The 401k vs Pension Debate

Call it a case of "not being able to save for your retirement and eat it too."

A recent Wall Street Journal column presented the idea that many of the initial 401k champions, now regret their involvement in pushing the investment vehicle in favor of the traditional pension plan offered by companies to employees. In effect, a 401k plan allows employees to save tax-advantaged money for retirement, usually with an employer-match, but shifts investment risk onto the employee rather than the company and the pension plan.

The problem is psychological. Most people place too much emphasis on current consumption compared to future consumption, so they save less and spend more in the present. Moreover, most of these savers/investors are untrained in the field of investment.

So the general result is: (1) employee's save too little and (2) don't generate a high enough rate of return on invested assets.

Now, I lean a little right of center when it comes to the pursuit of economic well-being. I think people should generally take responsibility of themselves, including financial matters such as saving for retirement and investing in the capital markets.

We live in a capitalistic society, after all. Those with superior investment skill and/or diligent savers should accumulate plenty of assets and be rewarded for those decisions.

I think it is a mistake to put the weight of an employee's future on the shoulders of private businesses and governments [I also realize I've never had the benefit of a pension, so that shades my view]. What generally happens is the pension plan overestimates the ability to generate returns and underestimates the future costs (by assuming shorter mortality schedules, etc), resulting in underfunded pension plans.

In the case of the Oregon PERS, lavish benefits and some years of recent investment underperformance (relative to assumptions; 7% I believe) and too little contribution to the plan from lower than anticipated tax receipts etc., has led to a plan that is currently $22 billion underfunded. That seems inherently unfair - that former public employee's get showered with retirement benefits [many times, retiree's are making more in retirement than they were while working], while private citizens pick up the tab [and don't have a guaranteed pension].

In the end, people and investors want the option to outperform when times are good [like in the 1990's when equity portfolios outpaced stated pension returns], but can't handle the idea of underperformance. That seems quite unrealistic.

The nature of markets is that there is volatility, both on the upside and downside. You can not have progress without risk.

Investors and savers need to realize that the way to mitigate the risk of running out of money in retirement is to save as much as possible. And once capital begins to build, to put in place an investment program that maximizes returns without a commensurate level of risk. That is a topic for another day.

On a side note, I'm approaching my 4th anniversary from "retiring." I managed to save a decent amount of capital in my 20's, keep a low(ish) overhead, and put together a few decent-sized wins [and many small losses too along the way; I don't presume to be infallible] to continue my path of being a full-time, private investor.

My strategy is to find small companies that can get big, fast. And to make significant sized bets when I find something I really like. I also put a lot of emphasis on a latticework of models to appraise a business: I want a high-quality management team, playing in a disruptive market with best-in-class technology, and a business model which lends itself to a large amount of earnings leverage/power that the market is not properly discounting. Given the size of my bets and emphasis on focus investing, I require balance sheet strength and a company that can scale without continually raising money in the equity markets.

I am reminded of Howard Marks thoughts regarding being better than average: in order to have a unique result, the investor's approach and portfolio must be different from the norm.

In the end, that is the strategy in a nutshell: be different in order to succeed with the humility to know that the result could be less than the average if things don't work out.

In other words, embrace exactly the notion many people/employees/savers can't: that one cannot have meaningful and unusual returns on the upside without the possibility of unusual losses on the downside. The trick is to have an investment philosophy in place that maximizes the possibility of winning while minimizing the chances of losing; in other words, being skilled in the art of capital allocation.