Robin writes:
We often hear the phrase “pensions crisis”. So how serious a problem do we face? And what can we do about it?
For the latest episode of The Investing Show, I’ve been interviewing John Ralfe. Few people understand the pensions world better than John, who has specialised in pensions for more or less his entire career. He used to be Head of Corporate Finance at Boots, and now works as a consultant. He also writes on pensions for the FT and has recently given evidence to the Work and Pensions select committee of MPs on how to improve the pensions system.
John is never afraid to speak his mind, and his message in this interview is pretty sobering. In a nutshell, those on average earnings, he says, really have their work cut out to provide themselves with a comfortable retirement. But he's got very some useful advice on how they should go about it.
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TRANSCRIPT
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Abraham Okusanya: Hello, Robin. What have you got for us this time?
Robin Powell:Well Abraham, I thought we'd have a look in the next two episodes at pensions and pension policy here in the UK. We often hear the phrase pensions crisis, don't we? So we are asking how serious a problem this is, and what can we do about it?
Abraham Okusanya: This is a hugely important subject, and successive governments have been kicking this particular can down the road for a long time. Who have you been talking to about this?
Robin Powell: Well, I've been interviewing John Ralfe. He's worked in the pension space for more or less his entire career. He used to be Head of Corporate Finance at Boots and now works as a consultant. He also writes on pensions for the FT.
Abraham Okusanya: So what's his take on pensions, generally? Is it broadly optimistic or pessimistic?
Robin Powell: I would describe him as a realist. He doesn't like headline- grabbing phrases like "Pensions Time Bomb", but he is concerned about the widening gulf between public and private sector pensions in the UK, and says private sector defined benefit - or DB - schemes, which guarantee retirees an income based on their final salary are definitely on the way out.
John Ralfe: Well, I think it's got to the stage now where we've gone from five or six million people, not very many years ago, to four or five hundred thousand people now. We're not quite at the final noggins, but it is only a matter of time - so I'm very clear that, in the UK, private sector defined benefit pensions are dead. Public sector - teachers, NHS, civil servants, the armed forces, local government - they're still going strong. They are still, for good or ill - and I would say ill, because it's bad for taxpayers - they are still open and they're still providing pension promises underwritten by the taxpayer. But in the private sector, we're dead.
Robin Powell: So what does it mean if private DB schemes are coming to an end, and defined contribution, or DC, schemes are the new normal? After all, there's no guarantee that DC schemes will provide members with sufficiently large pension pots. Well, the sobering truth, says John Ralfe, is that people on average incomes will have to save more, work for longer, and lower their expectations about their likely standard of living in retirement.
John Ralfe: The idea of retiring at 65 - or the idea, even more, of taking early retirement and going on a cruise - that is absolutely for the birds. So what people need to be doing is expecting to work longer. It's easy for me to say - but work longer, to be saving more as they are working, and to expect to have a more modest retirement. So there is a bit of self-selection in all of that process. And what does that mean? And it's quite an important social change to try and figure out: well, how do people work part-time when they get in their late 60s, or whatever, and / or how do they go onto a job? And maybe it's a completely different job from the sort of job that they've been doing for the 40 years of their career.
Robin Powell: So what should employees be doing now to ensure they have enough money in retirement? As Ralfe was saying there: they have to invest more, but they also need to be careful to avoid taking on bad debt, and to pay down existing debts as a matter of priority.
John Ralfe: If you are saving in your pension scheme at the same time as you are taking on debt, that's got to be a bad thing. So you can save by either paying down debt or not taking on debt. And again, in the UK, there've been various discussions about whether it's the right thing to do for people who are hard- pressed - inflation is running into double digits, energy prices, food prices... and the general consensus is, "no, keep on plugging away. Save more into your pension. Don't stop pension saving. You'll regret it in later life." My view is a bit different: if the alternative is borrowing on your credit card or paying into your pension scheme, you should stop paying into your pension scheme and should be using the money that you save to make ends meet.
Robin Powell: So what about those who are free of debt? How should they invest? Well, the key, says John Ralfe, is not to try to beat the market because - in the long run - your chances of doing so are pretty slim.
