I saw this question posted by a municipal employee on a message board and wanted to share it here with a broader audience and give my perspective – and invite thoughts/ideas.
“I have an offer to join a new retirement plan that boils down to a (one time option to join, non-revocable) guaranteed 7.25% annual return on 401K equivalent contributions. I’m not worried about the County being able to fund this rate of return if things get really ugly. I’m also not that financially interested, preferring a “set it and forget it” approach to retiring.”
If there were no risk whatsoever of renegotiation of labor contracts or lack of the municipality’s ability to pay in the future (unlikely a problem since municipalities just raise taxes, kind of like our federal government will have to do when they can no longer print money due to inflation), this is a very good deal.
Here’s why: The risk-free rate of return (Treasuries) is extremely low. You’re getting a 7.25% risk-free return, which is actually a double digit return risk-adjusted.
Why? Stocks carry with them massive volatility and there’s no guarantee that you’ll see a positive return over any particular period. Look at Japan or look at our past 12 years. There are some mildly involved equations I used in B-school for translating between risk-free and risky asset returns, but clearly, a risk-free return over 7% is unheard of, especially in the current low-interest rate environment. As mentioned previously, this now allows you to take some cash on the side and if you’re concerned about missing a major market run in the next few decades, just buy some real cheap out of the money options each year. If the market runs say, 30% one year, you can get a leveraged 200% return for example. On years where the market’s flat, you lose the premium which might only be a few hundred bucks…but you’re guaranteed that 7+% return for a long period of time.
Anyone think this is a bad deal?
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