Kick in the rear
It can be said that the financial turmoil in the world following the Russian invasion of Ukraine was the last straw for lawmakers to take hasty steps in promoting the financial security of future seniors.
The cumulative defect of the events following the invasion was the rapidly increasing losses in the conservative pension plan segment. At the beginning of the year, compared to the corresponding period last year, the losses were even measured by a double-digit percentage figure. If the portfolio of securities intended for retirement is sold out at such a moment, then the unpleasant feeling is only the least of the problems. Traditionally, such pension plans are supposed to protect investors from losses, but in reality the opposite happened. The uncertainty and stress initially created by Russia’s military activities led to a sharp increase in commodity prices on world commodity exchanges, followed by global inflation not seen in decades. High inflation itself is traditionally not long-term in nature, but it does have quite significant side effects. It should be noted that Russia’s military aggression did not create the great inflation, but only added to it. Even before the attack itself, commodity prices had risen sharply on both the ongoing recovery and the investment boom, which is relatively rarely mentioned as a driver of the cost of living increase. In one way or another, it led to high inflation, the beginning of combating which the European Central Bank, to put it mildly, put on hold.
As a result, stopping the inflation that had already “run in” required an extremely radical action, which has currently culminated in an extremely rapid increase in interest rates. Not only is this unexpectedly emptying the wallets of borrowers, but at the same time it has reduced the value of the previously issued debt securities on which conservative pension plan clients rely for their prosperity. At the moment, it is not so important to know whether the interest rates were even higher in the “fat years”, but the fact that this time their growth rate is incomparably faster. At the beginning of 2022, the yield of ten-year government bonds of the example of European financial stability – Germany – was around 0%, but now it is around 2.6% per year. A change in the yield of 10-year bonds by one percentage point is considered to mean a reverse price movement of 10%, so it can even be said that the price of these German securities has fallen by about a quarter during the mentioned time period. During the year, the drop in this price is less and reaches around 10%, so the environment to earn something has been very bad.
Losses turn into gains
With the improvement of the investment microclimate, the losses experienced by pension plans at the beginning of the year have significantly reduced or even turned into profits. The monthly yield of our second-tier conservative pension plans hovered around zero on September 5. The most successful pension plan had a one-year yield of 3%, the most unsuccessful – 1.3% worth of losses, according to the data of the “manapensija.lv” portal.
At the same time, some plans are currently making losses over several years, therefore radical and quick solutions are needed to improve the financial situation of pension savers. The second level of pension plans, which are allowed to invest up to 50% of their assets in the stock markets in parallel with bonds, perform much better. Here, the 12-month yield on September 5 ranged from 1.5% to 7.4%. During the five-year period, the yield ranged from 1.37% to 3.92% per annum. Meanwhile, the highest yield over the last five years is in the group of active pension plans, where up to 100% of assets can be invested in shares. The average annual yield here is not less than 5%, but the most successful plans even exceed the 7% limit. Meanwhile, over a 12-month period, the most successful pension plans have been able to work with even more than a 10% return. So far so good, but historical returns do not protect against future crises. Therefore, risk balancing regarding the movement of pension capital is still relevant.
To the first level?
In general, we have heard two good ideas that can reduce the financial risks of potential retirees and even create an opportunity to earn extra. One of them has been heard from the Ministry of Welfare, providing for the possibility to transfer the capital of the 2nd pension level to the 1st pension level already five years before retirement. The last five years before retirement is not the right time to take the risk of financial market fluctuations if the entire pension investment portfolio is sold at once. Of course, success can be achieved, but success is not fixed in nature, and if the financial market is in such a background as at the beginning of this year, then in one year what has been earned in several years can be lost. Therefore, according to elementary logic, capital should go where it is safer. At the same time, the first level of pensions has an advantage – indexation is applied to the pension savings there. Namely, the pension capital is indexed according to how social contributions in the country increase – an index is applied to the pension capital, which is determined for each year, taking into account the total amount of social contributions in the country compared to the previous period. The indicator of the potential index is the change in the wage fund in the country. For example, in the second quarter of this year, compared to the corresponding period last year, the wage fund in the country increased by 13.2%. Even if the first level of pensions fails to be indexed in this percentage for the year as a whole, in any case, the amount of indexation must be ahead of inflation, and by a lot. Therefore, if the economy develops as it is now, a potential senior citizen should not remain among the losers when moving from the second level to the first. If the opportunity to move to pension level 1 was already available, for example last year, investors of conservative pension plans would be the winners, despite the fact that the consumer price index grew faster than wages last year. This year, by the way, the situation will be completely opposite, unless something extraordinary happens in the world economy. One of the disadvantages of the first level is the so-called common pot, which does not have an individual character and is intended for all pensioners.
But as long as the state can meet its financial obligations, and it can do so now without much strain, there should be no reason to worry that someone will not be paid something. On the other hand, if the potential pension saver anticipates financial troubles in the country, he can simply choose not to transfer his pension capital from the second level to the first.
Allow investment to be saved
Another, probably successful idea, which has been discussed for a long time, is not to close the entire pension level 2 portfolio at retirement, but to make the payments in installments, allowing the money to continue working. Crisis situations such as the one currently facing conservative pension plans and bond markets do not last forever. More and more new issues of debt securities are entering the market with much higher percentage yields than in previous years, and the situation is already significantly better than at the beginning of the year. This is also confirmed by the above-described yield changes now and at the beginning of the year. We will experience even more drastic improvements in the situation when it becomes clear that the ECB interest rate hike campaign has become a thing of the past.
It is possible that we will reach this threshold as early as this month, and over the next few years the value of the bond market will increase, as will the yield of conservative pension plans. At the same time, the current economic situation brings certain risks to the stock markets and, therefore, to active pension plans, but as historical experience shows, crises are mostly short-lived and losses are quickly recovered in good times. That is, during each new up cycle, markets reach new all-time highs. For example, Wall Street’s broad market index Standard&Poor’s 500 is currently 185% higher than it was on October 11, 2007, when the previous pre-crisis peak was reached. Thus, if someone still has an active pension plan at retirement and there is a crisis in the market, then not selling the entire portfolio at once could allow you to avoid larger losses or even get additional profits. In the name of risk balancing, it would be advisable to change more aggressive strategies to ones that protect money as retirement approaches. The best solution would be if the legislators provided for the possibility that, when approaching the retirement age, part of the capital can be transferred to the first level, but at the same time, when retiring, it would be possible to withdraw the savings of the second level in parts.
2023-09-07 02:15:20
#future #pensions #safe #Independent #explores #ways #protect #financial #collapse
