The Benefits and Pensions Monitor Interview - Don Ezra
Benefits and Pensions Monitor's executive editor, Joe Hornyak, recently had an opportunity to discuss retirement planning with Don Ezra, co-chair, global consulting, at Russell Investments
BPM: Is it too late for baby boomers to save for retirement?
Don Ezra: It is unless they are prepared to put off retirement because we have already reached the point where they want to start to decumulate, to draw down so it is really for the next generation.
BPM: So what can we do to get the next generation and the one after that to recognize the importance of retirement savings?
DE: There is a chance if we make them realize how important it is.
There are a couple of things people misunderstand – one is longevity. People think longevity is life expectancy at birth. Life expectancy is the average age at death. If you consider retirement at 65, there are unfortunately a whole bunch of people who are going to die before 65. They bring the average down to just below 80.
However, those who survive to 65, have an average age of death higher than 80, probably beyond 85. Once you have reached 65, you are already part of a longer life group so your future longevity is not just another 20 years, but potentially longer. People misunderstand that. They also do not realize that when you are looking at a married couple, the chance that they will both die young, even after 65, is reduced. The odds are one might, but the other will live longer. So for a couple aged 65, the odds are that at age 90, one of them is likely to still be alive. So most people think from 65, I need 15 years of draw down. The odds are they will need 25 years of draw down plus. They do not realize that.
BPM: So it is the older you get, the more important it is that you had saved for retirement?
DE: In a sense, yes because your life expectancy goes up every year. That is just a piece of math that people do not understand.
BPM: They probably do not understand it because they never really encountered it before.
DE: Absolutely, that is absolutely right. Nobody ever talks about this stuff. Who in school would ever get to teach what life expectancy means to a bunch of kids? That is life on a different planet. None of this stuff ever gets talked or thought about. When the press writes it up, it is in terms of life expectancy at birth, not life expectancy at 65. For a couple, as I said, it is beyond 90. So at the very least, you should be planning for 25 years beyond age 65.
Try this one on your friends and family and see what they say. Tell them you have accumulated $100,000 and you are 65 years old. How much do you think that will support every year for the rest of your life? They will tell you probably $10,000 a year plus. Experts will tell you probably about $4,000.
Now, $100,000 is a lot of money for the average person but $4,000 a year is not. So what they think of is lots of worth, in fact supports very little income, so they do not realize how much they need. That is one of the things.
Another lesson that is relatively easy to explain, someone is going to have from age 25 to 65, 40 years of savings. Let us assume they only want 20 years of draw down, so 65 to 85. If they save 10 per cent of their salary every year, 10 per cent of their pay, and they invest it relatively risk free to get zero real return, so zero above inflation. That means you can take the investment return out of the equation because it is zero in real terms. We do everything in real terms. If you save 10 per cent a year for 40 years, how much can you draw down for 20 years, twice as much. You can draw down 20 per cent a year because there is no investment return to complicate things. Most people will find it tough to save 10 per cent a year and if they were told that will support 20 per cent a year afterwards, they would say I need a lot more than 20 per cent of my income afterwards.
The only way to make those two equate to each other is to take investment risk because we need investment risk to add to the pot. It may work, it may not. Over a long period, the odds are much more likely that it will, but risk is risk and so it may not. The need to save and to take investment risk, you can demonstrate relatively simply to someone who can just sort of multiply 40 by 10 and that is the same as 20 times 20.
It is simple things like that, yet, the population around the world does not have financial literacy. We try to make them investment experts when they are not. We would never give them advanced literature if they were illiterate, but people are not financially literate and we are trying to give them advanced investing.
The kinds of things we can do to explain some of these things are the kinds of explanations I have been giving face-to-face and then people realize 'I need to save' and 'I had no idea I needed to save so much,' and 'even if I save a lot, I still need to take investment risk.' You do not have to if you do not want to retire. You do not have to if you do not want to retire at 65, if you are willing to retire at 85 You do not have to save much, you do not have to take investment risk. But if you want to maintain the same standard of living from age 65 through a long post retirement period, it is expensive. I think people do not realize that and that is almost the fundamental lesson that there is.
