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The fundamental problem with retirement funds

Investors are being told the wrong thing.

According to Alexander Forbes, just 6% of South Africans will be able to retire comfortably. Not only is that an alarming statistic, but it’s not getting any better.

Despite the local financial services industry spending large amounts of money on consumer financial education, retirement outcomes don’t seem to be improving.

“We’ve been trying for years to do financial education in South Africa and its had almost no effect,” says John Anderson, the head of client solutions at Alexander Forbes. “Lots of money has been spent by the financial services industry with good intent, and the impact has been virtually zero.”

How many retirement fund companies have given serious thought to why this might be? Why are people not changing their behaviour despite all the efforts being made to educate them?

Nobel laureate and resident scientist at Dimensional Fund Advisors, Professor Robert Merton, believes that the answer lies in addressing a fundamental problem.

“It isn’t that people are dumb or that we don’t know how to educate them,” says Merton. “We haven’t been giving them meaningful information.”

The wrong measure

The key issue is that when reporting to investors on their retirement savings, most funds have been showing how much members have accumulated as a lump sum. This is, however, not what people are saving for.

“We require funds to report to members the value of their pot, but that’s the wrong measure,” says Merton. “Your goal in retirement is to sustain the standard of living you have enjoyed in the latter part of your working life. And standard of living is an income measure. We’re showing people the wrong thing, and it has lots of very dysfunctional aspects.”

This has nothing to do with how intelligent investors are, whether they understand risk and return dynamics, or what they know about asset allocation. It is simply that investors are being given information that is not meaningful.

“We have seen that if you show people the value of their savings as an income in real terms, they understand it,” says Merton. “If they are making R10 000 a month and you show them they are on track to get R2 000 per month, they can see that there’s no way they are going to be able to live on that. Also if they take their money out when they change jobs and spend it, they can see that they are going to reduce their income to zero.”

This is meaningful, and it therefore drives meaningful changes in behaviour.

Investor behaviour

“You have to change the framing to get to the right objectives,” says Shaun Levitan, the chief operating officer at Colourfield. “In the past, we tried to educate people based on the pot. Personal advice was given based on their account balance.”

This has not only created confusion, but encouraged poor investor behaviour.

“We’ve seen many people move their retirement savings out of default funds and into something conservative because the equity market is negative and they see their lump sum going down,” says Levitan. “And many of them never go back in.”

Investors worrying about the impact of short-term volatility on their retirement pot think that bonds and cash are safe investments since their capital is secure. However, if what they were shown was not a lump sum, but a projected income at retirement, they would see something else entirely.

“You frame things completely differently by asking what they need to live on,” says Levitan. “Then risk becomes a tool to help them reach that objective and cash becomes the most risky asset because it will never give them the long-term return that they need.”

Priorities

Showing the value of a retirement fund as a lump sum only, also leads to people seeing it as money that can be accessed.

“We train people to treat their retirement provision as if it’s a savings account,” says Levitan. “And so they treat it the same was as they treat a bank account.”

This is why so many people cash out their savings when they move jobs. It’s also the reason that many retirees prioritise leaving some of this money for their heirs instead of using it for what it’s really there for – generating an income.

“If you don’t take care of yourself you can’t help anybody else,” Merton says. “Of course if you have enough for your own retirement and you have something extra you may want to give it to your children, a charity, or society, but a bequest is a luxury.”

Alexander Forbes has adopted this approach in its Clarity retirement fund products. The key measure shown to fund members, on an individual, personalised basis, is their expected income at retirement.

“We don’t show a return against a SWIX or Alsi benchmark,” says Anderson. “We show a rands and cents income.

Merton believes this is an approach that all retirement funds must look at.

“It’s a process change,” he says. “Only give people meaningful information and meaningful choice. This is the way that things are going to go.”

