Читать книгу Ignore the Hype - Brian Perry - Страница 19

The Change: One of the most important changes individuals have experienced over the past three decades has been the shift from defined benefit to defined contribution plans.

A defined benefit plan is commonly known as a pension. The way these operate is that you work for an employer for a number of years and hopefully they pay you for your work. They also promise you that, if you work for a sufficient period of time and leave in good standing, they will provide you with a future pension benefit. In other words, the employer pays you while you are working, and then they continue to pay you once you stop working.

From your standpoint this is great. Having that future guaranteed income helps with your retirement planning. It's different from the employer's perspective, though. They've made a contractual promise to pay you a specific amount each and every year in the future. As such, they need to set aside and invest money today so that they have the resources to pay your pension in the future.

Because of that, defined benefit plans place the emphasis for saving, investing, and distributing funds on the employer. As an employee, you don't necessarily care what the markets are doing. As long as the retirement plan and employer remain solvent, you'll get your guaranteed income in retirement. As such, when most individuals were covered by a defined benefit plan, market fluctuations were less front-and-center in the public consciousness.

However, since around 1980, defined benefit plans have become increasingly scarce outside the public sector. Instead, defined contribution plans have become far more common. These defined contribution plans are relatively recent creations. The Individual Retirement Account (IRA) was only created in 1974, and the 401(k) account was only legislated into existence in 1978. Employers, tired of being on the hook for employees' retirement distributions, were quick to latch onto these new tools, and rapidly shifted away from defined benefit and toward defined contribution plans.

With a defined contribution plan such as a 401(k), the onus for the successful accumulation, investment, and distribution of funds shifts from employer to employee. When you are responsible for accumulating enough money to fund your future lifestyle, the daily gyrations of financial markets become much more real.

Today, most people work for organizations that offer defined contribution retirement plans such as a 401(k) or 403(b). Individuals without access to one of these plans might utilize an Individual Retirement Account (IRA) to save for retirement. This means that many more people are now directly participating in the financial markets.

The Impact: As is generally the case, there are both pros and cons to the transition from defined benefit to defined contribution plans. The main benefit is that people have more control over their financial well-being, and more flexibility when it comes to choosing whether to remain with their current employer. However, the downside to this flexibility and control is that individuals with little or no training in financial matters must now in effect become professional investors, at least in regard to their own retirement funds.

Defined benefit plans generally have pension boards overseeing them. The members of these boards have what is known as a fiduciary duty to make sure the funds are properly safeguarded and invested. The fund then hires actuaries to run calculations that determine how much they need to put aside today and what rate of return their investments must generate in order to fund future retirees' cash flow. Sophisticated, professional investors then control the investments.

Contrast that with the challenge facing you as a person whose background, schooling, and expertise lie outside the realm of actuarial projections, fiduciary standards, and investment theories. Despite these shortcomings, you still need to determine how much you need to save, how to invest those savings, and then how much you can distribute each year in retirement. And if you fall short on any of those tasks, the result is a future of financial ruin.

No wonder people say finances are one of the main sources of stress in their life!

This scenario is exacerbated by the phenomenon of other people's money, which refers to the fact that it is easier to stay calm when the money in question isn't your own. So, for example, a defined benefit plan manager can act in a more rational manner because it's not her money she's investing. But an individual managing his or her own 401(k) account is subject to greater emotional volatility, since he or she is dealing with his or her own money.

This becomes especially important during times when markets aren't doing well. For instance, the U.S. stock market posted poor returns throughout most of the 1970s, especially when inflation is taken into account. However, employees who were covered by defined benefit plans had no real need to concern themselves with the stock market's stagnation. To be clear, their employers may have been having difficulties meeting the actuarial assumptions built into the pension plan, but this issue probably wasn't front-and-center for the employee.

Contrast that situation with the first decade of the new millennium. From 2001 to 2010, the S&P 500 suffered two brutal bear markets, ultimately ending the decade lower than where it had begun. And this time, many individuals were responsible for investing their own retirement accounts, which made this feel more real than what occurred in the 1970s.

When individuals who are responsible for their own financial well-being see news headlines about declining stock prices and view their portfolio statements on a more or less real-time basis, the constant barrage of negative headlines and declining portfolio values creates an almost unconquerable urge to do something to improve portfolio performance.

Unfortunately, this urge to do something often results in taking action at precisely the wrong time and in precisely the wrong manner. Whereas a professional investor would (hopefully) hold on to stocks during the worst of a market decline, individuals often panic at the sight of their rapidly deteriorating net worth and sell just as the market bottoms. This results in locking in portfolio losses, and often leaves the person emotionally frozen and unable to reinvest in stocks even once they resume an upward trend.

Readers that experienced the nearly 50% stock market sell-off and equally sharp market rebound of 2008–2009 or the extreme volatility prompted by the COVIOD-19 pandemic can no doubt relate to the emotional challenges investors face when navigating volatile markets.