If my kids' generation or the one after them starts to realize some of this stuff, then they can make life choices. They may say, 'I am sorry, right now I have many financial obligations, I have a whole bunch of things I want to do, and I want to do this,' as long as they realize there is a trade off and the trade off comes at the far end, that is okay.
To make informed choices is a wonderful thing. The problem is when it is not informed because people do not know and the first time they hear about it is when it is way too late to do anything.
What I am doing is just explaining this kind of thing to as many people as I can in as many public forums as I can. That is what I am doing, hoping that if not the next generation, at least the one after will be able to make choices, not to be forced to do things, but to be able to make choices. In a sense, that is my life now.
BPM: How do you overcome the resistance to becoming financially literate?
DE: I do not think this is a question of retirement savings. I think this is a question of financial literacy, which is much broader.
Financial literacy starts with budgeting. It is a societal problem that needs to be taught in schools. Budgeting is very simple. It is when you want more than you can afford, how do you make choices?
And in no time at all, if you want more than you can afford, you have two things happening. One is to say well, 'if I borrow to make it up, what is the cost of borrowing?' The other one is is 'if I actually save, well, I want to put aside some money for the future, what is the return on savings?' Once you are into the cost of borrowing and the return on savings, in no time at all you are going to compound interest.
I will bet that there is not one per cent of the population in any country that understands compound interest. So, it starts with budgeting and there are courses laid out for 7, 8, 9, 10 year-olds that make it really interesting. Lesson number one, what are all the things you like every month? There is no right or wrong answer. Just write it out. Lesson number two, how much does that cost? You do not know? Go find out. How much does this cost mom? How much does this cost dad? Lesson number three, adding it all up. This is how much money you need. Suppose you only have half of that. Which things do you choose? You get into this in a way that makes it interesting. All this stuff is available.
I do not know what the obstacles to teaching this are in Canada, but I can tell you the main obstacle in the United States because my daughter is a teacher. I have talked to many other teachers. This is not part of standardized testing and if it is not part of standardized testing, it is not in the curriculum. That is the biggest obstacle.
It is not as if they do not have any courses. Sesame Street teaches this. Sesame Street teaches that if you have three little piggy banks, one for me, one for you, and one for later and what does this mean? Three 'S' words – spending, sharing, and saving and what are you going to do with the later? All the stuff is there. It needs to start at that age.
Once you start understanding the basics of it and making choices, this will then happen all through life and. in that context, it becomes easier to say is, 'you know the work you are doing now? You do not have to do that. You can do the things you want to do without having to do this. Does that appeal to you? Well then, you have to put some in the later piggy bank.
Then we get into the things I have been explaining. It needs to be that kind of stuff, starting in elementary school. We need to start there because if we do not, people are not used to it. How many people budget? A relatively small proportion of the population does this. It is tedious. I think people who are accountants, actuaries, whatever, professionals who work with numbers, they find this much easier so I think they have a chance to deal with some of this stuff. But again, it is not something they are trained to do. They have the capability. Some would have not just an appreciation, but a love of actually doing this kind of thing, but that is a very small portion of the population. We are really trying to educate the whole population and that needs to be done in the schools.
This actually shows up in happiness statistics around the world. We know 20-year-olds are happy. As they start living life, the stresses of life, you have a career to start, you have career advancement to make, you have a family to start, you have a home to start, etc., all that stuff when your pay is the least puts all kinds of stresses on you. So, happiness goes down in country after country, and it varies from country to country, until they are around somewhere between 40 and 60, the happiness curve starts to come up. There are all kinds of other stresses that come down and also, people start realizing all the dreams they had are not going to come true. But even though the dreams are not going to come true, this is still pretty damn good. I am still doing okay.
