Known Unknowns


Welcome to Known Unknowns, a newsletter that, much like life, is somehow always about pension economics.

It's always about pensions

No one thinks that we Pension Geeks are very exciting. Let’s be honest, we’re probably less interesting than actuaries. And yet it always comes down to pensions. There is so much civil unrest in this world, and lots of it is all about pensions. 1.5 million people took to the streets in France to protest pension reforms. They shut down transportation, and are causing all sorts of chaos. Citizens are protesting any sort of cut or increase in the retirement age—which is currently 62, among the youngest in the OECD.

Nothing gets people to take to the streets more quickly than cutting a retirement benefit. And this is an interesting contrast to what’s going on in Chile. It’s remarkable that protests in Chile are held up as evidence that Defined Contribution (which has become synonymous with neoliberal) pensions don’t work. No one is saying that about Defined Benefit pensions in France. I’m still a fan of Chile’s pension system. It certainly has its problems—it doesn’t cover enough people, especially people in the informal labor market; the fees were too high; and there should maybe be a higher guaranteed state-provided income floor. But compare their problems to France, where people freak out if they have to work past the age of 62, and the money just isn’t there to make it work. Chile’s pension issues are much easier to solve.

I’ve said it before: I’m mostly DC/DB agnostic, but DB plans create incentives to over-promise and under-fund. DC plans are always funded and there are no explicit promises, so getting the incentives right are much easier, and the Chilean government is actually in a much better situation than France’s or Brazil’s.

Moshe Milevsky makes the important point no one else is saying. We also need better financial literacy so people have realistic expectations of what their DC or DB plan can pay. Odds are nothing will finance 30 or 40 years of retirement.

Inefficient investing makes a comeback

I consider index funds one of the greatest advances in personal finance. A well-diversified portfolio is the most efficient way to invest. Efficient investing doesn’t mean that you avoid risk—it actually only means that you should avoid unnecessary risk. And here is my quick-and-dirty investment strategy.

  1. Select an efficient portfolio of risky assets (probably an index fund)

  2. Manage the remaining (undiversifiable) risk by investing some in the risky portfolio and the rest in something not so risky. The right balance depends on your risk tolerance, investment goals, etc.

    1. Note: risk-free also depends on your goal—it could be T-bills or long-term bonds, depending on your objective and investment horizon.

Easy, right? So why is everyone getting it wrong? The low rate environment means that financial firms are encouraging their clients to abandon the tried-and-true 60-40 equity/debt split. Now, I was never convinced that this was the best portfolio, primarily because there is no one-size-fits-all, risky/risk-free split. It is agnostic on goals, funding, etc. But if you think it’s right for you, fine. What bothers me is why people are ditching it altogether.

The justifications confuse steps 1 and 2. Research from financial firms argues the bond part of the portfolio (no word on duration) is supposed to diversify and hedge risk, so they think that between a changing bond/equity correlation and lower yields, clients should seek out higher income assets—real estate, dividend stocks, and shot-term junk bonds in the 40% part.

Keep in mind this is supposed to be the low risk or risk-free part of the portfolio. It's what happens when people are unclear about their investment objectives. No matter how you slice it, they are telling people to take more risk. Now, you can argue that yields are low, you can’t afford risk-free, so you should take more risk or save more. But that’s not the justification. The message is, “Let’s get you a higher return to make up for the low yields," with little mention of the extra risk that people will take on. They confuse diversification with hedging. And I don’t think that this will end well at all.

Oh, the and the Wall Street Journal reports how active investors are shunning diversification to get higher returns. But it’s not working, obviously. This isn’t smarter—it’s inefficient.


I’m starting to think that the biggest economic issue of our time isn’t the wealth of the 1%—that may just be a distraction. It’s actually the rural/urban divide, where rural communities are plagued with poor health, drugs, and a lack of opportunity. But I’m not sure what the best policies are here.

First, however, we need to figure out what’s driving some of these problems. There was an interesting paper at NBER last week about what sparked the opioid epidemic. It turns out that five states required triplicate prescriptions for schedule II controlled substances such as Oxycontin and Vicodin. One copy stayed with the doctor, one with the pharmacist, and the other went to the state. This was arduous enough that it dissuaded doctors from prescribing opioids, so Purdue Pharma (the maker of Oxycontin) focused its efforts on non-triplicate states. And those targeted states had many more deaths as a result. The paper estimates that marketing to non-triplicate states is responsible for 65% of the growth in overdose deaths.

This is a powerful demonstration of how important good regulation is, and it also shows that there is more going on here than deaths of despair.

My macro identity

I have a complicated relationship with macroeconomics, which was my primary field in graduate school, and was how I identified when I first graduated. But then I worked with financial economists and decided that their view—that risk is central to value and decision-making—was a better way in which to understand the economy. So I started to identify more as a financial economist, even if my roots were in macro.

And the field is in a messy place, anyway. The push to more empirics, experiments, and the search for causality leaves little love for macro, which tries to solve bigger questions and thinks about general equilibrium effects. Such thoughts are not the fashion anymore, and that’s fine, I get it. Macro was not offering satisfying answers to the big questions that it asked. But it did offer some answers.

After reading this story in the New York Times arguing that “economists” think that higher taxes will spur growth by taking money away from investors and giving it to consumers, it's clear we need a macro resurgence. I suspect that there’s a vacuum for big ideas, because many economists are working on answering the smaller questions. And some really out-there ideas are filling the void. That’s why we’re getting this weird stuff that is stunningly ignorant of even basic macro.

So, in solidarity with the misunderstood macroeconomists, I’m announcing myself as a macro-finance economist.

Until next time, Pension Geeks!