Working past the strong winds in the retirement industry
We have all heard it before. We need to reframe our thought pattern on retirement if we want to achieve our goals of having a comfortable retirement. But as much as we know that there is a need for this, and as much as we harp on about the subject, currently it is a case of throwing water into the face of a strong wind.
Will we ever win this battle and achieve our objectives? While messages regarding retirement have been pertinent in the past, perhaps we need to refocus our discussions?
The supplemental heir
FAnews spoke with Professor Robert Merton, Professor of Finance at the Massachusetts Institute of Technology (MIT) Sloan School of Management, to find out his views on the problem with global retirement markets.
Retirement is traditionally funded in three ways; government (through social security programmes), employer plans, and personal funding. In the past, most of the retirement systems in the world were based on a defined benefits (DB) model. After significant volatility in the market, employers were not happy to take on the risk they had and a move towards the defined contributions (DC) model where all of the risk of retirement is squarely the responsibility of the member, were made.
“By default, DC became the heir to the retirement savings throne. The problem is that DC was never designed to be an effective retirement savings model on its own. It always needed to be used in conjunction with a DB model as DC is supplemental in nature,” says Merton.
Embracing the wrong lens
Merton, a Nobel Prize winning economist and published author on retirement issues, firmly believes that the way in which the DC model is run is wrong.
“Nothing much has changed in the retirement space. The objective of retirement is still the same. People want a good retirement where they have a lifestyle that closely mirrors that of the lifestyle they had during their working lives. However, the way they go about it is wrong,” says Merton.
Merton believes that there is too much focus on the pot of money in the DC model. A person’s standard of living should be defined according to a stream of income, and not by a pot of cash.
This may also allude to the fact that humans are impulsive by nature and prioritise short-term gains over long-term benefits. A major problem in the South African retirement industry is that sopme people often forsake preserving their retirement savings over going on an international holiday or purchasing a new car.
The unhappy protagonist
Besides the fact that we are providing the public with the wrong message in terms of wealth accumulation, we are also forcing them to become the reluctant protagonist in a role they are wholly unsuited to.
“We are putting risk in the hands of people who are not suited to managing this type of risk. And if you measure risk incorrectly, you cannot save correctly. You will never ask a journalist to perform open heart surgery, so why are we asking the public to fill the role of the experts that used to manage these decisions under the DB model?” asks Merton.
Enter the hero
This possibly makes the role of the financial planner more important than ever. At the end of the day, people understand their debt better than they understand decisions regarding how much their investment will grow. “Any system that forces members to make decisions is a flawed system. They have never done it in the past and will never be comfortable doing it in the future,” says Merton.
Merton also adds that members’ situations do not change because the mechanism changed from DB to DC. The objective of a comfortable retirement is still the utopian vision. “Members need to be able to engage with the decisions they made when they started saving towards their retirement. Issues such as health, work and family changes over time; therefore, decisions will need to change. We need to give members a good menu of useful options that will help them to realise their individual goals,” concludes Merton.