Then, I think, their scale of measuring, whether they should be satisfied with things or not, becomes realistic instead of overly optimistic. Once you are realistic, you look back and you go, you know, this is not bad actually. Then, happiness starts going back up again. I think that shows. One of the other things I am studying in my spare time is the economics of happiness so this is one of the aspects of it.
BPM: It would strike me that it is even more challenging getting that message across in this day and age where there is so much credit, easy credit, and there is so much pressure on you to be a consumer. Is there any way to overcome these pressures on the younger generation?
DE: I think the answer is no, this is just part of life's choices. All we can do is point out these things. Unless we want to live in a severely regimented society, we have to give people choices. People want choices. I do not know the answer. This is a philosophical question.
BPM: A young person comes to you and says 'Don, I am 25, I want to save for retirement, where do I start?'
DE: Well I think about my kids. They look at their parents and realize their parents are living a dream and say 'we have a dream too, but it will never go any further unless we do something about it. Would you help us make a plan for that?' We sat down and looked at all the retirement stuff. When we looked at the retirement stuff, we projected retirement at age 70 because we had to be realistic about this. I said 'you may think 65 and you may hope 60, but realistically, if it works at 70, this is going to be pretty damn good for you. You have a long life after that.'
That is okay, so we overcame that. Here is what you are doing there. We costed out the dream. Here is what you need for the dream. He said 'we cannot afford that. Okay, that is alright.' I got a call the next week saying we have started saving towards the dream. I asked what have you given up? The answer was 'we do not know. We are working it out as we go along. There is no we will do 'A' and not 'B.' It is we will do 'A' because we realize how important that is. We do not know what B is going to be, but as life goes on, we will work out which of the things we feel least uncomfortable cutting back on and that is what they are doing.'
Now they have the advantage that they can sit down with me and play with some of the numbers and stuff like that and these are two highly intelligent, highly motivated people. They have all kinds of advantages, but it was still a very tough choice. They had to come to the realization and they had to realize if we want that dream, is it more important than something we are doing now. I could not tell them what to do. That was something they had to do.
If you get educated, intelligent people, they can make these choices. How we get everyone in the population to that level, I do not know. It is a societal problem. I do not know how to solve society's problems. I can only say here are some of the issues and here are some of the very quick explanations that even people who are not financially literate might be able to understand and get a grasp of and then trust them to make their own choices.
Part of freedom is freedom to make wrong choices. That is okay. We cannot guarantee everyone … guarantees are expensive. Heaven knows Defined Benefit pension plans have taught us guarantees are expensive and if we want to guarantee everyone in society all kinds of things, the cost of society will be colossal.
People have choices. All I can say is I am pointing out some of the choices that are expensive.
BPM: Is it fair to say that DB plans are expensive or are they only expensive because of the bubble that is going through right now and the longevity that we never imagined?
DE: I think so, that is part of it, but regardless of that guarantee, guarantees are expensive because guarantees say, essentially, 'I do not care what the circumstances are, I will underwrite it no matter what.'
So we are talking about longevity. We did not know longevity was going to increase so much so we did not know how much the guarantee would cost. Any time you provide an absolute guarantee, that no matter what happens, I will make sure this happens, the odds are it is going to be more expensive than you thought. You do not have to have a final two per cent pay plan fully indexed to say is that expensive, yes, of course. You can do a 0.2 per cent pay plan fully indexed and is that expensive, well, it is 1/10th as expensive, but it is probably more expensive than you thought because you just did not know all the other circumstances.
We are not good at imagining the future. Heaven knows, all the psychologists have done any number of tests that say we are not good at imagining the future.
BPM: So what about Defined Contribution pension plans?
DE: I was at the UK's National Association of Pension Funds Investment Conference explaining some of these concepts under the title of Innovations in Defined Contribution. I told them every concept I am going to talk about you are already familiar with. The only thing that is innovative in these concepts is actually using them. The concepts are not new.
Part of the reason we do not use them is that the people who are going to be using them do not understand all this. We need a complete mindset change. It is an attitude change or a mindset change. You need to start thinking in terms of 'well, you do not have to save, you do not have to take investment risk, if you do not want to retire.' If you want to retire, let me show you what the cost are. It is that mindset thing, and then, showing along the way, how close are you to your goal.