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COMMENTS   37

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Retirement savings are mostly an employer- and unions-driven compulsory savings exercise – at least in S.A. it is. To change the retirement savings pattern in S.A. it is imperative to change the thinking and actions of both employers and worker unions in regards to constructing remuneration, annual bonuses and annual increases.
The taxation relief on contributions towards retirement funds is very favourable and more than ample, but sadly very under-utilised.
The change towards retirement savings in S.A. have to be initiated by employers and worker unions to gain progress i.e.
a) change or re-negotiate the terms of employment contracts so that the compulsory contribution percentage by both the employer and employee increases to a total of at least 20% of total remuneration (known as cost to company) phased in over a over 5 year period;
b) change the terms of bonuses so that at least 25% of any bonus are going towards retirement savings;
c) increase the retirement contribution percentage during wage negotiations so that at least 15% of the annual increase will increase retirement contributions (i.e. 9% salary increase of which 1.5% have to go towards retirement savings).

If the retirement savings pattern of the mass employee market changes, the private sector and self employed will follow suite through the influence of their bookkeepers, financial advisors and the market trend as such.

another point – at my old work Alexander Forbes did the admin of the pension contribution payment every month.
They charged a certain percentage of your PACKAGE and then deduct it from your monthly contribution. Why like this? They have to doe the admin for the CONTRIBUTION and not your PACKAGE.
Go and look what the % of your contribution that is. I can’t remember the exact figures but it’s large (3%?)
I spoke to the trustees about it…………..

Is this still the practise today?
If so it’s high time people start cackling VERY LOAD about it

They charge a % based admin fee. I had a clients who after many years of working had accumulated a fair size in their pension the the monthly % admin fee charged by AF was greater than their actual monthly contributions…. wrap your mind around that.

That is one of the issues in the industry. Does a platform do more admin for a R10mil client than they do for a R1mil client? The only platform i know that has a fixed admin fee is Old Mutual Wealth – comes out at R7,000 pa. However they limited on fund choice.

Ok, so if we label high-carb foods differently people won’t get diabetes? If we put better information on a packet of cigarettes nobody will die of cancer?

If the gardener finds a sophisticated excuse for sleeping on the job he won’t get fired?
There is a difference in the time value of money for different people. More sophisticated reporting won’t change the fact that for some people R10 has more value now, than R20 will have a year later.

Part of the problem is scaremongering from companies like this. 6% can retire? Perhaps 6% of all their clients can retire comfortably with products sold by them only. (Which is an indictment on them – as is the efficacy of their efforts at educating their clients).
If companies like this were less greedy to try and capture all assets and let clients diversify their retirement savings (to include discretionary savings and property) we would have fewer people abdicating completely.
It is comments like this (and resulting articles) and poor research that lead government to want to nationalise the system with their social security proposals.

I don’t think it’s scaremongering at all. It is highlighting a genuine crisis. I am seeing it first hand. People simply do not have the means to retire comfortably, and it is going to get worse.

I am not denying the massive problem we have. The research is based on data available to them only, and not a broader picture, which is really what the industry should be delivering and providing guidance accordingly

Agreed, this is a genuine crises, I have been in the Financial Services industry since 1991 and 6% was the same percentage used whwn I started.
Real inflation (not the one branded about to soften the underlying reality) is also eroding the value of those retirement savings already saved for.
I am watching more of the eldery, whom retired relatively confortably 10 to 15 years ago, now having to forego their medical aid and cut down drastically on expenditure.
With some the income has declined to the extent, that they now qualify for the SASSA grant.It is indeed, going to get worse.

Governments confiscate the savings of retired people through the process of financial repression. After the Financial Crisis the levels of government debt in the developed world is at record levels. There is only one viable manner to lower these Debt-to-GDP ratios and that is by keeping the interest rates below the rate of inflation. It is simply impossible to repay the debt, for the crisis will return instantly. Austerity measures are not politically acceptable, outright default is not acceptable, so what is the only remaining solution?

Governments have to pay a yield on government bonds that is lower than the rate of inflation. To use a South African phrase, governments in the developed world are expropriating the property of investors without compensation. Retirees across the world are feeling the effect of the financial crisis. What began as a banking crisis was shifted down to become a crisis for retirees. You see, politicians know, if you steal from young people they will burn the place down. When you steal from old people nothing much happens.

