About 29 million Americans have been promised retirement benefits through state public sector pension systems. And more than half of those benefits depend on earnings generated by nearly $4 trillion in assets held in trust by those systems.1 However, with more than two-thirds of those assets allocated to risky investments—publicly traded stocks, also known as equities, and alternative vehicles, including private equity, real estate, and hedge funds—retirement systems’ ability to meet their commitments hinges largely on investments that are subject to stock market swings.

Market volatility since 2019 underscores the risks and potential rewards that accompany this strategy. The S&P 500 index fell 34% at the start of the COVID-19 pandemic in February and March 2020, which led pension asset values to plummet as well. Then, beginning just a month later, markets soared, pushing returns into positive territory for fiscal year 2020 and up to 27% on average for fiscal 2021—the highest annual returns in more than 30 years.2 As a result, plan assets increased by over $500 billion, driving the funded ratio—the share of promised benefits that plans have funds to pay for—above 80% for the first time since 2008.3

Despite this recent rally, pension fund returns have declined fairly steadily this century, and a combination of trends suggests that will continue. With stock valuations well above historical averages and the Congressional Budget Office projecting that real gross domestic product (GDP) growth—a major driver of equity returns—will be lower in coming years than in fiscal 2021, future returns are likely to drop as stock prices adjust. Additionally, interest rates have hit all-time lows, diminishing expectations for returns on fixed-income investments, such as bonds.

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