Fixed Pension Vs. Stock Investments

Fixed-pension planning begins long before retirement.

Differences in fixed-pension and stock investment choices are functions of how well the individual has saved for retirement and how much risk he can absorb once in retirement. Fixed-pension amounts do not usually change during the life of the payment stream and may not keep up with the cost of inflation and other cost-of-living issues. Stock investments tend to outperform but with long periods of underperforming and they tend to require professional management.

Fixed-Pension Investments

Stocks are risky but have provided returns greater then bonds over the long term.

Fixed-pension investments are agreements between the employee and the employer or they are purchased from an annuity company. The investor receives a guaranteed fixed payment for the remainder of their life. Usually there is no adjustment for inflation. The risk of funding the payment rests with the pension company. Companies that underwrite fixed-income pensions are usually well-regarded investment firms with large reserves.

Stock Investments Require Patience and Risk Taking

Retirement Planning Requires Active Involvement

Stock investments, whether through personal investments, mutual funds or investment counselors have historically provided returns equal to increases in inflation and other costs of living. This long-term process is subject to periods of underperformance during bear markets. Volatility can be controlled through diversification and buying bonds from stock dividends' cash flow. Once retired, investors who remain in stocks must be secure that they can sustain periods of capital loss.

Payments are a Function of How Much is Saved

Stock and bond portfolios should complement each other

Payments received after retirement are a function of how much is saved prior to retirement. Money is made when investments rise and the proceeds are reinvested. For both fixed-pension and stock strategies, returns are greatly improved the longer the investments are held.

Pensions Can be Created from both Pension and Stock Investments

Know the status of your investment plans.

Typically, investors apportion their retirement incomes from fixed-income investments and from stock investments. Portfolio balance favors increasing the investment contribution to a fixed pension as retirement approaches in order to decrease the portfolio's volatility. However, the superior earnings potential of stocks support maintaining both a fixed-pension and a stock portfolio.

Considerations

Use a best- and worst-case plan when planning retirement.

Fixed-income pensions should be examined with both a base (worst-case) payment amount and an expected amount. The final fixed-income pension will be higher if the portfolio manager chooses investment-grade bonds and corporate bonds as opposed to high-quality but low-yielding United States treasury obligations. Similarly, variations in stock portfolios will vary the returns. High-quality, low-volatility blue-chip stocks have higher dividends and capital gains than riskier technology companies, which tend to have higher capital-gains potential. Diversification is key.

Warning

Become aware of the style and diversification of any fixed-pension or stock investment portfolio and be certain that it is consistent with your risk profile. Pension plans are not black box investments whose parameters are unknown. Learn the terms and conditions of your fixed-income pension choices. Understand who is guaranteeing the proceeds, and in what fixed-income securities it invests. Investigate whether there is a base minimum payment and whether the plan includes cost-of-living adjustments. Most importantly, make certain that your investment plan is sufficient for your retirement.

Resources

• Social Security Planning Calculator