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Pension Plans/Retirement Funds Hard Hit By Economic Crisis

27 October 2008 - News - Editor

While world leaders gather in a series of meetings to discuss strategies to deal with the current global economic crisis, as well as looking into co-operative measures of preventing a repeat performance in the future, ordinary citizens are often baffled by what is going on. Many who regularly pay into retirement funds believe they are acting in a responsible manner by making provision for their later years, but have never given much thought as to how the money is invested. So, the all to frequent news headlines announcing that millions, billions and even trillions of dollars relating to retirement funds/pension plans have been “wiped out” or have “disappeared” are a major cause for concern.

With the objective of providing significant growth, large amounts of retirement funding are linked very closely to bond and stock markets. In the United States this link between retirement funding and the stock markets started back in the 1970s when the government started getting involved with retirement funds, resulting in Congress creating the Internal Revenue Code section 401(k). This gave companies the authority to make retirement fund deductions from paychecks as a sort of “forced savings” for retirement. Each month an individual’s retirement fund would grow by the amount of their monthly contribution, as well as the contribution that employees agree to make. Retirement fund money is invested in potentially high yielding investments, bonds and stocks in an effort to make this money grow by more than just the monthly contributions, or a percentage of interest that may be received if the money was invested in a fixed income bank account or similar investment. With retirement funding being a long-term investment, reinvesting earnings to generate more earnings, or compounding the investment over a period of years, has provided significant growth to pension funds. This has been working for decades, with returns of around 7 percent being achieved over a decade on riskier investments, as opposed to the 3 or 4 percent that may be expected in safer investments. However, to obtain faster growth on pension money, contributors must accept the risk that an economic downturn is very likely to sweep away some of their earnings, and even possibly some of their contributions, which is what is happening now. That is the downside to investing in the stock market – there are no guarantees!

Most 401(k) plans offer a mix of investments with different levels of potential risk, and each individual can choose where to invest their money. Financial advisers agree that a good option is to spread the risk by investing a portion in high risk, but potentially high yielding funds, with the remainder in safer funds, thereby striking a balance between security and earning potential. This may differ with each individual as each person must decide how much risk they are comfortable with. Age also has a lot to do with choosing a level of risk. It makes sense for young people to take bigger risks as their retirement plan is long-term, allowing time to recover from any possible drop in the market, whereas the closer to retirement age you are, the less risk you want to take.

The current economic melt-down has had a devastating effect on company pension plans, which generally invest around 60 percent in stocks, with the balance in fixed-income assets. In addition to hitting individuals, the drastic stock market losses of recent weeks may even put a company’s financial security at risk. Congress is reportedly addressing the issue of guaranteeing U.S. workers more security on their retirement funds, while still allowing room for some growth. In the meantime, taxpayers remain anxious to see what effect the government’s various intervention strategies will have on the market, with those who are currently at the stage of having to draw on their retirement funds feeling most vulnerable.

 


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