Gateway’s CEO, Paul Thomas, is currently on annual leave. In his absence, this week’s guest blogger is Anthony James. Anthony is a partner with accounting firm, PwC. He is a management consultant and partner in the Financial Services Practice at PwC. Anthony works with financial services organisations of all kinds to develop innovative solutions to their most complex issues.
‘Asset rich and income poor’ … would you trust a Noble Laureate in Economics to do the rational thing with their SMSF?
With over one third of Australia’s superannuation in self-managed super funds (SMSFs) … is it any wonder everyone seems to have an opinion when it comes to Australia’s favourite investment vehicle? And if the flood of inflows and burgeoning SMSF balances are anything to go by, the retirement of the savvy SMSF brigade looks assured. Or so it seems …
In a fascinating article in this month’s Harvard Business Review, Noble Laureate
Robert C. Merton discusses what he sees as a fundamental problem facing defined contribution retirement savings plans across the world.
Specifically, he highlights the shift away from members viewing their defined benefit pension and government welfare entitlements in terms of the income they will deliver (how much income will I be guaranteed in my retirement?), to thinking about their defined contribution super plans in terms of balances and investment returns (how well did my fund do this past quarter, year, five years etc?).
The distinguished professor makes the point that the modern preoccupation with growth and returns rather than retirement ‘outcomes’ is jeopardising the core purpose of super … to provide a stable, comfortable income in retirement.
A simple way to think about this is that common SMSF assets like shares and property (which have typically ‘performed’ over the long term), provide no ‘guarantees’ when it comes to retirement income (what if companies stop paying dividends because the tax laws change, what if the markets crash the day before I am set to retire, what if the bottom falls out of the rental market). The same goes for the large cash balances in many SMSFs – in a low interest rate; low yield environment with a very skinny range of attractive retirement income products, cash in the bank doesn’t guarantee income.
Whilst innovations in retirement income offerings is high on the agenda of many large funds, the preoccupation with preserving and growing super balances rather than securing retirement income is a significant SMSF blind spot … how many are happy with the ‘wealth’ being generated from the ‘good’ investment decisions they’ve made in their SMSF, but have no genuine idea how to invest to secure the right level of guaranteed income in retirement?
The fact is that a very large number of SMSFs (indeed much of Australia’s super savings), are not being invested in a way to ‘guarantee’ their members the right level of retirement income … good super savers are not necessarily going to retire with the lifestyle they deserve!
Rather than venture down the path of investment advice, I’d rather explore the point that relying solely on what appears to be ‘economically rational’ behaviour – in this case building ‘wealth’ in SMSFs or other super - is a potentially dangerous place for our governments and policymakers to pull up. Allowing wealth to accumulate without properly addressing the real need for income in retirement is not economically rational – the debate, our policies, and the products that come to market need to reflect this.
Of course to get this right we’ll not only need to shift the way superannuation investments are oriented. The way the government approaches reforms to allow better retirement income and protection products to be developed and taken up will also be very important.
Potential reforms like taxing investment income in retirement, changing social security rules to make annuities more attractive, liberating corporate bond and fixed income markets, avoiding the unintended consequences of ‘protecting’ consumers with initiatives like the MySuper league tables (which rank MySuper funds based on various criteria including short term performance), and exploring how to deal with the immense illiquid wealth locked in the family home must all be explored to find a sustainable answer.
Now let’s go to our Nobel laureate SMSF trustees (well potential trustees anyway)!
Daniel Kahneman (a pioneer in behavioural economics and himself a Nobel laureate for Economics in 2002), tells a story about a meeting held in Paris in 1952. The purpose of the meeting was to discuss risk economics and was attended by now Nobel laureates Paul Samuelson (1970), Kenneth Arrow (1972), Milton Friedman (1976) and Maurice Allais (1988) among other eminent economic thinkers.
By asking simple risk based questions like “Would you choose a 98% chance to win $520,000 or a 100% chance to win $500,000”, and “Would you choose a 61% chance to win $520,000 or a 62% chance to win $500,000”, Allais was able to show that even proponents like his esteemed colleagues (some of who happened to be leading adherents to the ‘economic rationalist’ school of thought), revealed personal preferences which were not economically rational! What hope is there for the rest of us?
I’ll leave it to you to decide which responses are ‘rational’ and which were not! In the meantime, let’s strive to be as rational as possible when trading off wealth in retirement (no good without income!), against the right level income in retirement (good even without wealth!) … and let’s insist that our policymakers to do the same.
After all, the true purpose of super was never to create an ‘asset rich, income poor’ Australia in retirement!
Posted Monday, August 25, 2014 0 Comments Make a comment