The analogy I use is someone wants to tell the time, instead of giving them a clock that tells the time, we sit them down and say 'here are all the parts in the watch, here are some of the parts and different makers, and you could buy this from so-and-so, and buy this from so-and-so, and you can assemble it this way.' They are not interested in that. They want to know what time it is.
So when you report to them, we are doing silly things. Here is your investment return last year. What meaning does that have? The only meaning is 'I made 8.7.' Well, that is better than someone who made 8.6 and it is worse than someone who made 8.8.
What it does not tell you is are you on track to get 70 per cent of final pay as an income afterwards. That is all we should be reporting. For example, I give them this other story that shows how you can change the conversation. I say 'I am not going to tell you whether the story is fact or fiction or fiction based on fact. Imagine you are me and we are at the start of 2009 and you have a kid aged about 30 who is taking your advice and putting money largely into equities who gets a report saying they just lost 30 per cent of their assets.' When you take away all the swearing, the fundamental question is not just what happened to my money. It is even more serious than that, it is 'dad, what did you make me do,' which is a far more serious question to answer.
The way you answer it is to say you have lost 30 per cent of your money. It is gone. Yes, it is absolutely true. It I will not come back. It is gone. What impact will that have on your goal? Well, the amount you have saved so far is about 1/10th of the amount you need towards your goal. So while this amount has gone down 30 per cent, your goal has gone down three per cent. So you have not lost 30 per cent of your projected retirement income, you have lost three per cent of that.
In the worst markets that the world has seen in 80 years, it has affected retirement income by three per cent. Is that too much risk? Oh, I get it, okay. That will show you are not quite on track, you are three per cent behind schedule. That is entirely different. All of a sudden, the fact that your investment return was -30 per cent is almost irrelevant. You are not reporting on the parts. What I am saying is you are now three per cent behind schedule. Then you can ask 'what do I have to do to make it up' or 'you are going to have three per cent volatility bigger than that year to year.' And the answer could be 'why wait a little while and see if something comes back or not.'
This conversation is entirely different from reporting you lost 30 per cent of your money. As I say, when you can change the conversation to a state where losing 30 per cent of your money is hardly relevant, that is the way we should be reporting. It is a mindset in the reporting where there is all that stuff and none of it has anything to do with investment returns or if manager A better than manager B. None of that stuff is half as relevant as you are three per cent behind your goal.
BPM: So if you have a DC plan provider, what you want to be doing is telling them forget what your balance at the end of this year is. What you want to be telling people is that you are 97 per cent or 103 per cent towards your investment goals?
DE: Yes, and for that, you are taking into account not only the money that you have already saved, but the money you are likely to save or planning to save in the future because that amount was not affected by the market crash. It was not in the market.
That is where when you are young, you can afford to take almost 100 per cent in equities and lose. When you are 60 years old, the idea that you can lose 30 per cent, whoops, that is probably 25 plus per cent of your final goal, Wow! That is where the target date investing comes in.
All this stuff suddenly makes sense in a way you can actually explain, but no one takes the time to explain it. The reason we do not is we are still fighting yesterday's battles. The model that I am talking about on this reporting is what I call the retirement income model - how much income you are likely to get.
The model we actually report on is what I call the fund supermarket model. Here are all the funds that are available. It is all available in the supermarket. You can choose this, you can choose that. In that case, how do you report? How did the funds you chose in the supermarket do relative to the other funds? That model is exactly the way you report.
So, we are reporting on the wrong model. All this stuff is, as far as I am concerned, attitudinal, mindset, arm waving, and not a thing that is technical in any of this. Nobody, to understand this, needs to be an investment expert. That is the message I am taking to as many people as I can in small forums and big forums, just to say these are problems. They are not easy to solve because there are tough choices, but they are problems that are relatively easily understood and we do not explain it properly.