We have lived primarily over the last decade in an era of low inflation, historically low interest rates for borrowing as well as investing, and historically low GDP growth rates. America is a mature country that is aging, has a population growth rate of less than 1% per year, and devotes more and more each year of its money or its borrowing of money for legacy items such as social security and healthcare. All of this means that for investors, investment returns must be lower, because inflation is quiescent, and therefore real returns are more proximate to the actual invested returns, than what was the case back two or three decades ago.
One of the fundamental things that helps defined benefit pension funds, that is to say pension funds that stipulate how much and how long you will receive a certain amount of money upon retirement, is that those numbers may or may not be tied to inflation, may or may not be limited to a certain cost of living increase ceiling, and may or may not be correlated with an inflation rate that favors the pensioner. This means in most cases, that inflation helps pension funds earn their particular goal of 7.5% or whatever it is, because inflation helps to push investment results up, even though the real return will actually be considerably lower because the value of that money has been devalued through inflation. This means that with inflation investments are able to utilize a tailwind that helps to achieve desired investment goals, and deflation or very low inflation provides a headwind.
The last decade has proven that low inflation, low GDP growth, and low interest rates, are not necessarily going to be transitory, that indeed, they may be part of the "new normal", which means that the type of safe investment choice, such as bonds, which historically offered a steady rate of return with minimal risk, are not an investment vehicle that many pension funds can take advantage of, because bond yields at the present day are so anemic. This means, that pension funds must increase their investment choices as well as their investment risk, which makes for a much higher volatility in their investment returns just to achieve what previously they had achieved, with relative safety and sanguinity.
In the investment world, there are going to be winners as well as losers, with those that just have to make 7.5% or thereabouts, forced to take risks in order to achieve their benchmark, because by not doing so, their pension fund will begin to suffer shortfalls to its commitments to its pensioners. At the same time by taking those risks, the volatility as well as the standard deviation of these investments will begin to accelerate into previously uncharted and shaky territory.
In the US stock market, all the major indexes at the present time are either at their all-time peak, or near them, which suggests that the easy money has already been made, further to the point, GDP growth in America has not exceeded 3% since 2005, and inflation has exceeded 4% just once since 1991. All of the above, points to the invariable fact that to get a return north of 5% going forward, pension funds have to invest outside of the United States market, which increases risk and unknowns, with invariably disasters coming back to haunt pension funds.
A more prudent course of action with pension funds is to reduce the benchmark to something far more legitimate, such as 4%, and make wholesale changes to defined pension plans so as to reflect those more realistic returns and therefore pension pools that will be disbursed must be lower in the future; rather than pretending that benchmarks of 7.5% can be hit year after year, when, in fact, in aggregate, that will not and cannot happen.