There is no silver bullet
The way that investment consultants talk about DC, you’d still think there is some silver bullet waiting to be loaded into the gun, to shoot away the DC blues.
The DC blues cannot be cured by a silver bullet from the investment community, they will be cured over time through engaging companies and employees in the need to contribute realistic amounts to meet retirement needs, by education on what individual responsibilities are to their retirement saving and empowerment of people to take decisions in their own best interest,
I do not exclude investments from the process, but I want to put some perspective on the subject. The percentage of today’s retirees who can articulate the investment strategy they have adopted can be numbered on one hand – or one digit of the hand!
We can only engage-educate and empower
I know those who devise investment strategies for DC defaults and construct the universe of funds into which members can choose to invest are conscientious and well meaning, but for most people , your theories, your strategies and the implementation of those strategies are the least of their worries.
Here are three things we can do to help people invest the contributions they make to their retirement funds.
1. Engage; there are only three things people have to get to grips with- risk, reward and the third dimension time. When people understand they can take more risk and get more reward , over time, they can see volatility as their friend, understand the equity risk premium and get pounds cost averaging. It is perfectly possible to engage people with these simple ideas and get them to understand that investment dynamics should change over time- their time!
2. Educate; once people get the fact that investment strategies are time dependent,then educating them on “what makes for good” is a whole lot easier. We know that there are some immediate wins, keeping costs down and only spending money on transactions when there is a good reason to do so is an immediate win. Warren Buffet says that his ideal investment is one he can hold forever is right. There is much we can educate people about, but keeping it simple is what’s wanted and what’s needed
3. Empower; most people do not want to make decisions on investments but they want the power to reject rubbish if rubbish comes their way. Whether you are an expert fiduciary or a total novice, you should feel you have the right to ask dumb questions and if necessary say no. It is when people are powerless, as they felt they were when buying an annuity, that things go really wrong. Empowerment for some can be no more than this negative capability – “I could have said no if I’d wanted to..”
If we simply stuck to these basics, we would have done much to restore people’s confidence in what is going on.
Engaging – educating and empowering the fiduciaries.
There’s a second level of sophistication which investment consultants need to work at.
This is a level that addresses the needs of IGCs and Trustees to state the principles by which they invest and properly explain why they have taken the investment decisions they have on behalf of policyholders and members.
At this level we can simplify things a lot. There are only three big decisions that need to be made
- The structure of the investment administration – do you use the target dated, the conventional lifestyle or a behavioural approach – such as Dimensional employ.
- The common investment destination– are you employing a whole of life strategy or simply investing for part of the life journey (accumulation or decumulation). If the latter – what is your strategy pointing at (annuities, drawdown or cash)
- The management of the money– who are you delegating the responsibility to manage money to.
Right now, investment consultants are tying themselves up in knots trying to get default strategies worked out that can act as silver bullets, pleasing all of the folk all of the time. Inevitably they are trying to employ their skills learned in the DB classroom so there is plenty of talk of “treage”, glidepaths and the like. There is a misconception that the new pension freedoms will mean a free for all and that the guidance on offer will be enough to make people their own CIOs.
The truth is that unless people know what they want, they cannot make informed decisions on the funds they need. And only a very small number of people will fully engage, get properly educated and empower themselves to make appropriate decisions. Statistics suggest that this is around 10% of the population.
The best we can do is not second guess
The rest of us simply don’t know and want to keep options open. I am currently in a scheme where the default fund is a conventional lifestyle strategy that assumes I will buy an annuity in 7 years time.
I would argue that if a fiduciary made this assumption it was a reckless assumption, and that the investment strategy employed was reckless in its conservatism. I do not need or want an annuity and I suspect that most people (having gone through the engage-educate-empower continuum) would want an annuity either. Annuities provide too much certainty and not enough income for someone with an average life expectancy at 60 (my default retirement age).
The prudent person
We need a new construct – something like the concept of the “prudent person” who is the imaginary figure who has gone through the “engage, educate,empower” continuum and is making an informed decision about his or her current and future circumstances and how to finance them.
The entire DC investment strategy revolves around this prudent person, there are outliers, the 10% who will make their own choices , those so in debt or income poor that it only makes sense for them to cash out their pensions and those who cannot abide any degree of uncertainty and will be insistent investors in annuities.
But for prudent person, the retirement income strategy will be all about meeting the bills and having that bit extra to have happy reclining years.
Meeting the needs of the prudent person
It is not too hard to devise an investment strategy that meets these needs, it is a strategy that provides value for money by only incurring cost where that cost adds value. It’s a strategy that allows for a regular income, makes sure there is scope to draw on capital from time to time and provides some protection against extreme old age and decrepitude.
People will say that this vision for the prudent person does not offer great freedom – that it circumscribes ambition within a very narrow band of variables and they would be right. The freedom in my vision of the prudent man comes to people who have engaged- got educated and become empowered. Every one of us has that option and many of us will take it.
Empowerment is about the right to say no without having to.
Empowerment- the end product- is the power to say “no”, to reject the concept of the prudent person and choosing to be an extraordinary person. But you ask 100 people if they want to be extraordinary and most will say “no” and of the remainder, only a handful really mean it. Most of us, when the chips are down, want to be the prudent person and we should not blame ourselves for that!
Common sense for the “solitary man”
In summary, what is needed from the investment community is some common sense- a sense of what it is to be a common person – a prudent person – what Neil Diamond called – “a solitary man”.
Knowing what is common- prudent- ordinary, means we can plan around that and while we need to give options for the extraordinary, we should invest our efforts in engaging , educating and empowering the outliers to take decisions for themselves, not trying to second guess their extaordinariness!
If you want to rid yourself of the DC blues don’t
just listen to this!