Factors Impacting the Selection of Superannuation Contributions in the Defined Benefit or Investment Choice Plan for Tertiary Sector Employees
The superannuation plans have been developed by businesses with the aim of saving funds for future of employees. The superannuation contributions are regarded as a type of pension program that are undertaken by the organizations for saving the funds for employees that are paid to them after their retirement (Power, 2012). This report has been developed in the above context for providing an understanding of the benefit of superannuation schemes for tertiary sector employees. Also, the report provides an analysis of the factors that should be considered by the employees at the time of deciding to place their superannuation contributions in the defined benefit or investment choice plan. The importance of the concept of time value of money in this decision is also explained in the report. In addition to this, the report analyses the impact of efficient-market hypothesis on the development of portfolio by pension fund manager.
The superannuation schemes are highly important for employees to secure their future life by saving funds that can be utilized by them in future life period. The tertiary sector employees refer to the service sector of the employees and as such superannuation schemes are highly significant for them to live an independent life after their retirement. The tertiary sector employees receive superannuation benefits after completing certain years of service as decided by several companies. The main benefit of such superannuation scheme for tertiary sector employees that money deposited in such a scheme is not subjected to nay tax implications. There are mainly two types of superannuation schemes available for tertiary sector employees that are, defined benefit and investment choice plan. The employees should carefully analyze the characteristics of above two plans while placing their superannuation contributions for achieving maximum benefit from their pension program (Smith, 2012).
Defined benefit plan is a superannuation scheme that involves of giving a specified amount by the employer to employee on retirement. The amount provided to an employee under defined benefit plan is fixed that is calculated on the basis of a predetermined formula that is based on employee income, service term and age. It is a type of pre-determined pension plan for employees under which the amount received by them is rather fixed and is not influenced by the performance of their portfolio. This plan provides a predictable benefit to the employees that is not associated with any type of risk as benefit received is not impacted by the asset returns. Also, the benefit received is dependent on the factor such as age, salary and is subjected to an exercise tax in the condition of any meeting the minimum contribution. The employees cannot receive the benefits under the plan before the age completion of 62 years (Dixon, 2012). The employees are not entitled to receive any extra benefit dependent on the performance of the portfolio as they receive only fixed compensation based on the formula. The main advantage of using the defined benefit plan is that employees receive fixed source of income after the retirement and the funds are professionally managed on the basis of strict guidelines. Also, the income received is not impacted by the rate of inflation or other economic factors as it is mainly determined on the basis of service tenure, salary and age factors. However, the main drawback that is associated with this benefit plan is it is more complex and involves huge cost for maintenance by both the employer and employees. Also, there is no scope for addition benefit received other than fixed amount in case of defined benefit plan (Henderson, 2012).
Impact of Time Value of Money in decision-Making of Placing Superannuation Contributions
On the other hand, the investment choice plan the employees benefit is decided on the basis of their individual choices that they make by investing in different type of assets. The employees can select the type of assets they want to invest their superannuation contributions under this plan. The type of assets in which invest their superannuation contributions include fixed-interest securities, bonds, overseas share and property and private equity instruments. Thus, the employers have complete authority over selecting the type of assets in which they want to invest based on the risk and return characteristics of each. The employees can take professional help in analyzing the risk and return characteristic o the portfolio and thus selecting the best investment strategy in accordance with their choice (Graney, 2004). The main benefit of this type of plan is that employees can earn higher benefits as compared to defined benefit plan in which the employee payout is fixed on pre-determined basis. The final payout in the case of investment choice plan varies as it is based on the returns generated by the selected investment strategy by the employees. However, the main drawback of this type of plan is that the employees do not receive a fixed amount of money on their retirement and their final payout may be less or more in comparison to defined benefit plan depending on the portfolio returns. Thus, it is a risky alternative for tertiary sector employees for placing their superannuation contributions in comparison to defined benefit plan (Kolb, 2009).
Thus, these all factors should be considered by the tertiary sector employees while placing their superannuation contributions either in the defined benefit or investment choice plan. The employees who possess sound knowledge of investing in different types of assets should select investment choice plan for gaining higher returns. However, the employees with limited knowledge of portfolio development should select the defined benefit plan. The tertiary sector employees should obtain adequate knowledge of both the defined benefit and investment choice plan to gain an understanding of the benefits and drawbacks associated with both the options. The superannuation sachems aim to promote the welfare of employees and therefore it is necessary that employees should select the best possible options for investing their funds in right type of superannuation scheme. The benefits and drawbacks of both the investment options are discussed above that will help in selecting the appropriative plan for employees to place their superannuation contributions (Smith, 2012).
The concept of time value of money is very important for investors to analyze and examines the present value of money in future time-period. The concept holds that money available in the present time is more worth as compared in the future time-period due to its earning capacity. The concept can prove to be of high significance for employees while taking decision relating to their superannuation schemes. The employees can utilize the concept to compare the various investment alternatives available to place their superannuation contributions by predicting the future gains that they will receive with investing their funds in superannuation schemes presently (Gitman et al., 2015). The time value money principle hold that a sum of money or periodic payments that is bound to be received in the future can be converted into an equivalent today through the use of time value of money concept. Conversely, the investors can also determine the value to which a present sum will grow in the future time period. Thus, the concept of time value of money can help in determining the present and future value of money thus helping the investors to take effective decisions relating to their investment. The employees can analyze the present and future value of money through the use of time value of money for taking better decisions relating to invest their superannuation contributions (Juchau, 2015).