The minimum wage rises along with inflation but the interest on your savings don’t.

This is the deplorable effect of inflation. Inflation is nothing but the expropriation of property without compensation.

Given the circumstances sketched here above by Sensei, it leads us to the logical conclusion that the younger working class needs to address how much they save for retirement in order to survive in their old age – as we all know the behavior of governments will not change for the positive.

But let me add that those still saving for retirement should also plan to retire somewhere else in the world and should explore ways to externalize some of that savings to a renown off shore destination. Once property rights are disregarded in a country, the next onslaught may very well be retirement funds and milking the retirees.

One of the more sane and pragmatic articles around retiring and retirement funding – however I can’t see the large Insurance companies in this country changing as it places more emphasis on their performance and providing more accurate projections and then of course their fees come into question. Speak to people who took out RA’s in the 60’s and 70’s and see what their LA’s look like today – dismal and these are the companies who employ actuaries – what for

What for? To make themselves a big profit of course…

Wow – imagine that – companies making profits. Mind-boggling, really.

And then when companies don’t make profits and the share prices go nowhere, retirees (whose money are heavily invested in company shares) complain about the lack of investment performance of their investment portfolios ….

Of course, there’s a very easy solution to this dilemma. I hear people complaining very often about the lack of business opportunities, so here’s one for free:
1) Start you own insurance company instead of complaining about other life assurers on financial websites.
2) Provides services almost for free (or at rock-bottom prices), thereby capturing the market and removing all the clients from the old profit-seeking insurers, whilst delivering brilliant service and astounding investment performance.
3) Profit. (Or not.)

Well, if the taxpaying citizen revived decent healthcare, education and security and didn’t need to pay for these privately on top of a high personal tax rate- there would be a lot more cash available to finance retirement.

at least an extra 10k per month per average middle class family with 2 kids

Or… Investors have (correctly) a significant distrust of financial services companies.
We see you fancy buildings in Sandton and know that we are paying for it.
For instance, why should we pay the investor of our hard earned money a performance bonus WHEN THE FUND LOSES MONEY(!) – just because it beat an arbitrary index which we had no say in?

…and the super-wealthy (who can easily afford to retire in their 50’s) are simply “too afraid” to retire, by sitting and do nothing.

They keep their minds going by continued business/leadership activities well beyond their 70’s. From Christo Wiese to Warren Buffet. They’re still working / earning active income….if I had their money, I’d retire RIGHT NOW & buy the motorhome / become a permanent traveler *lol*

Maybe the concept of retirement was “created” for the financial advisory / asset management industry to make a living off the rest of population(?)

The best (worst?) example must be old (mad) Bob Mugabe….still “working” by serving as president well into his 90’s (although sleeping on the job was commonplace). The poor chap is only now enjoying the benefits of retirement 😉

Problem with being retired, is that no-one comes out alive from it!

When retirement became a concept, life expectancy was under 70. Life expectancy is a lot higher and we’re still stopping at 65.

Hi guys – Is it safe to invest a large sum in a fixed deposit with African Bank – at an interest return of about 10% pa over 2 years.

I suppose it would be “reasonably” safe, considering ALL banks in SA have the same non-investment grade as the country’s sovereign rating.

Answer is yes AND no:

Yes, your capital is protected.

And NO…..you would still lose money! To SARS that is! i.e. once your interest earnings breaches the annual R23,8K (or R34,5K) interest exemption.

Pay it into your bond. Similiar rate, much safer, tax free and easily accessible

We all make choices as we go through life. We are responsible for those choices, and for the consequences of those choices.

The sooner people start to take responsibility for their own lives and their own choices, the better off they will be.

Stop blaming the system, the government, the employer, the financial services industry, society. Anyone with any kind of income can save. Choosing not to save, results in no savings, retirement or otherwise.

