Recent controversies involving South Carolina’s underfunded state pension fund offer some instructive lessons for individuals.
Many states, like many people, have poorly funded retirement plans, but South Carolina’s has caught some attention for trying to narrow the funding gap by putting more money into high-risk, high-expense investments.
And lately, there’s been controversy about a perceived lack of disclosure about what those investments are, and just what money managers are charging the state.
In a recent Post and Courier report, the state treasurer said alternative investment managers charged the state $344 million last year, but a member of the state commission overseeing the retirement system put the figure at $239 million.
While a New York Times story about “South Carolina’s Push Into High-Octane Investments” focused on a Lamborghini-driving fund manager, the way fund overseers were wined and dined at New York clubs and so on (dinner with a centerfold model?), I’m going to focus on what average folks can learn from this.
Lesson No. 1: Know what you’re being charged by institutions that handle or manage your money.
While it seems stunning that there’s a $105 million gap between the figures offered by different state officials as to the fees charged by high-risk fund managers, I’m sure that many individuals don’t exactly know the fees they are being charged to handle their money. That can be true for investments such as retirement mutual funds, but also for more mundane services such as having a checking account.
A plain-vanilla mutual fund that tracks stock and bond market indexes can carry annual investment expenses below one quarter of one percent. But some funds can hit investors for a full percentage every year, and that can really add up over time.
With banks and credit union checking accounts, debit cards and credit cards, some charge high fees and expenses for basic services. Others charge little. If you don’t know what you’re being charged, there’s a good chance you’re paying too much.
Lesson No. 2: Unrealistic expectations can lead to big financial problems.
South Carolina’s pension fund is greatly underfunded. One reason for the big gap is that the state, year after year, assumed it could earn an 8 percent return on the pension fund despite evidence to the contrary. Those assumptions led to pay raises for retirees, which further depleted the fund.
The takeaway for individual investors is long-term savings plans for things such as college costs or retirement have to be adjusted to reflect what’s really happening. If investment funds or interest-bearing accounts aren’t delivering what you expected, you’re going to have to save more or deal with having less to spend.
Or, you could try to bridge the gap by taking bigger risks, which leads us to …
Lesson 3: Following the crowd can lead you over a cliff.
Remember when real estate and mortgage-backed securities were can’t-lose investments in the mid-2000s? How about Internet stocks in the late 1990s? Japanese stocks in the 1980s? Gold in the 1970s? Tulip bulbs in the 1630s?
The investment world veers from bubble to bubble, as naive investors follow, waving money. Many studies have found that individual investors have a terrible habit of buying popular investments at the top of the market and selling them at the bottom.
Jumping in out of greed, jumping out due to fear and losing big in the process is partially human nature. When other people seem to be making big money doing something, others will say, “Hey, why aren’t we doing that, too?”
But unless you’re a sophisticated investor with money to risk, keep it simple. There are plenty of solid, low-cost, long-term investment funds available; the kind where you pick the year you plan to retire or pay for college, and the fund shifts toward more cautious investments as that date nears.
Trying to make up for disappointing investment returns by taking bigger and bigger risks can lead to big losses, not unlike doubling down at a casino table.
Reach David Slade at 937-5552 or Twitter @DSladeNews.