Freedom to invest, at what cost?

The following was written by John Authers

Some countries, such as Canada, the Netherlands, or Japan, still leave all or most pension provision to defined benefit plans but these countries are slowly shifting the balance to defined contribution plans following the US lead, which shifted the balance to defined contributions in the 80’s.

In the UK, the government announced that it would allow pensioners to sell their annuities - the stream of guaranteed income that the government required them to buy with the proceeds of their pension fund when they retired. This change continues a series of reforms, which would allow pensioners to reinvest annuities, somewhere or to cash them in and spend the annuity.

In the US, people are demanding that advisers who sell pensions should have a fiduciary res­ponsibility - in other words, whether they are required to act in line with the interests of the client and the political world is finally listening.

The problem is that fiduciary rules could rule out payment by commission, in which the adviser earns more for selling more or may earn more for selling one product than another may. Many in the industry fear many would refuse to take financial advice if they had to pay an upfront fee.

We believe that individuals have the ability to make wise decisions about their money; this is not true. In the 90`s in the UK and in the US people were persuaded to switch from investments that gave security to investments which gave more risk. The result is people lost money, while sales people and companies made money.

Behavioural finance tells us that we will make mistakes with our investments, dispassionate; thinking is hard, if not impossible for amateur investors making decisions about their retirement.

So individual investors should have a diversified range of assets which should work well for them in the long run. Individual investors should also maintain a strategy, which requires discipline and consistency

So can we provide freedom to invest with the security needed for retirement? We can but it will not be easy. We need to develop a system, which allows individuals to build savings using clear-cut default savings options, which allows the individual to re-balance regularly to keep constant proportions of stocks, bonds and other asset classes. However, this approach requires not only discipline to buy low and sell high, but the skills to understand the market and to take advantage of the swings. To minimise the costs and risks we need the investment community to develop these programs, which allow people the chance to opt out of this arrangement if they wish.

Designing these default options and getting them up and running is critical to allowing people to have a secure retirement. 

Once we are sure that people have a sound option that will look after them in retirement, then maybe we can start allowing them to take extra risks, such as selling their annuities, while the vexed issue of paying intermediaries should dwindle in importance.

Ultimately, pensions are about looking after people. Freedom of choice is important, but it is secondary to the overriding need to maximize people's chance of a good pension in retirement