1.What are the important factors that should be considered by tertiary sector employees when they are deciding whether to place their Superannuation Contributions in the Defined Benefit Plan or the Investment Choice Plan?
2.“If the Efficient-Market Hypothesis is true, the Pension fund Manager might as well select a portfolio with a pin.” Explain why this is not the case.
1.Employees working in the tertiary sector are the employees who are involved in availing the services that is working in providing the services of the employment area. In the tertiary as well as in the service sector there are three types of sectors. In these sections it is required that the employees should make their own superannuation fund because they are not working under any employer (Arnold, 2013). There are two major plans which are related with the superannuation from which employees are required to make the decision of choosing the most appropriate one. These two plans are defined benefit plans or investment choice plan. Choosing these two plans it is required that certain set of factors should be taken into consideration. Further discussion will help in making appropriate decision regarding selection of the appropriate plan (Bacon, 2010).
Defined Benefit Plan
In defined plan the amount that will be received in the near future is being decided in the initial phases. Employees working in the tertiary sector or in the service sector have to make the decisions regarding the future amount that will be received at the time of the retirement. It is a plan in which the amount which is being specified is being paid by both the parties which are employers as well as employees (Aslan, 2015). The amount which is to be specified is being decided on the basis of the earnings of the salary, his age, and the tenure of employees for which he will work. It could be used as the tool for increasing the salary or the pay of the employees (Arnold, 2013). Defined benefit plan is one of the most common plans which is being used by the employers in which the pension of the employees is being calculated (Aslan, 2015). So as to calculate the pension of the employees there are three variables which are required to be undertaken by the employers, these three variables are:
Pensionable Service which is the number of the years for which the pension is required to be paid to the employee (Baker and Filbeck, 2013)
Pensionable earnings which is the estimation of the amount which will be drawn by the employee at the time when he will retire
Accrual interest which is the portion of the earning which will be received by the employee at the scheme selected. (Baker and Filbeck, 2013)
The formula with the help of which accrual interest of an individual is being calculated is under the defined benefit plan is:
Number of the year worked x Salary at the time of the retirement x Accrual rate (Paramasivan and Subramanian, 2009)
With the help of the information gathered an analysis is being made that there are various factors on which the pension fund or the funds of the employees is dependent these factors are salary, number of the years of the services, and the accrual which belongs to the employee (Perry, 2011). This is a type of superannuation fund in which the employees can set the amount of the contribution in the funds and will be able to get the pension at the time of the superannuation according to the decisions made. Information related with all set of benefits could be provided to the employee at the time when the plan will be created. There are certain other set of taxes and the incentives which are being availed in the plan, hence it could be said that for tertiary sector employees defined benefit plan will be more suited (Rayman, 2013).
Investment Choice Plan
Investment choice plan is the plan in which the investments accounts will be opened with the investment companies and the amount of the investments could range from any amount. It is the plan in which the employer contribution and the employee contribution or any type of gain or the interest and the unit which is being earned during the period will be invested by both single and the multiple investments (PROJECT MANAGEMENT INSTITUTE., 2017). In this plan, employees have the power of choosing the option of making the changes in the investments which is based on certain set of factors. One of the major advantages attached with the investment choice plan is that employee has the freedom to manage the superannuation funds on the basis of their requirements. Investment choice plan also provides a support to the employee that in this employee can make the portfolio of the investment or make the assets in which they want to invest in (Rayman, 2013). Certain set of strategies could be adopted so as to use the investment choice plan. Some of the examples of the investment funds are investment funds, secure funds, trustee funds and stable funds.
There are certain set of factors which are to be taken into consideration by the tertiary sector employees in the selection of defined benefit plan and the investment choice plans these factors are as follows:
Risk Profile: One of the major considerations that could be made and should be taken into consideration by the tertiary sector employees is the level of risk they can bear while making an investment (Reilly and Brown, 2012). Defined benefit plan is the plan which includes less risk ad a defined amount will be received at the time of maturity. On the other hand investment choice plan includes higher risk as the investment is dependent on the choice of the employees. High risk is involved in the investment choice place and the superannuation amount that is being received is high (Valentine and Scott, 2011).
Inflation Rate: The rate at which the dearness of the cost increases with the increase in the rate of the inflations. In order to make appropriate set of decisions related with the investments it is necessary that the superannuation contributions should taken into consideration. Defined benefit plan is a long term plan in which inflation plays a very vital role (Westerlund and Narayan, 2013). As the defined benefit plan is a longer period plan so the value of the money declines in the same after each yea. Hence, more concentration is required from the side of employees in the defined benefit plan so as to ensure that the appropriate set of return could be received on the date of maturity.
