Reuters Money

This piece by Nanette Byrnes originally appeared on Portfolioist.

What rate of return can we realistically expect from our investments?  Seven percent? Eight percent? 12 percent?

This is no academic brain teaser to anyone saving for retirement or a down payment. It’s not easy to get right, and getting it right is critically important.

Guess too low, and you end up with a dour view of your chances of making your financial goal. Guess too high, and you could end up in dire straights.

If it’s any consolation to the amateur investor, the pros often can’t agree on the ideal rate of return either.

Fighting over investment returns in California

In California a debate on this issue has been sparked by the chief actuary of the massive $227 billion California Public Employees’ Retirement System (Calpers) pension plan. He wanted to lower its expected rate of return from 7.75 percent to 7.5 percent, but the fund’s board, under pressure from local municipalities who would have had to contribute more, voted against that. Over 20 or 30 years, even that small a change can have a significant impact on your final balance.

Such a drop would require cash-strapped local governments all across the state contribute more in pension plan payments, and they fought that idea hard.

Calper’s expectations are not especially high. According to survey data compiled by the National Association of State Retirement Administrators (NASRA), the median assumed rate of return among the largest public funds is eight percent, though some funds use estimates as high as 8.5 percent, and others as low as seven percent.

According to Wilshire Associates, the range among the largest corporate pension plans is 6.5 percent to 8.75 percent, with an average of eight percent as well. Among corporate plans, which have seen some significant changes in the pension accounting rules, the average has come down significantly in recent years. In 2000, it was 9.5 percent according to Wilshire Associates.

What’s interesting is that public and corporate pension plans come out in the same spot on their return estimates, despite fairly different average asset allocations.

Big pension plans calculate their returns

Public plans today are far more heavily invested in alternative investment classes, like hedge funds and private equity funds, and in real estate than their private sector counterparts. Major corporate plans, meanwhile have gone much more heavily into cash.

Here is the average asset allocation among the public plans surveyed by NASRA:
52.1 percent stocks
29.0 percent bonds/fixed income
5.9 percent real estate
8.7 percent alternative investments
4.4 percent cash/other

Wilshire reports that the average corporate plan has the following asset allocation:
54.1 percent stocks
34 percent fixed income
1.7 percent real estate
2.2 percent alternative investments
8.0 percent cash/other

Based solely on their projections for indexed investments in their asset class mix, without any premium for potential “outperformance” by their investment mangers, Wilshire puts a rate of return of 6.5 percent on the public plan’s asset allocation and 6.4 percent on the corporate plans. Both figures fall significantly below the pension plan manager’s 8 percent estimates.

What’s your number?