The point being made is that people struggle to make meaningful choices if they don’t have meaningful information.

Patrick, is one not aware that many people in the low income group and even above that believe they will not reach “the retirment age” and therefore deem it right to cash in?

Agreed ! There is a sickness in South Africa, and it is spreading fast. It is called the victim mentality. Start taking responsibility for yourself. It is not somebody else’s job to look after you when you retire. If you don’t have sufficient information, go out and find it. “If you really want to do something, you’ll find a way. If you don’t, you’ll find an excuse.”

― Jim Rohn

“Of cooourse”

John, completely agree. Get to know the system in depth, then exploit it for your own benefits.

I will maintain that before playing the game, understand the rules first

You need to answer a more fundamental question for most people – why save at all?
Many people assume (because of inflation I think) that they’ll just work till they die – they lack the imagination to think of exciting things to do if they weren’t working – or even to work less. The only reasons most people mention are scaremongering tactics – too old or sick to work.

Make people want to save/free up time first – then incentives.

So how many free lunch saving incentives does one want?

== R23800 +- interest income tax free under 65

== R33000 per annum in tax free savings accounts to a total of R500 000 currently

== 27.5% of your taxable income can go to retirement. Anything over a company plan can go to an RA and invest all in interest bearing investments of you like. (Yes this is really a deferral of tax but it can help I getting to a target lump-sum much easier)

Maybe make ALL interest income free of tax? Then hear the socialists moan.

“The fundamental problem with retirement funds” – they under perform and never meet their calculations. I am yet to find an RA that actually meets their ‘calculations’ before signing up.

Rather fed up having to use after tax money and see it slide and hear of horror stories of people being down hundreds of thousands near retirement.

Mine has no calculations. The unit trusts in my RA will perform the exact same as those same unit trusts outside of the RA.

That’s why one uses pre-tax money, in an RA…

A lump sum is a fact while a projected income at retirement is very much dependant on reading the future correctly. Up to now RA’s have always underperformed against future projections and there’s a lot of sceptisism around retirement products. Maybe this has a larger influence on client behaviour than lack of education and understanding. Many people do not trust pension funds and may go so far as to delberately change jobs to get access to pension money. A low cost standardized product with good credentials will have a larger impact on the savings culture than playing around with various future income scenarios. Don’t know the latest on forcing people to transfer pension funds when changing jobs but is probably up to the Unions.

The 6% might have been fairly accurate in 1991,today’s figure is much closer to 0.6% than 6%!

Maybe people just don’t believe the compounding “miracle”. Maybe these retirement vehicles just preserve the real value of the principal, in which case speculation on a house or other assets seems just as good a choice if not better.

You have companies doing FREE training and then selling products to people who cannot afford them BUT need them (according to the broker who is getting the nice commission!) There are a lot of people who get hired by H R people looking to fill the void for FREE training. I ask then “do you work for free?” Then how can they? It’s simple a good rule of thumb (bendable at certain ages) You save no money other than in a PROPER retirement fund whilst you have debt!
You are paying HUGE amounts of interest on your bond and AT THE SAME TIME, making a pittance on your outside retirement annuity. You are PAYING HUGE AMOUNTS OF INTEREST ON YOUR CAR LOANS, CREDIT CARDS AND PERSONAL LOANS, whilst making a pittance on your small investment. What your company needs is Financial Fitness Training

I agree – sounds great but the usefulness of those income projections will depend on how accurate the assumptions on future returns, inflation, fees and annuity rates are….

The guys that use the BS-baffles-brains approach now to sell expensive products which have little hope of leading to successful outcomes for clients will simply just massage the numbers to tell the unwitting end user what they want to hear and sell more product….

If there was a set standard that was used across the board then we would quickly find that the Discovery, Liberty, Old Mutual and co charge fees which give most people absolutely no chance of success almost regardless of what they do.

Its going to get worse and volatile with Trump’s inward looking stance.
South Africans can say goodbye to any significant growth in their portfolios.

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