Extended Functional Fixation Hypothesis †MyAssignmenthelp.com

Question: Discuss about the Extended Functional Fixation Hypothesis. Answer: Introduction: The focus on superannuation contributions has witnessed an increasing trend in the present scenario. Furthermore, the superannuation fund manager (Unisuper Ltd) has offered two different types of plan to the tertiary sector employees so that they can decide whether to place their superannuation contributions in an Investment Choice Plan or Defined Benefit Plan. Unisuper provides services and manages the superannuation funds for the employees in the tertiary sector. In relation to both these plans, studies have stated that risk transfer costs are the key reason why tertiary employees have a minimal acceptance rate for the Investment Choice Plan. In addition, studies have depicted that both those who selected to stay in the Defined Benefit Plan and those who chose to transfer to the Investment Choice Plan were prepared to take into account tradeoffs in their choice[1]. The employees in the Defined Benefit Plan were prepared to forego an enhanced quantity of expected benefits for higher security of advantages expected in the plan, whereas the employees of Investment Choice Plan were prepared to forego such benefits or security and expected risk of larger investment in exchange for a greater control and greater expected quantity over their benefits[2]. Further, variations in financial proficiencies and variations across academic disciplines assure that risk transfer costs were the prime cause for the majority of employees rejecting the Investment Choice Plan. This makes it clear that employees who are not willing to undertake any risk are more likely to select the Defined Benefit Plan and employees who are ready to undertake high risks in expectation for a higher return are more likely to select the Investment Choice Plan[3]. Another factor that must be considered by such tertiary sector employees in order to decide whether to place their superannuation contributions in Defined Benefit Plan or Investment Choice Plan is that in a defined benefit plan, the sponsoring employers assure to offer a specific level of advantages during the retirement of employees[4]. This retirement benefit is generally ascertained as a multiple of the final salary of the employee and his years of service. Besides, employers fund this assurance through periodic contributions. However, if the fund is insufficient, for instance, returns on assets held in such superannuation funds are lesser than anticipated; it is the duty of the employer to make good such deficit by making further contributions towards the fund. On the contrary, in Investment Choice Plan, employees can select the type of portfolio to decide where their superannuation contributions must be invested. In such plan, employers are only liable to pay an agreed percentag e of superannuation contributions to the fund. Once such contributions are made to the fund, the obligation of the employer is completely discharged. Therefore, since the return of employees under this plan is generated based on the selection of their choices, they are liable to bear the risk related to the same. Moreover, employers sponsoring the Defined Benefit Plan bear the risk that advantages will cost more than the anticipated risk, and the risk that invested assets will provide inappropriate returns[5]. Therefore, they efficiently undertake the plan and bear the investment and administrative expenses related to the operation of the fund. On the contrary, because the duty of employers is discharged in Investment Choice Plan, employees become vulnerable to fluctuations in the investment returns and hence bear the investment and actuarial risks related with the fund. Nonetheless, when benefits are restructured because of an alteration from a defined benefit plan to investment ch oice plan, several risks, and related expenses efficiently is transferred from the employer to the tertiary employees[6]. This phenomenon is also called risk transfer costs. Hence, the obligation of employees to make good the shortfall also becomes a factor for tertiary employees to make a valid decision. Another reason as to enable the tertiary employees to decide whether to place their superannuation contributions in either of the plans is the expectation regarding the standard of living after their retirement[7]. In other words, the main goal of superannuation contributions made by an employer and employee is to ensure that the employee gets a sufficient amount of benefit after his retirement[8]. Therefore, the decision as to whether such benefits must be higher or not directly relates to the selection of either of the plans. In relation to the above, if an employee has more than one source of income apart from his or her superannuation fund, then an Investment Choice Plan would be more advantageous to them because having more than one source of income can allow them to undertake higher risks in lieu of a higher return. In other words, the employee can gain uniformity with the other sources of income through such higher risks, and he can anticipate a greater rate of return on the superannuation contributions. On the contrary, if such an employee does not procure additional sources of income except superannuation funding, then an Investment Choice Plan will not be favorable to them because it facilitates in a higher risk in anticipation for a higher return. Nevertheless, having no additional source of income can prove effective in Defined Benefit Plan as it can provide a uniformity of revenue after retirement with minimally involved risks in the plan. In addition, the characteristics of workers are contrib utory factors to variations in the anticipated value of benefits attained from both the plans. Such workers characteristics comprise of years of service, age, longevity after retirement, etc. The key risks that result in differences in the anticipated values of both the plans are those related to financial market risks and changing jobs as a whole[9]. According to studies, employees in the Defined Benefit Plan undertake the risk of market mobility of labor because their entire working life advantages are minimized because of the use of financial earnings formulas. In