With occupational pension plans, employers are not only required to make contributions towards retirement funds but also, to invest these funds on behalf of their employees. It is the earnings generated from the investments that are used to provide income to workers who have attained the age of retirement. Choosing a pension plan investment strategy is therefore key. Management of a pension fund is challenging and demands the prudent management of pension assets which will ensure retired workers receive their promised benefits.
The success of an investment is dependent on the investment strategy. In this article, we look at some of the things an investment manager or employer needs to consider when designing the pension plan investment strategy.
What is a Pension Plan Investment Strategy?
An investment strategy is a set of principles designed to help an investor reach their investment goals. A pension plan investment strategy is the set of guidelines that direct pension scheme investors towards achieving their financial and investment goals. For a strategy to be considered exhaustive, it must be carefully crafted based on an individual plan’s needs, it must include both short and long-term goals, and it must be reviewed periodically as circumstances change.
Risk is an inherent part of any investment. Employers must understand the short and long-term objectives of their pension plan before settling on a strategy. The two foundation questions which can guide employers towards an appropriate strategy are:
- What amount of return is needed in the short term to ensure that cash flows are met?
- What levels of return are needed to achieve any further objectives?
Careful analysis of the organization’s needs and current situation provides a clear understanding of the returns and risks needed to achieve objectives. This, in turn, helps one make informed choices.
Type of Investment Strategies
Investment strategies can be categorized according to the level of risk taken and the method of investing. Goals, risk tolerance, and future capital needs are some of the factors that lead to a specific strategy.
Risk Investment Strategies
These vary from low-risk to highly aggressive, and mainly depend on the risk tolerance of the scheme and time available for investing.
- Conservative strategy: Safe investments that come with low risk and provide stable returns. This portfolio may include fixed income and money-market securities
- Highly aggressive strategy: Risky investments to generate maximum returns. This portfolio may include emerging market and private investments.
Method of Investing
This refers to the type of investment that an employer or investment manager chooses as the most appropriate way to meet the scheme’s goals.
- Value Investing: A long term-strategy that employs the use of financial analysis. It involves focusing on stocks that appear to trade for less than their intrinsic value.
- Growth Investing: Primarily involves investing in young companies with the potential for earnings growth with a focus on increasing the investor’s capital.
Pension funds promise their members a certain level of retirement income in the future. The strategy chosen to invest in contributions must balance between risk and achieving a sufficient return to cover guarantees.