Making short term sacrifices to achieve long term gains
Studies done by European psychologists in the early 1960s suggest that a person’s natural state of happiness is maximised when he/she is given choice.. However, further developments on the studies show that when a person is presented with too many options, they often become confused as to which option is the best for them.
Because no two people are the same, member choice, when it comes to designing a retirement savings vehicle, is essential. While this is dependent on a number of factors which can change in a heartbeat, Old Mutual Corporate Consultants feel that offering too much member choice may actually be detrimental to a person.
The plethora of considerations
Michelle du Toit, Principal Consultant Old Mutual Corporate Consultants, points out that there are many considerations that need to be taken into account when a person is making key decisions regarding their retirement plans.
“We need to look at the mindset of the person who is making these decisions. The majority of decisions are made when joining a company. Usually, these decisions are being made by young staff members who are very excited about getting their first serious job. The driving force of their decision making process is pensionable salary vs take-home pay. They really want to maximise take home pay and retirement benefits are seen as method of increasing this,” says du Toit.
She adds that if you present a young staff member with contribution rates of 2,5%, 5% and 10%, the majority of them select the lowest contribution option as they see retirement as an event that is far on the horizon.
Where is the value add?
Du Toit asks where is the true value add behind offering young staff members a plethora of choices when they are most likely going to take the option that will offer them short-term gains over long-term benefits.
“If there’s an option of flexible approved risk benefits, does this add value? We need to find a cost-effective method of increasing cover. We need to do this because members don’t generally compensate for earlier choices by supplementing it with additional savings,” says Du Toit.
The obvious point for added value comes with the client engagement from the human resources department at companies. Studies show that when faced with greater choice, people become conservative. “We also need to ask how often members review this choice. How much information are they provided? How much time is spent on reviewing investment choice options? These are questions that HR departments at companies should seriously consider,” says Du Toit.
Stripping for benefits
The real question is, what if we were to strip away choice? Would it be beneficial? Martin Poole, Asset Consultant at Old Mutual Corporate Consultants says that the contributions in the first ten years of a fund only make up 1% growth in that fund. However, growth on those contributions makes up a third of the fund.
Stripping choice early in the fund may be beneficial. There is also a lot of benefits to presenting contribution choices to members who have been with the company a number of years as they probably take the mindset of saving more seriously at 35 then they do at 25.
If there is no other reason for saving, we need to be aware of the longevity challenge which is affecting the market. On average, the life expectancy of men has increased by 20 years while the life expectancy of women has increased by 25 years.
Have we got a grip on this challenge? We all know that a living annuity is essentially an investment product that provides you with an income from your retirement savings. But will this provision last if we are living longer?
In terms of a living annuity, it is possible for a person to be disciplined and not tap into their savings at a drastic rate. However, we must remember that there is simply no way to not tap into this money.
“If we consider an investment that has a drawdown ratio of 6.5% and has an investment strategy that keeps up with an inflation rate of 3%, a person can live well into their golden years without running out of money. However, if they do not make provision for living past the age of 90, then there is a significant drop in capital,” says Poole.
Editor’s Thoughts:
As a rule, people live for the “here and now”. But there are major implications for bad decision making that needs to be brought to the attention of members of pension funds. Engagement is the key piece to the puzzle because if member choice is stripped away, it needs be explained why this is in the best interest of the member and how they can benefit from future savings. Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts [email protected].
