows. Which brings up a companion topic to thinking and investing like a pension plan. Markets will soon be in the midst of sifting quarterly earnings and future guidance reports. Accordingly, let’s revisit one common task of reporting companies.

That is, the need to deliver better-than-expected results. Quarter, after quarter, after every quarter! Analyst estimates and expectations have become benchmarks to match or beat for each quarter. A very tall order for any company, quarter in and quarter out.

Companies live or die under the magnifying glass comparisons to analyst figures. Investors often make sweeping portfolio changes based only on one quarter’s results. Heaven forbid when corporate margins shrink over several quarters. Dare to miss on revenues, profits or guidance and corporate fortunes can change very quickly.

Consequently, companies are always trying to manage analyst and investor expectations. Stock prices can easily slide if reported results don’t measure up to predictions.

Think for a moment about this herculean task. Analyst estimates can be adjusted frequently, like a moving target. Delivering increasingly better quarterly results is neither easy nor realistic. Investing lasts a lifetime; investor patience can boil over in one quarter.

Companies are in need of some relief for periodic slippage. Longer term directions of the results are more important measures than one quarter’s results. Pursuing quarterly improvements is akin to the trader mentality. It does nothing to foster the long run investing approach.

“Behold the turtle. He makes progress only when he sticks his neck out” said American chemist James Bryant Conant. Global economic headlines continue to show signs of a weak recovery. Investors are anxious about sticking their necks out.

Stock and bond markets are confused. As the joke goes, figure out the logical investment move then do the opposite. Investing is not likely to be a cakewalk, so best to be fully prepared. Like the turtle, investors too may also be sticking their necks out.

A few simple steps help steer through the investing curves ahead. Expect to encounter more market volatility, in both directions. Design loss/gain and buy/sell strategies carefully in view of sudden price moves.  If the overall tone of the future guidance is cautious, markets can slip. If earnings forecasts point to added optimism, markets can move higher.

Some companies provide no guidance; others issue guidance that is easily achieved. Remember that revenue growth is the biggest challenge for companies in this environment. Uncertainty can muddy the markets all too quickly, so simplify the money matters. Look upon accepting short-term portfolio volatility as the tradeoff for long-term investing potential.

Position the portfolio for low returns to continue well past this year. Keep bond ladder maturities under five years and start selling longer maturities. Many portfolios fare better by reducing needless investment risks. Especially, those whose stocks and mutual funds exceed 60% of total portfolio value.

Prudent investors skip the fanciness and focus closely on where they are headed. For the rest of this year and thereafter. Investors have enjoyed a bull market since March 2009 without long corrections. However, many gurus think things could change.

Hordes of predictions are making the rounds. They run the gambit from substantial pullbacks, slowdowns, sideways steps and more upsides. All flavours can be heard on the same day. So, should investors be concerned? Is it time to jump ship? Perhaps, run and hide? Reality is that nobody really knows.

The right answer should be no, unless the nest egg is truly in tatters. A well-designed portfolio ought to ease investment jitters and concerns most times. A couple of smart moves improve retirement portfolios year-round in a pension-like fashion.

To borrow a phrase from a previous Ford advertising campaign, “quality is job one”. Serious money portfolios benefit from owning a healthy splash of quality. It’s wise to stick with quality investments, especially for the core selections. Make sure the portfolio foundations are fortified with quality. Both for the equity and fixed income mix.

It’s far too easy to trade in quality for the lure of higher yields. The last few years have been brutal on fixed income returns, so it’s completely understandable. Just not always wise. Quality is a best friend of prudent long-term investors. Remember the phrase from children’s books that reads something like “slow and steady wins the race”.

In baseball, it’s preferable to get on base frequently rather than always aiming for home runs. The same applies to retirement portfolios. If some excitement must be part of the portfolio, carve out a small portion. Something that won’t hurt much if it crumbles. Hitting investment home runs is exciting. However, trying to achieve high returns on a few hot selections is a low percentage strategy.

Strikeouts can inflict serious portfolio damage, often for a long time. So, limit exposures to single stock investments to sensible accumulations. Particularly, if the company is also the employer. Individual stock levels above 4% raise the caution flags. Also refrain from loading up on the must have sizzling bandwagons of the day.

Adopt these moves for year-round investing. Keep your line of sight on how pension plans think and invest to deliver long run income for decades. Just don’t bet the farm for any reason.