What If Warren Buffett Is Right?

Tucked away in a corner of Warren Buffett's Berkshire Hathaway (NYSE: BRK-B, BRK-A) annual report is an interesting little detail, which suggests that Buffett isn't expecting blow-out results for some of his investments. Savvy Fools will give that opinion due consideration, and invest accordingly.

You'll find the clue in Buffett's discussion of Berkshire's pension assets. His company is ranked No. 11 in the Fortune 500, employs more than 200,000 people, and encompasses many subsidiaries. Some of them offer pensions to workers, while others offer different retirement benefits, such as 401(k) plans. As of the end of 2009, Berkshire had nearly $2.3 billion in pension liabilities, and Buffett's stated "expected long-term rate of return on plan assets" was a relatively modest 6.9%.

Many of us tend to assume that on average, a stock portfolio will return 9% or 10% a year, the market's long-term historical average. But many of our portfolios include plenty of investments that aren't stocks. Mixing in lower-yielding investments may ensure that you don't reach that 10% threshold.

What it means for investors
Buffett's 6.9% figure may not be as conservative as it looks, considering that the assets it's tied to aren't entirely in stocks. Clearly, Buffett believes it's the right number, and the most sensible expectation. Since 1965, his company's per-share book value has grown at an annual average rate of more than 20%, so his opinion clearly carries weight.

But are other companies being just as modest with their pension plan assumptions? As it turns out, many of them make Buffett look downright gloomy. According to Vanguard founder John Bogle, corporate pension funds increased their return expectations from 6% in 1981 to 8.5% in 2007. These large companies used much higher return assumptions than Berkshire in their most recent annual reports:

Data: SEC Filings.

When you're evaluating a possible investment, cast an eye on its pension obligations and its expected asset return. Steep expectations mean that the company can rationalize socking fewer dollars into the plan, which can make it look stronger in the short run. In the long run, though, if those rosy expectations aren't realized, the company and its workers could find themselves in trouble.

Careful scrutiny of retirement return projections can also reveal useful trends. Alcoa's expected rate is high, but not as high as it once was, suggesting that management is getting more realistic. For companies that are already in trouble, steep expectations can be particularly worrisome. Valero and Rite Aid have been losing money for several years now, while Harley-Davidson just recently started posting red ink on the bottom line. High expectations present an additional red flag.

Even Monsanto, which has continued to earn substantial profits, merits a closer look. Before you buy these stocks, ask yourself whether you're comfortable with how they're dealing with their pension obligations. Remember, mismanaged pensions can lead to nasty earnings hits.

And in our own portfolios…
It's great to hope for the best, but you should be ready to deal with less. Temper your expectations for your portfolio. If you position it to grow as effectively as possible, it may well end up trouncing that 10% average. But you ought to make sure that if your holdings average 6% or 7%, you won't be in big trouble.

For companies and individual investors alike, risky investments can be awfully tempting. If things go your way, you can reap a bonanza. But the investment world is full of surprises. No one ever expects a year like 2008, when the market dropped almost 40%, but they happen now and then. Play it safer, and when you turn 80, as Warren Buffett just did, perhaps you'll be having adventures of your own, instead of worrying about running out of money.

To gain growth without sacrificing safety, search for the best dividends.