TV breakfast shows often air the live reactions of people who have answered the phone to win ten thousand dollars or the like. Screams of delight or speechless surprise are usually followed by plans for holidays or loan repayments or some new purchase.
If most of us can get very excited by a few thousand dollars that drops out of the sky, we should be absolutely fascinated by our hard-earned retirement savings. So why is it so difficult to get interested in superannuation?
First, super is money I have to wait for and it’s hard to care about the older version of me. Many of us probably don’t even want to think about how we will look and feel several decades from now. Because of that, we tend to take less responsibility and make poor provision for our future selves.
Research led by Dan Goldstein, a psychologist from Yahoo Research and the London Business School, suggests that just showing young people a digitally aged image of themselves encourages them to save more.
Their future as an older person becomes easier to imagine. Although we are dramatically more likely to survive to older ages than our forebears, our farsightedness may fail to keep pace with our life expectancy.
Second, is the maths. Long-term saving plans like superannuation have two complex features: compounding and risk. Most people have the mental arithmetic to deal with sums that grow linearly, like simple interest, but very few of us can imagine the exponential growth implied by compounding.
Compounding makes putting-off saving very costly. If I agree to save $1000 every year for forty years, I will deposit a total of $40,000. If it earns 5% annually, I end up with about three times what I have deposited.
If I wait ten years to start saving, I finish up with only about twice what I have deposited. In other words, delaying a quarter of the time costs me half of the earnings. These types of trade-offs are difficult to do in your head.
Risk is an even harder problem. (I used the computer for this one.) If we factor in modest variations in investment returns (for the nerds, I use volatility of 10%) there’s about a one in 100 chance that my $40,000 of savings will not grow at all over the forty years, and about the same chance that it would increase to seven times larger. Confused? You are not alone.
Financial decision making for ordinary people has become increasingly complicated over the past few decades. Even before the global financial crisis exposed the problem sharply, regulators and academics were uncovering a widespread and worrying lack of basic financial nous.
I’m part of an inter-disciplinary research team (based at the Centre for the Study of Choice, UTS and the Centre for Pensions and Superannuation, UNSW) which recently surveyed more than 1200 Australians for numeric skills and financial competence.
Around 30% of the people we surveyed could not answer a simple question about compound interest, and similar proportions did not know the advantages of spreading wealth among different investments, or knew which investments were typically riskier. This lack of skill can lead to problems when we have to deal with financial service providers like superannuation funds.
Economic theory predicts that if you put two people into a contract where one knows something the other doesn’t, and that something matters, two problems often arise that no amount of ‘free competition’ can fix.
First is ‘adverse selection’ – it is hard to know the skill of a fund’s manager in advance (past performance is not a reliable guide to future outcomes in the financial markets) and fee structures can be bogglingly complex, so we can have trouble picking a good fund from a bad one.
Second is ‘moral hazard’ – once in a fund, random investment returns, the administrative burden of moving an account and the difficulty of comparing outcomes between funds, makes it costly to evaluate whether a manager is really on the job. Clear and effective communication is needed if the balance is to be tilted back in favour of the members.
Our research team has been unpacking some of the key areas of communication between members and superannuation funds. Take the crucial issue of investment risk. Using experimental surveys of ordinary superannuation fund members, we tested a range of standard formats used by the financial sector to describe investment.
How well people understood what was going on varied significantly with the risk description we gave them. Some common formats, say, stating the frequency of negative returns, were linked with around 50% more confusion than formats that explained the likely range of returns. And confusion was also amplified by youth and low numeracy skills. Clearly, disclosure and communication is not the same thing, and effective communication will likely vary from person to person.
Many people reaching retirement now have about 20 years of superannuation contributions behind them but few know what’s out there in terms of retirement income products. Funds are also ‘scratching their heads’ over the best ways to help people manage what they have saved for the several decades of retirement.
Along with some key industry groups, we have begun mapping out what people know, expect and want as they prepare to leave the workforce, and thinking about the necessary ingredients for efficient retirement incomes products.
There is a continuing conversation going on between ordinary funds members, the superannuation industry and regulators, and the outcomes matter enormously. Within the next 25 years, the superannuation sector will be managing about $6 trillion of Australian savings – we need it to work efficiently.
So finding superannuation to be a yawn does us no good. If many of us can muster enthusiasm for home mortgages (just as complex and probably more risky), margin loans (even worse) and investment properties (a minefield), the view that disengagement with superannuation is incurable surely needs some rigorous examination.
Professor Susan Thorp is Australia’s first Chair of Finance and Superannuation at the University of Technology Sydney.
The Superannuation Choice research team also includes Hazel Bateman (UNSW), Christine Eckert (UTS) John Geweke (UTS) Fedor Iskhakov (UTS) Jordan Louviere (UTS) and Stephen Satchell (Trinity College Cambridge; University of Sydney).