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[–] pumeler 0 points 1 point 1 point (+1|-0) ago
Let me start by saying yes, decisions made on these things after the fund is established can be disastrous. Especially ones that ignore the math for convenience reasons. Changing rules mid-game can really wreak havoc on the final score.
How is it that "everyone gets more money than if they had invested their portion alone"? By the way I don't mean to pick on you, just that statement and "They go wrong when the agreement guarantees an increase in pension payments regardless of how much the investment returns or the agreement". This whole topic sparked my interest and I wanted to type about it. I don't mean to start a flame war or anything like that, just wanted to type my thoughts.
Example 1:
You and 9 others put in $100 each. The group has $1000. You invest in a mutual fun which ends up getting you 5%. After a year, the fund is worth $1050. $105 of the pot is kinda for you, however since they aren't sure how long you are going to live, we can't let you draw more than the a calculation coming from how many years you and the others are estimated to live and your assumed interest rates over the coming years and your share of the pie. So lets say you all retire after a year and get checks. Assuming you'll live about 40 years in retirement you might get $6 a year in this example. (Probably not) The reason being is that the company running the pension is taking the risk that they will be able to get 5% every single year for 40 years or that you will die before you make it 40 years. If you die, you get nothing / little.
Example 2: You put $100 into the same mutual fund. At the end of the year, you have $105. Year one you draw $6. You die, your family has ~ $104.
Obviously this is an extremely simplified example. Most mutual funds have minimum initial investments and minimum contributions. So in that way, you might be right. However the thing to keep in mind is that with any long term plan like this, someone is taking a risk. In finance, the one who takes the risks also will reap the benefits if there are any (There may not be). A pension will guarantee an amount of income at the pension plan's risk. If they can't make that type of money, it is their fault for offering that type of guarantee. They should take the loss (which they won't and many times simply can't because there really is no money left and another reason why you lose with the pension method). If you shoulder the risk yourself and invest your own money, you are taking the risk. If things go well, you get the benefits. Your family gets the leftover money as well.
This Wisconsin pension is like the worst of both worlds to the people who are in it in my opinion (which I'm sure isn't a popular one). The payments adjust in order to stay solvent. Fund does poorly, you get less. Fund does better, you get more. You die, you are out of the pension. Whereas if you'd kept control of your own money and your investments do poorly, you get less and when they do better, you get more. Then when you die, your family gets the remainder.
Thanks for the 2 people who may end up reading this. I'm sure at least 1 of you thinks I'm an idiot, but oh well.
[–] ARodge ago
You had it.
If you have $100 to invest you will have a hard time finding someone to take it outside single stocks. Then you cannot diversify to any real extent with $100 which, as Wutang tells us, is important when investing. Since investing is gambling you never know but funds do have average returns that are actually hard not to hit with a reputable manager. Also, people who are decades away from being able to retire are also kicking in their money every month with the promise of the same when they near retirement.
So you have more money to invest into more varied areas and are receiving funds from people who do not expect a return for decades.
[–] pumeler ago
I quote this video to people all the time. I love it.