Keep that 8% Investment Return in Context

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News of Rhode Island’s 8% return on its pension fund is being spread far and wide. Here it is in Chief Investment Officer:

The $8.3 billion Employees Retirement System of Rhode Island returned 8.03% for the fiscal year ending June 30, ahead of its 7.0% annual target, and its benchmark, which returned 7.5% during the same period.

Read on, though, and you see how inadequate this really is:

The fund also outperformed a traditional 60% stock/40% bonds portfolio, which would have earned just 6.25%. The fund also reported three-, five-, and 10-year annualized returns of 6.3%, 7.2%, and 5.8%, respectively, compared to its benchmark’s three-, five-, and 10-year annualized returns of 6.0%, 7.0%, and 5.6%, respectively.

The only number in all of these comparisons  that matters is the 7.0% “annual target.”  Indeed, this phrase is misleadingly minimizing.  Everything depends on hitting that number — even, arguably, the solvency of state government.  One wouldn’t say that having enough household income to pay the mortgage is an “annual target.”

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In that context, 7% is really the zero line, and an 8% return on investment is really only 1%.  Moreover, the zero line has to be hit every year for decades.  So, every year that falls short requires multiple years of higher returns.  Over the past decade, the average annual return has been 5.8%, which is really more like -1.2%.