In my article today about CDC, I mention that DC is unable to do what CDC can do, which is keep people invested in retirement. The FCA’s Retirement Income survey data shows that the vast majority of redemptions from personal pensions are to cash and suggests that people , given half a chance , will bank their pension profits. They either don’t trust the markets or don’t trust their bank balances , but it seems a lot of people are prepared to trade off the long term growth of a tax- incentivized pension investment for the meagre returns from cash.
Given the choice do we choose to invest in stocks and shares or cash? The answer seems to be “cash” which says some interesting things about the investment of workplace pensions and some interesting things about the real value of CDC.
The ONS stats on ISA investing are quite stark
There is a good proxy for what we’d invest our retirement savings into if we were left to our own devices. The latest ONS statistics tell us that around 11.2 million Adult ISA accounts were subscribed to in 2018-19, up from 10.1 million subscribed to in 2017-18. The number subscribing to cash ISAs subscriptions increased by 1.4m from 2017-18.
The number subscribing to stocks and shares ISAs fell by 450,000. The share of
accounts subscribed to in cash has increased to 76% of accounts, compared to 70% in 2017-18.
These stats are very stark and they are reflected in the amounts invested. What is more, despite their meagre returns and disputable tax-advantages, cash ISAs seem to be getting more not less popular!
So far we’ve looked at subscriptions not accumulated market values. The market values of cash and stocks and shares investments are much more equal. Indeed, as time goes by, invested ISAs overtake the market value of cash ISAs. Clearly there is something going on here.
Assuming that people keep their money in cash and investment ISAs for equal periods (I’d be grateful for any statistics on relative durations), then we have to suppose that the rates of return on investment ISAs are superior to those on cash ISAs. This isn’t hard to believe when you compare the market returns of cash and a typical 80/20 default accumulation fund (80% equity – 20% bond)
The tenure of money in cash and stocks and shares is harder to find but anecdotal evidence suggest that both are “sticky”. People regularly report that they are using ISAs to save for retirement and in retirement.
We might then ask why 90% of money in workplace pensions is invested not in cash but in stocks and shares. The answer is of course that savers in workplace pensions are defaulted into investing in funds that allocate to stocks and shares and not to cash deposits. Which turns out to be a jolly good thing too.
If we want to point to the value of pension over ISA investment, I suggest that it is down to the long-term allocation of funds to real assets. By comparison with DC funds, ISA funds are invested heavily in low-risk , low performing funds.
The vast majority of value from a pension scheme is delivered by the investment performance. This chart has been produced by AgeWage and the benchmark return (IRR) is measured against the average return (IRR). It might be better to refer to Annual Percentage Return (APR) when talking about this to members.
The average cash fund has underperformed the average pension fund by considerably more than 1%. (the chart below assumes monthly investments increasing by 5% each year and starting at £100pm). The pot values are based on actual contribution histories and actual market returns. They include the impact of sequencing of contributions and costs and charges. These are net returns based on experience (hence the slight waviness of lines).
I can draw two obvious conclusions
- If we continue to allow people the freedom to “invest” retirement funds as they choose” they will choose to invest more and more in cash,
- If we can find a default way of getting people to invest their savings in retirement, they will remain invested to their long term benefit
We need to help people keep their money in the market, no matter how awkward this may seem. We have managed to get the vase majority of money in our DC schemes invested in growth assets and we can do it for later life investments too.
I can draw one less obvious further conclusion
Most DC schemes de-risk in the years leading up to the scheme retirement age. Presumably this is to improve member outcomes and the fear is that value would be at risk if members stayed invested. This is tantamount to admitting that most members will take their assets as cash or maybe annuitize (unlikely).
Maybe, we are using lifestyle de-risking strategies to undo the good work of the previous 40 years invested. Maybe we should conclude that the defaults of many DC pensions are actually planning around failure, failure to remain invested to and through retirement.
If we draw this conclusion , then perhaps we should be asking what more we can do to encourage ongoing participation in growth funds to and through retirement. Which leads us back to the start of this blog. We may conclude that there is no need to de-risk pensions that work on a collective basis, which is what CDC can do , that DC can’t.
Put another way, maybe we should be running DC defaults that allow people to opt-in to de-risking programs, not opt-out.