Why we should question the appropriateness of Defined Contribution investment strategies?
Why do we all fall down? Recently, one of us was asked this question by a four-year-old child after a game of ‘Ring a ring a rosies’.
Children have an ability to ask excellent questions that we often brush off or simply dismiss. Sometimes we become so accustomed to something that we fail to question why, or have forgotten why, we actually do it.
All too often, we become so accustomed to something that we fail to question why, or have forgotten why, we actually do certain things. With regards to Defined Contribution (DC) Funds, we should take a step back and question the appropriateness of DC Investment strategies. After all, the main concern of the DC fund member is and always will be whether they can achieve a good retirement.
A good retirement is measured by maintaining a standard of living in retirement. This is not defined by a ‘pot of money’ but rather a stream of income that allows you to uphold the lifestyle that you have become accustomed to. We at Colourfield refer to this as an income goal and not a wealth goal.
Now that you have identified your income goal, you may be wondering how to go about achieving it? The most important thing to have in place is an investment strategy that is tailored to providing the required level of income in retirement (i.e. bespoke for your individual goals). This strategy should be revisited annually or more often, if your circumstances change.
This allows you to assess your current standing with regards to meeting your retirement goals and making decisions based on your current standing. For example, you can retire later, perhaps take on another job if there is a mandatory retirement age at your current place of work or you can take on more investment risk.
The question begs: what should members of a DC Fund be investing in?
- Your investment strategy should contain a mixture of risky assets such as equities and risk-free assets (which is not cash).
- The allocation should change over time so that the likelihood of you achieving your investment goal is maximised.
- It is always imperative that you read the fine print and fully understand all the details of your plan. The key differences to current frameworks are that risk is defined as the possibility of not achieving the required retirement income, and the risk-free asset is defined with reference to a deferred inflation-linked annuity.
It’s convenient and tempting to dismiss a four year old’s question about ‘ring a rosies’ by saying it’s just a silly nursery rhyme and we shouldn’t pay too much attention to the words. The reality, though, is that it describes the Black Plague in England centuries ago, with the final verse of “we all fall down” referring to the inevitable death due to the disease. Conversely, it is also tempting for a retirement fund member to assume that his/her default DC fund investment strategy is well thought out (when closer analysis in many instances suggests otherwise). By identifying meaningful goals and asking the right questions, we can help prevent our members from all falling down.