Wallingford's pension plan is becoming more costly. The town can tamp down cost increases, however, with a cultural change based upon research and common sense. Dear reader, stay with me for a short explanation.
Taxpayers and town employees have been contributing to the pension plan for a long time. As employees retire, they get a benefit that's defined in labor agreements. That benefit is paid from the pension trust, and it is now has a value of about $210,000,000. As time goes on, however, payments to retirees will grow, so the town needs to keep growing the pension's assets, too.
Although employees contribute to the pension plan according to a fixed percentage of their pay, the town's contribution is variable. Actuaries, using their algorithms and software, annually estimate what the town should contribute to keep the pension trust healthy. That sum is put into the budget and reflected in the tax rate. Employer and employee contributions are not enough, however. The Pension Commission, which administers the pension trust, must also invest the assets, and investment returns are important in determining how much taxpayers have to kick in each year to meet future pension obligations.
Simply put, if investment returns are higher, taxpayer contributions can be lower. If investment returns are lower, contributions from taxpayers must be higher.
Blue chip stocks, like those in the S & P 500 index, have higher returns than bonds. Some individual investors, however, are told by their advisors to hold bonds (typically 40 percent) because if they need to raise cash when the stock market dips, as it occasionally does, investors can sell bonds in a down market rather than sell stocks. That's usually less painful, although bonds can lose value, too.
The legendary investor and billionaire Warren Buffet points out, however, that small investors can't be compared to pensions funds, like Wallingford's. Towns don't need a high ratio of bonds because they will never need to "cash out" for living expenses or emergency medical costs. Towns aren't nearing retirement. Towns aren't in the 4th quarter of their lives. Besides, unlike individual investors, municipal pension funds do receive continuing contributions from taxpayers and employees, so pension plans can weather a multi-year market correction without a lot of low performing bonds on hand.
That's why Buffet said that a municipality like Wallingford would make a "terrible mistake" if it held more than 10 percent in bonds in its pension fund. And Wallingford is making that mistake. It has about $65,000,000 in low returning, fixed-income investments, which is almost a third of its portfolio. The town doesn't need nearly that amount to pay benefits during a market downturn. Most of this market value could comfortably be invested in a basket of higher returning "conservative" stocks, and that would mean tens of millions of dollars in additional future returns to the pension trust and some relief for taxpayers.
Why is Wallingford over-weighted in bonds? It's not a matter of avoiding losses because of market risk. Rather, there's another risk at play: The risk of adverse public perception. If the market should crash, a headline in the R-J might tell of millions "lost" in a bad quarter or two, even though the market would come back if we are patient. Or, in one or two fiscal years, the town's pension contribution could be higher because of a temporary decrease in value of the pension trust. But that can be mitigated, and a temporary budget adjustment would not be nearly as serious as the tens of millions lost due to a timid investment policy.
So, dear reader, the solution is evident. Consider seriously Warren Buffett's view, tolerate short-term market swings, and promise the Pension Commission to be patient with an asset allocation that does not include too many bonds. That way, the pension's returns would be higher in the long run, and the town would be much better served.
Mike Brodinsky is a former Wallingford town councilor and host of the “Citizen Mike” public-access television show.