Behavioural Finance and Retirement Solution Design John Wilson, Head of PIMCO Australia

Transcription

1 Behavioural Finance and Retirement Solution Design John Wilson, Head of PIMCO Australia September 2011

2 Understanding the human element is crucial to designing effective retirement solutions Behavioural finance can help super funds understand: Why individuals accept different investment strategies and solutions at different stages in life How to motivate individuals to act in their best interest during decumulation years 2

3 Hyper Loss-Aversion Study by Professor Eric Johnson (Columbia University) How much would you be willing to risk for a 50/50 chance of winning $100? A. $100 B. $50 C. $10 D. Not even $10 3

4 Hyper Loss-Aversion Study by Professor Eric Johnson (Columbia University) 49% of Retirees would not even risk $10 For a 50/50 chance to win $100, how much are you willing to risk? 49% 33% 15% Not even $10 $10 More than $10 4

5 Cognitive Impairment Study by Professor David Laibson (Harvard University) Which of the following numbers represents the biggest risk of getting a disease? A. 1 in 100 B. 1 in 1,000 C. 1 in 10 Only 71% of individuals aged answered this question correctly 5

6 Tangible Mental Accounts Study by Professor George Loewenstein (Carnegie Mellon University) People often divide their money into separate mental buckets to monitor their spending. The process of bucketing is often associated with earmarking the sub-accounts for specific goals (e.g., a dining fund). Earmarking savings nearly doubled the saving rate of individuals 6

7 Tangible Mental Accounts Study by Professor George Loewenstein (Carnegie Mellon University) Reinforce the positive effects of bucketing and earmarking by offering account structures that mirror retirees goals Set pay the rent and spoil the grandkids accounts with the former invested more conservatively Can provide peace of mind about covering the basics and reduce the pain of paying for a vacation with the grandkids to Disneyland Current retirement frameworks, e.g., floor with upside, bucketing, can be effective ways to leverage the mental accounting heuristic 7

8 Fairness Study by Professor Suzanne Shu (UCLA) Individuals assess the fairness of retirement solutions Traditional annuities may be perceived as unfair because individuals lose access to savings if they pass away before running out of money, ie others benefit from their savings If the retirement solution is perceived as unfair, the individual will opt for a different solution Retirement income solutions are most successful when designed and presented in a way that maximise perceived fairness 8

9 The Accumulation strategy leaves a retiree uncertain about his or her future Impact on account-based pension balance with different starting points in time Data and assumptions: $500,000 invested in a diversified, multi-sector balanced portfolio comprising 25% Australian shares, 25% International shares, 30% International bonds and 20% Australian bonds rebalanced annually. Historic retirements commence in 1875 and every 2nd and 5th year thereafter until last commencing in Each portfolio funds an initial 5% drawdown in year one, thereafter an amount adjusted by the historical average of 3% inflation. Inc 1.8% fees. Source: Wealth benchmarkstm 9

10 Behavioral finance can help super funds retain retirees by delivering the right products & message Retirees are loss averse, want income certainty, and want to retain "ownership' flexibility over savings Bucket approach solves some problems and appears consistent with way retirees think of savings Longevity risk remains major unsolved problem with investment solutions as growth solutions conflict with risk aversion (i.e. lack of certainty) Default option design defaults need to nudge retirees toward optimal retirement income decisions 10

11 Disclaimers PIMCO Australia Pty Ltd ABN AFS License Level 19, 363 George St. Sydney, NSW 2000 telephone: facsimile: The financial services described in this communication are only available in Australia to persons who come within the category of wholesale clients as defined in the Corporations Act 2001 (Cth). They are not available to persons who are retail clients, who should not rely on this communication. This material is to be used for one-on-one presentations to institutional investors and not for any other purpose. The services and products provided by PIMCO Australia Pty Ltd are only available to persons who come within the category of wholesale clients as defined in the Corporations Act They are not available to persons who are retail clients, who should not rely on this communication. Investors should obtain relevant and specific professional advice before making any investment decision. The information contained herein does not take into account the investment objectives, financial situation or needs of any particular investor. Before making an investment decision investors should consider, with or without the assistance of a securities advisor, whether the information contained herein is appropriate in light of their particular investment needs, objectives and financial circumstances. Investment management products and services offered by PIMCO Australia Pty Ltd are offered only to persons within its respective jurisdiction, and are not available to persons where provision of such products or services is unauthorised. Past performance is no guarantee of future results. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. This presentation contains the opinion of the manager as the date of this presentation, and such opinions are subject to change without notice. This presentation has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. The content of this presentation remains the property of PIMCO. No part of this publication may be reproduced in any form, or referred to in any other publication, or conveyed to a third party without express written permission. Copyright 2011, PIMCO 11