The fundamental problem with retirement funds
Despite the financial services industry spending large amounts of money on consumer financial education, retirement outcomes don’t seem to be improving.
Nobel laureate and Dimensional Fund Advisors’ resident scientist, Professor Robert Merton, believes it’s because people haven’t received meaningful information.
Wrong measure
When reporting to investors on their retirement savings, most funds show how much they’ve accumulated as a lump sum. This isn’t what people are saving for.
“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,” says Merton.
“We have seen that if you show people the value of their savings as an income in real terms, they understand it. 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.”
This is meaningful and therefore drives meaningful behaviour changes.
Investor behaviour
“In the past…personal advice was given based on their account balance,” says Colourfield’s Shaun Levitan.
“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. And many of them never go back in.”
However, if they were shown a projected income at retirement, not a lump sum, they’d see something else.
“You frame things completely differently by asking what they need to live on. 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.”
Showing the value of a retirement fund as a lump sum only, also leads to people seeing it as money to be accessed.
Hence so many people cashing out their savings when they move jobs, and retirees prioritising leaving some of this money for their heirs instead of using it for generating an income.