Investment Time Period – Time period of investment is taken into consideration while choosing a plan for retirement contribution. Employees should decide the time period of investment whether it is for long time duration or short duration (Valentine and Scott, 2011). For shorter period of time, investment choice plan is also beneficial and on the other side defined benefits plan is only beneficial for providing large benefits in long term. As a result, investor should focus on the investment time period before choosing a plan (Peterson Drake and Fabozzi, 2009).
Financial objectives – Every individual sets its own financial goal. There are various financial aspects related to the investment plan that must be focused upon before making a decision of investment (Bacon, 2010). If employees of tertiary sector have a goal to earn more revenue as well as also capable for taking risk then investment choice plan is for them. But if employees want to get pension income at moderate level on constant rate then in this situation defined benefit plan is beneficial.
Problems associated with Time value of money concept
Time value of money defines the conception based on decreasing the worth of money in the upcoming period of time. Time value of money plays an important role in choosing the plan for retirement contribution (Peterson Drake and Fabozzi, 2009). Time value of money management is considered as difficult task and for that purpose both plans defined benefit plan and investment choice plan play their role accordingly. They both have their own procedure and treatment for managing the funds which helps in process of decision making of selecting retirement contribution. This concept is beneficial to calculate the nearby value of retirement contribution as well as an amount of pension which is to be received at the time of retirement or after it. Existing rate of inflation and current market trends are considered as a few factors that provide a proper support to the concept of time value of money in making decision (Shim, 2012).
Time value of money is helpful in calculating the current value of contribution which is made for retirement and also calculate the amount which is to be received after the superannuation. Inflation rate can help in adjusting the contribution present value and pension amount that is to be received at superannuation period. In this concept, real cash flows problems associated with retirement contribution and amount which will receive has been taken into consideration (Peterson Drake and Fabozzi, 2009).
It is concluded on the basis of above clarification that between these two plans desired benefit and investment choice, the plan which should be selected for superannuation contribution is investment choice plan as it is most customised plan and involves high returns (Baxamusa, Mohanty and Rao, 2015). This plan is suggested to select because it is considered that this is highly flexible plan in respect to establishing retirement plan as well as cash inflows and outflows. One more reason to select investment choice plan is that the amount of pension in defined benefit plan is remain stable, not even increases but in investment choice plan there is a possibility of amount increment on the accordance with the situation of market (Cox, Lin, Tian and Yu, 2013).
2.Efficient market hypothesis
In efficient market hypothesis, organization’s stock price or commodity price reveal the relevant set of information about current financial status of the company. In another term, efficient market hypothesis is used to identify the stock and share prices of an organization with the help of collecting set of information regarding company. This is implied by efficient market hypothesis that the prices of stock or asset at always its fair value in which no one can get loss or profit in the market. The theory of efficient market hypothesis has been contrasting on availability of various factors which are responsible for setting the price of assets (Khan and Ikram, 2010). So, on that basis the selection of investment can be chosen with ease without putting any extra efforts or skills. In efficient market hypothesis, there is no any intimation about the information regarding past, market trends analysis, market conditions and market information has been taken to the price of asset or stock. In this hypothesis, the stock prices are stable or do not make any movement due to market trends (Karapinar, Zaif and Torun, 2012).
Pension fund manager’s responsibility in managing the portfolio
There is not much responsibility of fund manager in managing the portfolio as the prices of stock or assets remain same and do not change. In this hypothesis, the role of fund manager will be ended soon as there is no need to focus on any aspect. By this hypothesis, the pension fund manager role and importance will be diminished as there is no intimation of past market trends have been taken into. In investment choice plan, there is a task for the pension fund manager to update the plan as well as portfolio of the employees. But in efficient market hypothesis it is not necessary (Westerlund, Norkute and Narayan, 2014).
It can be assumed by the above discussion that this type of theory as explained in efficient market hypothesis does not have any existence because there are various aspects that are taken into consideration during the time of investment for retirement (Valentine and Scott, 2011). This type of case does not exist into the market because there are various forces which are responsible to influence the price of stock or assets. As it is described that there is no need of hire fund manager for managing the portfolio because all investor would earn same amount of revenue in this type of situation (Shim, 2012).
So as a result, it is assumed that efficient market hypothesis is not relevant theory and it does not exist in real market situation as well as in the market of investment. It is proven that efficient market theory is unproved and unclear (Westerlund, Norkute and Narayan, 2014).
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