Major companies began phasing out defined benefit pension
plans in the mid-1980s. Under a defined benefit pension plan, an
employee of a company is guaranteed a defined lifetime pension,
calculated on his or her years of service and salary earned. The
companies, as guarantors of these pension payouts, deposited cash
with a life insurance company or other financial institution that
served to manage these pension funds. These institutions invested
the funds and paid the retirees. Each year the companies calcu-
lated how much they must contribute to the pension plan based on
the rate of inflation and the demographics and retention rate
within its workforce.
Some major companies are behind in their contributions to
their pension plans to this day. You can determine this amount for
any company by looking at the unfunded pension liability on their
balance sheets. The pension funds were strictly regulated in re-
gard to what investments they could make with the funds they
held in trust for the future retirees. Most had to be invested in
bonds or other fixed-income securities, and only a small portion
could be placed in the stock market—and then, typically, only in
blue-chip stocks.
Seeking ways to reduce this pension expense, most large compa-
nies shifted from defined benefit pensions to defined contribution
pensions, which are the schemes most prevalent today in the private
sector, with the ubiquitous 401(k) plan. This shift resulted in a big
increase to the amount of money flowing into the stock market.
The money held in the pension funds is now managed by the em-
ployees themselves, who hold it in trust for themselves until retire-
ment. With the restrictions that prevented retirement savings from
being invested in the stock market gone, 401(k) money poured into
the stock market. Buoyed by a booming economy, the dot-com
craze, and this new and enduring influx of cash from retirement
savings, that had traditionally gone to the bond market, the stock
market as characterized by the Dow Jones Industrial Average
(DJIA) more than tripled. Employees put their retirement savings
into mutual funds that invested primarily in the stock market and
forgot about them, except to watch the growth in portfolio value
each quarter. “Buy and hold” became an investment strategy that
anyone could win with. Many new investors realized unprecedented
gains with little or no understanding of the market, business, or ac-
counting. Stock market success seemed deceptively easy.
In 1999 the dot-com bubble broke. In 2001 the war on terror
The U.S. Stock Market—Psychology and Prognosis 23