New model needed

Fo­cus on the is­sue of longevity risk

Finweek English Edition - - Creation and preservation of wealth -

ONE OF THE BIG­GEST FEARS OF re­tirees is the pos­si­bil­ity of last­ing longer than their money. Yet global in­creases in av­er­age life ex­pectancy are mak­ing this a more fre­quent oc­cur­rence, serv­ing to un­der­pin the re­quire­ment for sound re­tire­ment plan­ning.

The is­sue of longevity risk is now be­ing worked into the num­bers as fi­nan­cial plan­ners en­sure their clients have suf­fi­cient re­sources dur­ing the lat­ter part of their lives. In 1901, the av­er­age life ex­pectancy of a male in Bri­tain was 46. Women were ex­pected to live to 50. By the turn of the cen­tury, ex­pectan­cies had moved to 76 and 81 years re­spec­tively, and SA is not lag­ging too far be­hind in this re­spect.

The up­shot is that there are more re­tired folks out there, mean­ing big­ger ex­pen­di­ture on things like health and care of the aged by both in­di­vid­u­als and Gov­ern­ment. With so­cial sup­port struc­tures and Gov­ern­ment pen­sion funds al­ready creak­ing un­der the strain, new mod­els are be­ing de­vised to cater for the “life be­gins at 60” brigade.

In South Africa, it’s com­monly ac­cepted that 31% of peo­ple who reach re­tire­ment age will have to con­tinue work­ing; 47% will be de­pen­dent on fam­ily; 16% will de­pend on a mea­gre State pen­sion and only 6% will be able to re­tire fi­nan­cially in­de­pen­dent.

Andrew Bradley, CEO of in­de­pen­dent as­set con­sult­ing and fi­nan­cial plan­ning firm ac­sis, points to an evolv­ing re­tire­ment sav­ings “gap”, mean­ing that the ma­jor­ity of re­tirees would not be in a po­si­tion to re­tire on a gross in­come of about 60% of their pre-re­tire­ment in­come. He sug­gests fur­ther that on cur­rent trends, the ma­jor­ity of mid­dle and up­per in­come earn­ers also suf­fer se­vere de­clines in liv­ing stan­dards when they step out of the em­ploy­ment pool.

“Ef­fec­tively it’s only those on ei­ther end of the scale – the very rich and the very poor – who will ex­pe­ri­ence lit­tle change to their liv­ing stan­dards when they re­tire,” says Bradley.

De­spite all this, as a na­tion we seem in­tent on dig­ging an even deeper hole for our­selves. “More South Africans are in­creas­ing their debt and spend­ing more than they earn ev­ery month and house­hold debt as a per­cent­age of dis­pos­able in­come is at its high­est level ever. So South Africans on the 50-plus end of the scale are find­ing them­selves chron­i­cally un­der-in­sured, un­der-saved and un­der-in­vested.

It’s not like there’s an af­ford­abil­ity is­sue, or there aren’t enough prod­ucts to cater for our re­tire­ment plan­ning. More, it’s to do with our in­her­ent be­havioural make-up. “In the same way that poor phys­i­cal health can of­ten be as­cribed to in­ap­pro­pri­ate be­hav­iours, poor fi­nan­cial health can be ac­cred­ited to lack of con­trol, a ‘live for the day’ men­tal­ity, peer pres­sure, striv­ing for sta­tus, and the tan­gi­ble ver­sus in­tan­gi­ble ben­e­fits of sav­ing for the fu­ture,” says Bradley.

What he’s re­fer­ring to re­lates to the the­ory of “be­havioural fi­nance”, a dis­ci­pline that has at­tracted a grow­ing pool of ad­vo­cates who be­lieve that peo­ple don’t al­ways dis­play eco­nom­i­cally ra­tio­nal be­hav­iour. While that might sound ob­vi­ous, be­haviourists have out­lined a hand­ful of ar­eas where in­vestors al­low their in­grained be­hav­iours to up­set the in­vest­ment ap­ple cart. The first is in ex­trap­o­lat­ing past re­turns, as­sum­ing that re­cent events will con­tinue into the fu­ture and buy­ing good per­form­ing stocks and avoid­ing those that have per­formed poorly. An equally dis­rup­tive in­flu­ence is over­con­fi­dence, or over­es­ti­mat­ing pre­dic­tive skills, while an­chor­ing, or form­ing ex­pec­ta­tions based on his­tor­i­cal trends of­ten leads to an un­der-re­ac­tion to trend changes. Be­haviourists re­fer to the flip side of that, bet­ting on when a run of gains or losses is likely to end, as the gam­bler’s fal­lacy.

Ar­guably one of the big­gest prob­lem ar­eas re­lates to loss aver­sion, where in­vestors place far more weight on losses than gains, feel­ing more dis­tress for a R1 loss than the sat­is­fac­tion they de­rive from an equiv­a­lent R1 gain. They there­fore tend to avoid in­vest­ments where they have made poor in­vest­ment de­ci­sions in the past. In­vestors also tend to com­part­men­talise in­di­vid­ual in­vest­ments and take de­ci­sions ac­cord­ingly, rather than view­ing the over­all in­vest­ment holis­ti­cally.

Be­havioural fi­nance goes some way to ex­plain­ing in­vestors’ over or un­der re­ac­tion to price changes, ex­trap­o­la­tion of past trends into the fu­ture and lack of at­ten­tion to fun­da­men­tals un­der­ly­ing a stock. It also could ex­plain why, ac­cord­ing to re­search by Dal­bar in the US and ac­sis lo­cally, av­er­age mu­tual fund in­vestors only achieved re­turns of be­tween 2% and 3%

Poor fi­nan­cial health can be ac­cred­ited to lack of

con­trol, a live for the day men­tal­ity.

over the past 20 years, com­pared to the US S&P 200 re­turn of about 12%, while in SA, av­er­age in­vestors in unit trusts achieved 4,6% dur­ing the pe­riod from 1996 to 2003, less than half the av­er­age re­turns of 9,5%.

Bradley says that this is where qual­ity fi­nan­cial ad­vice comes in. It’s about ev­ery­thing a good ad­viser does to en­sure that you live the lifestyle you choose. Ev­ery­thing a good ad­viser does should help re­in­force the be­havioural changes peo­ple are mak­ing. This starts with the way they de­sign and pack­age their ser­vices and in­vest­ment ve­hi­cles, the mar­ket­ing col­lat­eral they pro­duce, pol­icy doc­u­ments, state­ments, and all other com­mu­ni­ca­tions.

“The ad­viser and sup­port in­fra­struc­ture are there for one rea­son and one rea­son only, to help you make and sus­tain the be­havioural changes re­quired to over­come the chronic lev­els of un­der-in­sur­ance, un­der-sav­ing and un­der-in­vest­ment that are preva­lent in our so­ci­ety,” says Bradley

An evolv­ing re­tire­ment sav­ings gap. Andrew Bradley

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