It is natural for investors to be wary of the markets after a period of economic downturn. The “Credit Crunch”, and subsequent recession, has left a bitter taste for many. The news has been filled with stories of pension fund values plummetting, and pensioners losing large proportions of the savings that they have accumulated over their lifetime. You cannot avoid being influenced by all of this recent history and it can be difficult to make objective decisions about the best place to invest your money. This can lead to apathy and inactivity when just about everyone does NEED to be investing for their retirement.
As someone looking to invest in a pension it is important to understand that where the money is invested can dramatically effect how volatile the funds are likely to be. The buzz word at the moment is “spread the risk”. This means that if you are worried about market volatility then funds should be invested in lots of unrelated geographical and market sectors. Obviously, if all of your pension funds are invested in a single UK bank they are much more suscepitble to a banking crisis than if some are in bonds, gilts, asian emerging markets, gold etc. Spread the Risk!
The fallout from the banking collapse has caused the Financial Services Authority to instigate more stringent control over the way financial firms are running their businesses. An overhaul was certainly needed as it was clear that the banking system was using a business model that was unsustainable in the long-term. With these new controls, and organisations like the Financial Services Compensation Scheme (FCCS), a shrewd invester is less likely than in the past to see their pension funds crash.
Volatile economic conditions are always around the corner. The economy is cyclical, and unfortunately it seems that economists are either not able to confidently foresee economic downturn, or are unable to influence the way business is done, coming second to the influence of politicians and big business. The nature of the world is that theorists and scientists often fail to get heard amidst the hum of the corporate machine. Investors should therefore seek regular pension reviews, and satisfy themselves that their fund managers are decisive in thought and action when market indicators begin to swing.
So can a pension fund go bust I hear you ask? Short answer is yes. Long answer is it is very unlikely to happen in the next decade. If one looks at the financial clamaties over the last decade many of them have been as a result of irresponsable business practices. Take Northern Rock as an example. Northern Rock went to the brink of extinction and required a huge governmment intervention to survive in it’s now very different organisational form. How did this happen? They focused on the most risky lending sector, sub-prime mortgages, and chased new business too hard, causing them to not sufficiently mitigate their risk through deposit requirements and high interest rates. In essence, they over-exposed themselves to bad debt and did not have enough assets to counterbalance them.
What about the Equitable Life Debacle? Equitable life’s near collapse has been widely attributed to their policy of promising high investment values to their investors, when in reality their coffers could not support the figures they were quoting. This sometimes happens during economic downturns with the situation recovered during market booms, but Equitable Life remained in this position for almost a decade without bridging the gap between their assetts and their liabilities. Both these examples demonstrate the effect that Shareholder pressure to win new business can have on Board decision making.
Now that we have been through another recession, and have felt the pain of job losses, banking collapse, and wealth disappearing, one would hope that the Boards and Shareholders will take a more long term view on their businesses. Financial regulators are putting systems in place to discourage short term thinking and ensure businesses run on models that survive the bust periods of economic cycle, and not just boom during the booms. People are greedy though, and it is enevitable that next time a recession comes, whenever that may be, businesses and individuals will have become over-exposed in volatile sectors and will feel the pain again. Whether this causes the collapse of companies and pension funds will depend on just how irresponsible the business leaders have managed to get.