For years now, the Irish pension industry has been actively encouraging Government to take firm action against the ‘low levels’ at which Irish people have been saving for retirement. The ESRI is also a regular contributor to the debate.
By many calculations, roughly half of the population have no pension investments other than what they expect to receive from their contributory pension entitlements; this is about to change.
Government has now earmarked 2022 as the year where it plans to introduce ‘auto enrollment’. For those not familiar with the term, this is where a deduction is automatically taken from gross wages and invested on behalf of workers. The concept is simple; people need to be protected from themselves and their lack of pension planning so Government will do the auto-enrollment and investing for them.
The logic to auto-enrollment, according to behavioral economists suggests that once enrolled, workers are highly unlikely to take action to exit ‘auto enrollment’ in significant numbers. In other words, people are simply too lazy and won’t be bothered walking over to their HR or payroll department to fill out a form instructing HT / payroll stop auto-enrollment.
While the intention of Government is good, it has an enormous duty to citizens to ensure it trims the full cost of managing such money along with the various investment strategies employed by investment managers.
In his 2018 letter to investors, Warren Buffet lauded ‘The Bet’ which he won hands down. That bet of course was the 2007 wager that a virtually cost-free investment in an unmanaged S&P 500 index fund would over time, deliver better results than most investment professionals.
What Mr. Buffett was saying is the cost of investing money can be so high that any potential returns can be destroyed to a point where the investor gains very little in the long term, other than perhaps the original tax benefit provided by Government.
Here in Ireland, there has been a long history of investment fees that are opaque and completely out of kilter with modern fees arrangements. Too many pension investment fees have resulted in way too many mediocre returns. Additionally, the level of opacity on how fees are charged means that only seasoned actuaries really understand the true cost of management to the individual investor.
This high-fee culture is a legacy of the Defined Pension era. Defined Pensions are also known as final salary pensions. Regardless of their name, this was an era where few people were really concerned with the cost charged by investment managers to manage pension funds. This was because funds were simply replenished by those that funded them, be it Aer Lingus, RTE, the Irish Independent or even, the State. As long as employees retired on two-thirds of final salary and the money flowed, nobody really asked too many questions about the nitty-gritty of day-to-day management; nobody really cared!
But as more and more people live longer swelling the ranks of the retired, Defined Benefit pension arrangement were exposed. Many ceased being offered to new employees, many converted to Defined Contribution arrangements, handing lump sums and investment headaches to confused employees. Some schemes simply went bust!
I find it so sad when I talk with confused individuals that work hard and are suddenly presented with having to make highly complex investment decisions that will have massive life consequences in their post-employment years. This is typically what happens when a DB pension scheme converts to a DC and the investment risk is transferred from the employer to the employee.
But what is most concerning of all are the poor choices many Irish people face when it comes to their pension investment options. Without the faintest hint, many are often presented with sub-standard investments choices carrying inflated management and investment fees; these destroy investment wealth.
Here in Ireland, while the official 5 & 1 arrangement is often the fee structure presented to those doing the right thing by setting up PRSA or AVC or participating in an Occupational Pension Scheme through their employer, this is not the full picture. The 5 & 1 refers to the allocation rate; maximum allowable is 5% of the invested amount and 1% Annual Management Charge.
But how investments are managed will impact workers enormously. For example, if the investment is made in some bog-standard series of low yield funds without annual rebalancing, then growth is sure to be anaemic and the only real growth will come from the tax-benefits given by Government and the individuals own contributions. This by definition is not investing, it is saving and the value of any potential investment yield is lost to the fees charged by the manager. In other words, it just becomes a zero-sum game purely for the benefit of the manager, not the investor. In a nutshell, this is the reality for many Irish people investing in various pension plans at present.
This is precisely what Government needs to avoid if it is committed to convincing more workers that it really has their long-term financial well-being at heart. It cannot explore the simple 5 & 1 figures. Instead, it should force a radical new approach to investing here in Ireland, one that goes much deeper, one that looks at a head-to-tail trail of fees that have plagued pension trustees for decades and one reason why low-cost leaders including Dimensional and Vanguard have captured such a significant percentage of market share in recent years; their low-fees, high growth strategies create more wealth for families and workers.
Frank Conway is a Qualified Financial Adviser and founder of MoneyWhizz.org, the financial literacy initiative.