Escape the financialisation of retirement

Nick Hubble

Why do we invest our retirement savings in financial markets?

The answer better be damned good given it’s practically government policy.

Ironically enough, the government policy of auto-enrolment tells you plenty about the nature of the system. It relies on apathy – the real reason we invest in stocks and bonds.

HR platform provider HiBob did a survey on the realities of the new defined contributions scheme. Here are some of the results:

  • % of pre-tax salary employees are willing to spend on pensions each month: 2%
  • % of employers who agree auto-enrolment is just another tax on their business: 75% of businesses
  • % of employers who agree they do the minimum to meet legal obligations: 66%.

People don’t want to spend time and money on their future. And even less on the future of others, especially employees. Surely retirement is something you can borrow money to buy, just like everything else in our life.

The technically correct answer to why we invest in financial markets for our retirement is simple: lobbying.

Pension apathy and auto-enrolled savers are the financial sector’s dream. Combined, they’re a licence to make money from everyone, especially people who won’t pay attention to what their fund manager is doing (ie, how much they’re charging).

It’s also about the quality of the product we end up with. Imagine what would happen to the quality of doughnuts if we were all forced to allocate 5% of our income to them. And our employer chose the doughnut provider, paying them our money directly.

There’d be no reason for doughnuts to be delicious ever again. Boozy lunches hosted by doughnut companies for their corporate clients would become decadent… and decisive to a doughnut brand’s survival instead of comparative deliciousness.

In Australia, which has a very highly rated pension system, the consequences of compulsory pensions have played out in spectacular (and predictable) fashion.

Vast lists of financial products are sold to people through their pension accounts that they don’t even know about. (I have no clue what my fund covers me for.) So people never claim what they’re entitled to, or even buy the same product again separately. This is especially true for different types of disability and life insurance products.

A friend worked for the tribunal which attempted to resolve disputes between pension fund customers and the providers of insurance products to pension funds. I heard so many bizarre stories from within the system I’m surprised it survives.

The biggest problem is that the pension fund itself buys the financial products for their pension customers from the insurance company. The lack of a direct link between the customer and the insurer makes the whole legal regime a complete mess.

Not to mention corrupting the incentives. The person selecting the financial product has their employer’s (the pension fund’s) interests in mind, not their employers’ customers (the pension holders and beneficiaries of the financial products). So the person choosing the insurance product for the pension fund has an incentive to choose a bad policy for their customer…

I don’t know what sort of nonsense the new UK pension system will generate. But the point here is that complexity misaligns incentives and apathy encourages taking advantage of this.

Markets don’t deliver on their promises

Given the questionable incentives of our pension system, let’s ask again, why do we invest in financial markets for our retirement?

Perhaps because of the assumption that financial markets deliver superior returns? Growing your retirement pot is better than having it sitting in the bank.

That’s not always true though.

It’s not true for the last 20 years in the FTSE, for example. A term deposit would’ve outperformed the stockmarket dramatically.

But a term deposit is still very much inside the financial system in a way. And it hasn’t done especially well either. There are alternatives though. More on that in coming days.

But first, what about the costs of using the financial system to build your pension pot?

Academics have long known that costs have such a big impact on returns they become the key to the whole equation. An investment that promises a few per cent in returns becomes pointless if costs amount to a huge chunk of that return.

Everyone missed the correct conclusion to draw from this. It’s not that costs should be minimised. It’s that the system must be rubbish if it delivered this outcome.

If the cost base is too high to justify investing, that tells you more about the investments being peddled than the nature of the costs. Not to mention the people doing the peddling.

But instead of chasing the higher risk strategies that could deliver returns which are cost efficient, we’ve agreed to accept the return of the broader market and tried to fight costs. Financial advisers are now supposed to recommend index funds and exchange-traded funds (ETFs). Funds are ranked by costs, because their returns should be the same.

Maybe people invest their savings in financial markets for convenience. Heck, their employer does it for them.

Of course, the nature of the system changes dramatically when you retire. Suddenly it’s your responsibility to find your pension entitlements, spread out among the many employers as they may be… and you’ve got to figure out the rules for getting your hands on your money, or pay someone else to do so.

By then, it’s too late to do anything else and you’ll have to accept what you’re given, including the costs of getting it. Supposedly there is a new search engine to help you find your pensions, but it’s only in the initial testing phase…

Retirement is a political promise

The biggest danger of a government run pension system is one very few people appreciate. Your wealth is locked into a government system. It’s not even your money, as far as I’m concerned.

Does giving a huge chunk of your money to the government to manage seem like a good idea in any circumstances?

Yes, you’re not technically giving it to the government. It’s worse. The money is invested by a manager chosen by your employer.

Whose interests will all these people and companies have at heart? Yours?

The regulation supposed to protect us from being taken advantage of has a completely different effect. Back when robo-advisers and fund managers were all the rage in the news, everyone missed the real conclusion: funds management and financial advice has become so prescribed by law that you might as well not have real people doing the job. Why pay them to do whatever the government prescribes anyway?

Back to your pension. It really is entirely beholden to the government. Not only how it is invested and managed, but how you get at it too.

Government policy determines when, how, and how much of your money is accessible to you under what terms. I’m not just talking about what the laws may be now. I’m talking about how they’ll change too. The ability to change the rules is why I described your pension money as being managed by the government.

In Australia, where I’m qualified to write about the pension system in detail, the rules are slowly tightening as I warned about years ago.

Pensions are the market

My biggest worry for investing generally is that the nature of financial markets has completely changed thanks to our retirement system. The markets themselves have been turned into defacto pension funds. And in that condition, they’re in no position to deliver returns anymore.

This is most obvious in Japan. The Japanese Government Pension Investment Fund (GPIF) is the biggest in the world – $1.41 trillion in assets. You can imagine the impact a small change in policy of a fund like this has on markets. It practically is the market.

Actually, you don’t have to imagine how this plays out. Just when the GPIF fund changed from an extremely conservative stance of holding bonds to buying stocks, the Japanese stockmarket began to surge. The Japanese central bank added to the buying spree too. But it’s the weight of the GPIF that’s moving markets.

A Japanese bull market 30 years in the making sounds good. But markets moving because of pension funds is a disastrous development. Because, at some point, those pension funds will max out on stocks and become net sellers. Just when their dependents need returns to finance retirements, the pension fund selling will undermine the markets which are supposed to deliver those returns.

I hope you can see that you’ll need an alternative to the nation’s pension and financial market savings system in coming years. More on that soon.

Until next time,

Nick Hubble
Capital & Conflict

Category: Uncategorised

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