A mutual fund pools sums of money from investors, which are then invested in financial assets. Each mutual fund has its own investment objective, such as capital appreciation, high current income, or money market income.
A mutual fund will state its investment objective, and investors choose the funds n which to invest. Two basic constraints face mutual funds: those created by law to protect mutual fund investors and those that represent choices made by the mutual fund’s managers.
Some of these constraints will be discussed in the mutual fund’s prospectus, which must be given to all prospective investors before they purchase shares in a mutual fund.
Pension funds are a major component of retirement planning for individuals. As of March 2001, U.S. pension assets were nearly $10 trillion. Basically, a firm’s pension fund receives contributions from the firm, its employees, or both.
The funds are invested with the purpose of giving workers either a lumpsum payment or the promise of an income stream after their retirement. Defined benefit pension plans promise to pay retirees a specific income stream after retirement. The size of the benefit is usually based on factors that include the worker’s salary, or time of service, or both.
The company contributes a certain amount each year to the pension plan; the size of the contribution depends on assumptions concerning future salary increases and the rate of return to be earned on the plan’s assets.
Under a defined benefit plan, the company carries the risk of paying the future pension benefit to retirees; should investment performance be poor, or should the company be unable to make adequate contributions to the plan, the shortfall must be made up in future years.
“Poor” investment performance means the actual return on the plan’s assets fell below the assumed actuarial rate of return. The actuarial rate is the discount rate used to find the present value of the plan’s future obligations and thus determines the size of the firm’s annual contribution to the pension plan.
Defined contribution pension plans do not promise set benefits; rather, employees’ benefits depend on the size of the contributions made to the pension fund and the returns earned on the fund’s investments. Thus, the plan’s risk is borne by the employees.
Unlike a defined benefit plan, employees’ retirement income is not an obligation of the firm. A pension plan’s objectives and constraints depend on whether the plan is a defined benefit plan or a defined contribution plan. We review each separately below.
No comments:
Post a Comment