The value of active management
How much and for how long?
Pension systems and their design have attracted considerable column inches over the years. From questions around the sustainability of corporate and government pension promises to the structure and costs of funding arrangements and the right investment approach, there has been no shortage of analysis and opinion.
However, the biggest question that faces individuals (and taxpayers more broadly) is how much do I need to fund an adequate retirement? While the answer can and will always be “it depends”, the purpose of this paper is to consider some very long term scenarios and obtain some insights as to how much and on what it depends.
Ultimately every dollar, pound, yen or euro that is deferred from current consumption (be it directly into a funded pension system or indirectly into a government tax pot from which pensions will be paid) will eventually yield some form of future consumption. However the size of that deferral, what happens to it during the deferral period, and then how much future consumption it needs to buy, gets to the heart of the pension funding problem. In particular, increases in longevity and changes in demographics have vastly altered the mathematics and the importance of the calculation. As governments and society gradually push more of the responsibility onto the individual for the provision of their future pension requirements, the potential to smooth over mistakes or “grow” our way out of it diminishes substantially. We would add that while investors may be currently cheering the actions of global central banks in providing “free money”, this is particularly bad news for those with some way to go to retirement or those requiring higher rates of return to fund retirement.
In this paper we utilise over 300 years of historical UK equity and bond returns to analyse the impact of alternative contribution rate and pension payment policies. We are particularly focused on the impact at an individual level as with a defined contribution (DC) scheme but also maintaining broader macro-economic sustainability – what works for the individual must also work for the whole. By looking at what would have happened if we followed various funding and investment paths we aim to glean some insights into:
1. How much do I need to save;
2. How long will it last;
3. How should those savings be best invested; and
4. What else matters, and what doesn't.
Opinions, estimates and projections in this article constitute the current judgement of the author as of the date of this article. They do not necessarily reflect the opinions of Schroder Investment Management Australia Limited, ABN 22 000 443 274, AFS Licence 226473 ("Schroders") or any member of the Schroders Group and are subject to change without notice. In preparing this document, we have relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources or which was otherwise reviewed by us. Schroders does not give any warranty as to the accuracy, reliability or completeness of information which is contained in this article. Except insofar as liability under any statute cannot be excluded, Schroders and its directors, employees, consultants or any company in the Schroders Group do not accept any liability (whether arising in contract, in tort or negligence or otherwise) for any error or omission in this article or for any resulting loss or damage (whether direct, indirect, consequential or otherwise) suffered by the recipient of this article or any other person. This document does not contain, and should not be relied on as containing any investment, accounting, legal or tax advice. Schroders may record and monitor telephone calls for security, training and compliance purposes.