We all know the truism that you can’t predict the future by projecting the past. Henry Ford’s “History is Bunk” was the title of the first question on my S-level history exam. I remember writing then that history taught us what worked and what didn’t and if we properly applied its lessons to our lives, we would get on very much better. At a very basic level, I still see things that way and I wonder why it is that I can’t use the experienced performance of my pension pot to predict what I am likely to have in five- ten or thirty years time (being 60, I’m giving myself 30 years).
This idea has been troubling me ever since I engaged with how we see projected outcomes of our pension saving on the dashboard. Putting aside the damning fact that we are still relying on annuity conversion rates as the best proxy for how we turn pots to pensions, I am interested in understanding what people think my fund will be worth in seven years time (assuming I take state retirement as my DC pension date). What are the options?
The first option is to assume that whatever I have now , I keep and that it purchases a pension at today’s rate. This has the advantage of taking inflation out of the way, I’m being told that investment growth will match inflation , no more and no less. This is the simplest way of doing things and it works best as I approach retirement. After all, most DC pension pots are on glidepaths that aim to provide certainty not growth. However this approach is rubbish if I have no need for certainty as I won’t be cashing out my pot or using my pot to buy an annuity. Infact it is downright unhelpful in getting me to think about my future investment strategy.
The second option is to project my pension pot forward at an agreed rate based on what experts think are likely returns on the assets into which I am invested. This approach is favored by “experts” as they have assumptions on returns which they use for DB pension fund valuations. This approach is effectively a replication of what an actuary has been doing for pension schemes for the past fifty years and it’s helpful, though it doesn’t help us think much fo ourselves, effectively we are all in it together, even if we are all taking our own risks of things not working out.
The third option is to base the future on the past and comitt heresy, projecting our pension forward , not as if we were simply keeping place with inflation, or getting returns based on actuarial assumptions, but based on the returns we’ve had on our pension pot in the past.
This approach is not much good if you are on some de-risking glidepath towards low-risk assets as you’ll be invested for the future based on a completely different investment strategy employed in the past. But let’s say you are sailing towards destination retirement with no intention of changing your investment strategy , then using past performance as a guide to the future makes some sense, especially if the performance of your pension pot is based on your experience as an investor. By this I mean that you work out – or have had worked out for you – the experienced return you’ve had – based on the timing and incidence of your pension contributions. I call this the internal rate of return of my pot, it is the “experienced return”. I’m interested in the history of what I’ve been doing and want to understand whether it informs on my current decisions (whether to save more or less, combind my funds, what investment pathway to buy etc.) It may not be perfect information but it’s my information and that counts for a lot – when it’s my risk!
As I understand it, the Financial Reporting Council are going some way down the third option which is annoying those who want the simple – “no real growth approach” (1) and the “growth on our assumptions” approach (2). The FRC are saying that we should use growth asumptions based on achieved growth – not expected growth. This is a way of looking at the future using your rear-view mirror. This may not be very “sound” , but it has the virtue of making intuitive sense to ordinary savers who generally think of the return they get on money as cash +interest.
Though this approach is shockingly simplistic, it has at least some basis in experience. You can , to some degree, explain your projection on some historical evidence. There are a lot of people who subscribe to the theory of “evidence based investing”, typically Joe and Joanne Public for whom history isn’t bunk – it is what they base future decisions on.
What I’d like to see on my dashboard.
When I compare my Nest pot with my Legal and General pot, I’d like to see how my two pots have got on (call it interest or return- it makes no odds to me). I would also like to know how the interes/return compares with others – how I would have done if I was an average punter. That would tell me if the Nest strategy or the L&G strategy had worked better.
Based on this information , I would be interested to know what I would be likely to get in 7 years time (67) based on more of the same. I could set my target return on these projections , knowing that past performance is not my only guide to the future, but is the best guide I’ve got. Of course, I’d be comparing apples with oranges – the timeframes of my investments would make throw my rates of return out of kilter, but at least I’d have examples based on what had happened to me.
We talk a lot about “personalisation” of communications ,but never about personalisation of performance. I suspect that that will change and that we will look in the future at comparisons based on how our pots have performed. It just makes more sense to Joe and Joanne.