Navigating the pitfalls of retirement planning

Many people wake up one morning and realise it’s time to plan for retirement. Often, they are in their 40s or 50s.

By then, much precious time has been wasted; cash could have been deployed to work in the financial markets much earlier.

One common human trait is the fear of loss. Confronted with falling asset prices, investors sometimes sell at the bottom of the market and never return. When prices then start to rise, inertia sets in until it is too late. Or sometimes, investors sell too early and miss out on longer-term gains. Not everybody has the discipline or the stomach to invest steadily through market cycles. Yet that is the best way to build up a nest egg.

Hence, to ensure people are on their way to financial security, some compulsion is necessary. This can be an automatic deduction into an insurer’s savings plan or a government or private sector pension fund. Planning for retirement is one instance where human beings have to subscribe to a system that works for them in spite of themselves.

But getting people to agree that compulsion is necessary is not easy. Should they be allowed to withdraw most of their money and use it however they wish – a system the UK is headed towards implementing – or should the government take the paternalistic route and assume people do not have the discipline or knowledge to invest their pension pot?

Evidence is tilted towards the latter view. People have not demonstrated an ability to invest wisely, or to defer short-term spending for long-term gains. Financial planners can talk about the magic of compounding, but one will not be able to see its effects for a long time. Moreover, unscrupulous financial intermediaries keen to churn clients’ portfolios or recommend unsuitable insurance products will always be around.

Another issue is how much one needs to spend in retirement. Recent public discussions on Singapore’s Central Provident Fund (CPF) show no consensus. Some considered basic needs to cost them just S$600 a month – an amount that having about S$80,000 in the CPF Life annuity scheme would be able to provide. Others wanted as much as S$3,000 a month for basic needs. In that case, one would need a nest egg by age 55 far bigger than what they are currently setting aside in the CPF.

Without a consensus on how much people spend during retirement, there will be no agreement on how much they ought to set aside in the CPF. Set the amount too high, and many people will not be able to afford the contributions; set it too low, and people will not have enough, leading to further complaints in the future.

Thus policymakers face contradictions as they design a national pension scheme. The problems are compounded when people do not understand human behavioural quirks and biases around money, as well as their own spending habits. As this year’s CPF debate has shown, there are still many out there who do not even understand the basics. Some view the CPF as a scheme that enables the government to take away what is rightfully theirs. Others speak of 4-5 per cent risk-free returns as low, without appreciating the vagaries of a low-interest-rate environment or risk-return tradeoffs.

Ultimately, the CPF is a political issue as much as an economic and financial one. It concerns tradeoffs like working longer, saving more or spending less. These are deeply personal issues on which society is unlikely to come to a consensus. But if the required amount to be set aside is biased towards the low end, the option for people to invest more in a stable, government-run scheme must be present. Compulsion might have its limits – but some degree of being compelled for one’s own good is always prudent. 


This article was first published in The Business Times on December 11, 2014

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