Retirees are often too conservative in their spending of superannuation money. How do we address this issue when developing retirement products?
Retirement has become a big discussion topic among Australian pension funds and for good reason.
Since the start of the superannuation system in 1992, the focus has been on accumulating wealth in order to give employees the best possible start to retirement.
But now more and more members are retiring, combined with pressure from regulators, funds need to have a retirement product that is suitable for as many people as possible.
Finding a solid retirement product that addresses the needs of the majority of members, however, has proven to be elusive.
In a discussion at the [i3] Retirement Strategy Roundtable 2020, held last week, participants agreed that often the very starting point from which discussions about retirement strategies begin is problematic.
Too often, retirement strategies are based on ideas akin to the endowment model, where the aim is to preserve the principal investment and live off the income generated by the portfolio.
This might work for endowments with their billions of dollars, and perhaps also for high net worth individuals who aim to leave a substantial inheritance, but for the average super member this is a largely inappropriate strategy.
Retirees need to spend their money if they are to maintain their standard of living.
Especially in the current market environment, where a 10-year Australian government bond yields 76 basis points, you can’t expect to generate a return that matches the drawdown rate.
Behavioural Aspects of Retirement
But product design isn’t the only issue here, participants argued.
You can design the most financially sophisticated retirement strategy possible and yet retirees tend to underspend.
This behavioural bias towards conservative spending in retirement needs to be considered in the development of a sensible retirement strategy too.
Perhaps the best way forward is to stop the search for the perfect solution and, instead, come up with a halfway product that acts as the starting point of a discussion.
For example, a simple bucket strategy, which splits out an account balance into a cash bucket from which income payments are made and one or more investment buckets that still generate a return, is often found to make intuitive sense to older members.
Equip Super has in place such a bucket strategy, which invests 20 per cent in cash, 40 per cent in a conservative bucket that includes cash instruments and bonds, and 40 per cent in growth assets. Australian Catholic Super also has a bucket strategy in place, but has reduced the number to just two buckets: cash and growth.
This strategy might not address everyone’s needs, but these funds have found it to be a good point of engagement. It is a strategy most members understand and it allows them to adjust the allocations along the way, depending on their individual circumstances.
Rather than offering a wide range of complex building blocks from the get-go, providing them with a simple starting point, even if it is not the ideal retirement solution, might very well lead to better outcomes in the long run.
[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.