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Lifting The Foreign Content Limit

By: Jeffrey Stinchcombe & Chris Lennox

With a December 31, 2005, deadline for compliance with the new CAP Guidelines, sponsors face new requirements for keeping their members informed of their responsibilities. Jeffrey Stinchcombe and Chris Lennox, of HealthSource Plus, look at some fundamental investment terms which sponsors and members need to be aware of.

Let’s face it, investments can be intimidating. And with the dizzying array of choices, sometimes we choose to bury our heads in the sand rather than make the decisions that will affect our financial lives decades from now. When you are making those decisions for others – the pressure can be even more intense. Welcome to the world of group retirement solutions. Defined Contribution pension plans and Group RRSPs can lead to some heady decisions for plan sponsors – decisions that should be based upon best practices and the best advice of a professional.

We hear so much about the advanced concepts of investments including hedging, shorting, and net-present values, but what about the fundamentals? Wouldn’t it be nice if we could just make it simple? It’s time to get back to basics and review some investment terms.

Buzz Phrase
Let’s start with the buzz phrase for 2005 – Capital Accumulation Plan. What exactly is a Capital Accumulation Plan (CAP)? A CAP is a tax-assisted investment or savings plan that permits the members of the CAP to make investment decisions among two or more options offered within a plan. A CAP may be established by an employer, trade union, association, or any combination of these entities for the benefit of employees and/or members.

From the point of view of a consortium of industry professionals, including plan sponsors, an Investment Fund is a mutual fund, pooled fund, segregated fund, or similar pooled investment product which is designed to accumulate capital on behalf of its beneficiaries (the employees). The plan sponsor should provide its members with education and information to help them make investment decisions within the plan. Some examples of education and information include:

A plan sponsor should also provide its members with decision-making tools including:

A CAP can consist of many different kinds of asset classes including:

Stocks represent a percentage of ownership in a corporation. Stockholders are entitled to a share of the profits every year (if any). Pension plans include stocks in their portfolios for many reasons including participating in the growth of the economy, participation in the growth of earnings of the corporation, capital appreciation, and possibly dividend income.

Bonds represent a loan or a debt in the form of a contract secured by assets. A bond is for a defined term at which time all principal and interest is repaid to the bondholder. Pension plans include bonds in their portfolios for many reasons including creating a reliable flow of income, the security of the principal, and their lower volatility than stocks.

Each of these vehicles creates a Return on Investment. Return on Investment is the profit or loss an investment makes in a year expressed as a percentage of the original amount invested. Investment horizon is how long the plan member expects to hold their investment, based on when they believe they will need their money back. Usually the shorter the investment horizon, the less risk the member should take with their money.

Inflation is the increase in the cost of goods and services over a period of time. Inflation can greatly decrease the purchasing power of the dollar. It is critical in pension plans to maintain or even increase purchasing power on an ongoing basis. Inflation is the enemy of future purchasing power. Risk is the uncertainty or the variability of returns. Risk can also be described as the degree of chance that the value of an asset may at any time be below expectations. Risk tolerance measures the plan member’s comfort level with market fluctuations. The greater the risk, the greater the potential reward.

Ensuring Diversification
Asset Mix is an important factor in total pension performance. A good asset mix is key to ensuring diversification, minimizing risk and volatility, and maximizing returns. A balanced portfolio will contain a mixture of various asset classes including Common Stocks, Fixed Income Securities (Bonds), and Short-term Paper (GICs). Stocks can provide the highest returns over a long period of time, but they do not alone provide inflation protection and they are exposed to increased volatility and risk. Bonds provide lower returns, but with a lower level of volatility. A mix of stocks and bonds will provide better returns over the long-run while reducing risk. While reviewing the basics, it’s not hard to see that even the basics get complicated in a hurry. With compliancy looming within the new CAP Guidelines by December 31, 2005, the basics have become more important than ever – and so has the advice and guidance of a pension professional.

As a plan sponsor, reviewing the fundamentals from time to time is a valuable exercise in staying on top of the ever-changing world of investments and in ensuring that your members are aware that they must keep their investments working together to achieve their short- and longterm financial objectives and obligations.

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