John Ralfe: I start from the principle that you can't beat the market - and people who do beat the market one year, probably don't beat the market the next year. And we've seen in the UK, we've seen in the US, we've seen elsewhere; star fund managers who have got a brilliant track record: more often than not, it ends in tears — not necessarily for them because they've already taken their fees out of it. So I think, wherever you are in the world, you should start from the principle: you can't beat the market. And if you can't beat the market, what should you be about? You should be about your asset allocation. It's much more important to get the strategy right and saying, "what proportion of my assets do I want in - crudely speaking - equities, bonds, cash, maybe a bit of property." Spend the time and effort getting that right and then saying, "OK, the execution should be as cheap as possible. And as simple as possible.
"Robin Powell: So Abraham, the general message there for investors on average incomes is pretty sobering, isn't it? They have to invest more. They may well have to work beyond state pension age, and even then they may have to settle for a more modest retirement that they were hoping for. Do you agree?
Abraham Okusanya: I mean, it's hard to disagree with a lot of what John has to say about this, but I am always on the optimistic side of this conversation. I think that it's up to us in financial services to give people a little bit more than just saying: "save more, spend less, or die sooner." I think we need to actually give people practical tips. Some of that - of course - is saving more, working for longer. But I think one thing that's often missed is the role of investing more money, more allocation, more proportion of our retirement pots in in equities. The vast majority of people - too many people in this country - have portfolios that are maybe invested in 50/50 equities and bonds. We need to do a bit more. I totally believe that, for vast majority of people, the practical implication is that we need to be prepared to allocate a higher proportion of our retirement savings to equity. I think, depending on how long you have before you retire - if you have more than ten years, you certainly need to be - in my view - allocating 70, 80%, if not more, to equities. And what that means is that the portfolio can do a little bit more heavy lifting in terms of giving you a better return.
Robin Powell: These are difficult times we are living in, aren't they? Interest rates have gone up, and even those on high incomes are struggling with debt. How important is it, do you think, that people deal with debt first before trying to put money away for retirement?
Abraham Okusanya: It's really an important point, and it's important that we acknowledge how difficult things are for people. I have been an advocate just for people to try, as much as possible within their power and within their income, to avoid debt. Now, I'm not talking about mortgages. I'm talking mostly about consumer debt. I think that we've created an economy and a society where the reliance on debt has become way too much.And to me, a big part of that is: we all have to really work a little bit harder to get clarity on our spending; on this balance between income and expenditure. This balance between living for the now, and for the future. And I think the more clarity we have over our expenditure, the more we can spend money on things that are important to us as individuals, that align with our values, that bring happiness to us. And there's a lot of research that suggests that that isn't about just accumulating and buying a lot of things. So look, it's easier for us in financial services to say that people should spend less focus their expenditure. But the reality of the matter is: that is an important part of this conversation.
Robin Powell: We've also heard John Ralfe advocating low cost, evidence- based investing. Expressed as percentages, fund management fees look small, but they can make a huge difference over time, can't they?
Abraham Okusanya: Yes. I think that it's one of these hard concepts for people to understand that - if you are paying 1% of your investment, for instance, in investment management fees - then you are sacrificing a big chunk of the return. Over a 30-year period, you're sacrificing a big chunk of the return paying for this. All of the evidence out there is that it's really hard for fund managers to justify their existence, net of fees. Over a 10-year period, you know, 80, 90% of fund managers don't actually beat the market. So, I think that John's point is important and you and I, of course, agree that for the vast majority of people, and for their retirement savings, they approach low cost - and by that we mean for the fund management or portfolio aspect of things, we're talking maybe a fifth of 1%, so 20, 25 basis points. Paying too much - much more than that for investment management is really hard to justify.
Robin Powell: Well, as we've seen, John Ralfe speaks very articulately and there are plenty more things he said, which warrant further discussion. So next time, Abraham, we're going to see what our politicians can do to tackle the pensions crisis. Ralfe has recently given evidence to the Work and Pensions select committee of MPs about this and says it's a problem that requires radical solutions.
Abraham Okusanya: So you've heard our opinions. What did you make of our latest interview? Please send us your views. Until next time. Goodbye.
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