It is generally accepted that people do not save enough and often underestimate how much they will need in retirement, writes Justin Taurog. And there is a psychological reason why ...
Deloitte believes UK savers will have to, on average, find an additional £10,000 each year until retirement if the nation is to meet a growing ‘savings gap' that could hit £350bn by 2050. However, there is a deep-seated psychological reason for our inability to process risk, and it has implications for both advisers and providers and the way they approach retirement advice and product design.
The author Michael Lewis is probably best known for his book about the 2008 financial crisis, The Big Short, but his most recent work is more directly relevant to the way advisers speak to clients and the types of products providers build for them.
The Undoing Project, based on the work by two academics which led to a Nobel Memorial Prize in Economics, discusses how people take mental shortcuts in investment decision-making. It shows how the human mind struggles with calculating risk and odds.
In the field of financial planning this could lead people to miscalculate how much they will need every month in retirement, how long they are likely to live, the expected shortfall in funds at the age at which they want to retire and how much they actually need to save in order to sustain their lifestyle in the long-term.
This lack of comprehension of financial reality is backed up by the latest data from our consumer Retirement Savings calculator, completed by over 6,000 people in the months up to May 2019. It suggests there is a major shortfall in retirement savings, most likely because of people's inability to assess their risk of running out of money.
The results were starkest for women. The data shows women's retirement savings are set to fall short of their consumption needs by 16 years, compared to men who are on average likely to come up 10 years short.
So, although the average women in the UK wants to retire at 63, if they did so their savings at retirement would run out by the time they were 69, assuming they are spending £27k per year. This is based on an average life expectancy of 85 and average savings of £392 per month. In order for them to fund their living expenses to age 85, they either need to drastically increase the amount they save or continue working for significantly longer.
The implications of the data is that people, women in particular, will have to either work longer, save more, or accept a lower standard of living in retirement - or possibly a combination of these compromises. Women face a number of challenges that explain this variance, including career breaks while raising a family and the fact that women can, on average, expect to live longer than men. That said, both groups have seriously mismatched their expectations against reality.
So what does this suggest for the way advisers approach retirement advice? The differences between the savings and retirement expectations between men and women are important for advisers to consider in order to be able to better advise clients - especially the younger generation who have just started their long-term savings journey.
There are plenty of tools and software available to help model how a client's financial decisions now will affect their goals when they're older, to help overcome their misunderstanding of financial risk.
As well as having an adviser create a tailored financial plan based on clients' goals and aspirations, we must also create new ways to inspire long-term savings that does not rely solely on doom and gloom messages.
These should help advisers engage with all types of investors using incentives for all types of client groups - in other industries these commonly take the form of fee reductions, loyalty schemes or financial bonuses - all in combination with a robust investment risk-return strategy. Encourage an aspirational approach, rather than rely on worrying people with potential future risk.
Even the shrewdest investor will likely have an inherent misunderstanding of risk - and that includes the risk of how mismatched their desired outcomes are to their savings inputs.
We need to find new ways to incentivise people to save - ways that do not depend on an intuitive understanding of a 50-year savings and consumption journey - in order to overcome our in-built fallibilities. Otherwise we will not be doing our best to prepare clients financially into their old age.
Justin Taurog is deputy CEO of VitalityInvest
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