The employees can pre-determine the fixed amount that they are likely to receive in the future under the superannuation schemes through the use of compounding and discounting methods stated by the time value of money. The future cash-flows arising from investing the superannuation funds today can be determined by the employees through the use of time value of money. The employees can easily predict the future lump sum amount of money that they will receive in future through discounting the present value of money. On the other hand, the concept of time value of money can also be used to analyze the returns received by the employees under the investment choice plan (Fiestas et al., 2010). The concept of time value of money utilizes the valuation models at the time of taking decision relating to investing in securities such as stocks and bonds. The security valuation models incorporate the use of time value of cash flows arising from different securities. The time value of money concept thus helps tertiary sector employees to compare the funds that will be received in the future time-period through the use of defined benefit or investment choice plan. Thus, developing an appropriate understanding of the concept of time value of money is critical for tertiary sector employees to make investment decisions for placing their superannuation contributions (Wendt, 2015).
2. The efficient-market hypothesis (EMH) states that share process reflects all the information about a stock or security. Thus, as per the theory the price of an asset or stock incorporates all the necessary information that the investors need for taking decisions relating to their investment. According to the theory of EMH, it is impossible to beat the market as its absolutely efficient as the share process reflects all the information to all the investors and thus they would gain similar rate of returns by investing in similar type of assets. However, this is not the case as many investors have beaten the market averages and all the investors gain different rate of returns by investing in similar type of assets. Thus, if the theory of EMH holds true then pension fund manager can easily develop a portfolio for its clients that would generate higher rate of return. This is not the case for pension fund manager as they have to carefully analyze the risk associated with each type of assets before incorporating them into portfolio development. This is because share prices do not provide all the useful information about the risk and return characteristic of each type of assets. Thus, the selection of stocks without the proper evaluation of their risk and return characteristics can maximize the risk of the portfolio with reducing the returns obtained. The pension fund manager has to diversify the risk of the portfolio by selecting the assets that have low co-relation between them so that the performance of one asset does not impact the other assets (Brealey et al., 2012).
Therefore, it can be stated that the theory of efficient-market hypothesis does not hold true as information about a particular asset is not available to all the investor equally. The investors perceive the information about different assets in varying manner and thus the return gained by investors varies accordingly. The theory of efficient-market hypothesis suggests that market is efficient in all conditions and does not incorporate the occurrence of market risk. However, this is not the case as market risk cannot be eliminated completely but can only be minimized through diversification by selecting the assts that have low co-relation between them. Therefore, in the light of above discussion, it can be stated that the statement ‘if efficient market-hypothesis is true, the pension fund manager can select a portfolio with a pin’ is false. The pension fund manager have to carefully evaluate the risk of each type of assets at the time of creating portfolio in order to maximize the profit for its clients and cannot rely only on the share prices (Maginn et al., 2007).
Conclusion
The above discussion has inferred that superannuation schemes are highly important for tertiary sector employees to secure their future life tenure. The employees should consider the benefits and drawbacks of each of the define benefit and investment choice plan before selecting from both the options to place their superannuation contributions. Also, the report has stated efficient-market hypothesis does not hold true in all market conditions and has no relevance for pension fund manager at the time of developing a portfolio.
References
Brealey, R. A., et al. 2012. Principles of Corporate Finance. Tata McGraw-Hill Education.
Dixon, D. 2012. Securing Your Superannuation Future: How to Start and Run a Self Managed Super Fund. John Wiley & Sons.
Fiestas, H.V. et al. 2010. Better Returns in a Better World: Responsible investment – overcoming the barriers and seeing the returns. Oxfam.
Gitman, L. J. et al. 2015. Principles of Managerial Finance. Pearson Higher Education AU.
Graney, P. J. 2004. Retirement Savings Plans. Nova Publishers.
Henderson, S. 2012. SMSF DIY Guide: Everything you need to successfully set up and run your own Self Managed Superannuation Fund. John Wiley & Sons.
Juchau, R. 2015. Fundamentals of Investing. Pearson Higher Education AU.
Kolb, R.W. 2009. Corporate Retirement Security: Social and Ethical Issues. John Wiley & Sons.
Maginn, J. L. et al. 2007. Managing Investment Portfolios: A Dynamic Process. John Wiley & Sons.
Power, T. 2012. Superannuation for Dummies. 2nd ed. John Wiley & Sons.
Smith, B. 2012. Self Managed Superannuation Fund Handbook: A Practical Guide to Starting and Managing Your Own Fund. John Wiley & Sons.
Wendt, K. 2015. Responsible Investment Banking: Risk Management Frameworks, Sustainable Financial Innovation and Softlaw Standards. Springer.
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