other words, frequent changes of the job will result in multiple Defined Benefit Plans and destruction of the aggregate benefits. As a result, it is expected that employees who alter their jobs on a frequent basis prefer Investment Choice Plan instead of a Defined Benefit Plan. In relation to the above, the issues of the concept of time value play a key role in the decision-making process regarding superannuation. This is because studies have depicted for main drivers of selection of an effective superannuation plan. These drivers are the length of time invested, costs, performance, and security. The concept of time value of money states that the value of money today is more relevant than the value of money in the future. The reason behind this can be attributed to the fact that there are in reality, no uncertainties with time and instead, it primarily depends upon the account of timing. Moreover, an investor is keen to know what part of his income will fetch him an effective return and in what time. Nevertheless, this variation in the present value of money and future value of money is the concept of time value of money. The issues that are prevalent in this concept form a significant part of the decision-making process in relation to superannuation contri butions. Employees make a significant contribution to their earnings towards superannuation funds in order to procure an effective return after retirement. Further, the income received by such employees are again reinvested by them in order to enhance their returns with the due passage of time. Since due passage of time refers to a huge consummation of time, it is very vital that such employees utilize the concept of time value of money in order to compute the future value of their investments. Besides, according to the concept, if an investment consumes a higher amount of time, it is more likely to fetch higher returns than an investment with a lower amount of time[10]. Therefore, the investment concept regarding the time value of money is very vital for the investors or employees in order to assure that their investment will fetch them an effective return in a proper time. Further, an employee who does not consider the investment issue of the time value of money is more likely to suffer loss. On a whole, by making an effective investment in an appropriate portfolio with the help of a superannuation fund can allow the employees to procure higher benefits in their time of retirement. The issues of the time value of money concept are also related to the risk appetite of the employees because superannuation funds can be procured after retirement and it takes years for such process to happen. Moreover, generally, a higher period of investment ensures higher returns because more risks have been undertaken in this case. However, losses may still happen in bad years where such risks were undertaken and patience maintained goes in vain. Therefore, proper planning of strategies must be made by the employees in order to determine the time period for which they are ready for investment and in what kinds of assets. On a whole, a balanced approach is a key towards procuring higher returns in an appropriate time. Over the past fifty years, Efficient Market Hypothesis (EMH) has been the subject of intense debate and rigorous academic research. According to this theory, it is not possible to beat the market because the prices already accommodate and depict all significant information. Moreover, supporters of such theory believe that it is irrelevant to look for undervalued stocks or attempt to forecast market patterns through technical or fundamental analysis. However, the efficient market hypothesis does not mean that the selection of portfolios by pension fund managers must be done with a pin. In relation to this, the pension fund managers have three relevant jobs to do. Firstly, the pension fund manager must make sure that the portfolios are well diversified in nature[11]. Moreover, in relation to this, it must be noted that a large number of stock is not sufficient to ensure diversification. On the contrary, diversification signifies that investments can be made in various stocks that are f rom the same kinds of industries. Hence, the pension fund manager must always make sure that throwing pins or darts at the stock page may allow them to generate a diversified portfolio but there is no method to control for the anticipated risk or return of the resulting portfolio. Secondly, the pension fund manager must ensure that the risk of such diversified portfolio is adequate for the managers clients. This is because pin risk occurs when a seller is incapable of speculating his position and therefore, it is the duty of the pension fund manager to consider the risk appetite, which they can bear before investing the resources of their managers clients. Nevertheless, in the case of pension funds, the manager must select investments that are safer and can offer stagnant returns, which depict of selecting such stocks or shares that have a lower risk. Thirdly, the pension fund manager might intend to tailor the portfolio in order to attain advantage of special tax laws that are applicable to the pension funds. In relation to such special tax laws, it must be noted that these play a key role in ensuring the likelihood of enhancing the expected return of a portfolio without enhancing the risks[12]. Moreover, the position of tax of an investor is the ultimate aspect of investment of funds in order to gain a higher return[13]. Therefore, it is the duty of the pension fund manager to select a portfolio that possesses the efficacies of such special tax laws so that higher quantum of benefits can be obtained. Besides, such benefits can only be obtained in the case of pension funds. Nevertheless, based on the efficient market hypothesis, since stocks often trade at their fair prices on their respective stock exchanges, it becomes problematic to sell stocks at an overstated price or procure undervalued stocks[14]. Hence, in lieu of the pre viously mentioned reasons, it can be stated that even though the efficient market hypothesis is true, it does not imply that the pension fund managers must select the portfolios with a pin. 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