Deferring Retirement: Switch on to Working Until 75+Published: March 15, 2011 in Knowledge@Australian School of Business
Widespread financial illiteracy plus increasingly longer life expectancy equals an unpleasant retirement for many, according to Olivia Mitchell, a professor of insurance and risk at the Wharton School. A comparative international study shows people across the world are lousy at doing the sums that will enable them to be cashed up and comfortable for what were once anticipated to be the golden years of retirement. In addition are the risk factors for retirement savings, including political instability and volatile financial markets. To fund increasingly longer lives, the alternative is keeping people hanging in at work for much longer, perhaps to age 75 or older. While this may not have universal appeal, it does have a silver lining, Mitchell suggests. As she tells Julian Lorkin of Knowledge@Australian School of Business, recent research also found that staying at work is good for the mind.
An edited version of the interview follows.
Knowledge@Australian School of Business: Olivia, is it right to suggest your recent research reveals an upside to the global financial crisis when it comes to saving for retirement?
Olivia Mitchell: Indeed, I think this is a teachable moment. It has provided the opportunity to get people thinking, at all different ages, about how they need to prepare better for retirement, save more, invest more cleverly and diversify, and then – at the retirement point – to manage their money more sensibly so it doesn't run out.
Knowledge@Australian School of Business: Your research finds that people seem to be woefully financially ignorant. Do you have figures to support this?
Olivia Mitchell: It's very interesting. In the Health and Retirement Study in the US, we've asked a representative group of people over the age of 50 a question like, "What are the chances of getting a disease?" If 10% of people out of 1,000 have the probability of getting a disease, how many of them will actually get it? And what we find is that very few people can actually answer that. Then we ask them about diversification (in investment): "What's safer – a stock or a mutual fund of stock?" Very few people get that right. What's interesting now is we've taken a series of questions and asked them around the world in a number of different countries and, in fact, here – at the Australian School of Business – there's a group of people comparing the Australian and the US numbers and they're remarkably similar. So, widespread financial illiteracy is very common. Not only that, it's related to lack of saving, lack of planning and, in general, what portends to be a very unpleasant retirement.
Knowledge@Australian School of Business: Does education make a difference in how well people plan for retirement?
Olivia Mitchell: More educated people do tend to perform better on these questions. Specifically, they are able to able to understand inflation and compound interest better, the things that are really important to long-term investing. We also find that certain groups have more trouble – for example, lower paid employees and, in most countries, women as well. And that's very important because women tend to outlive their spouses or live a long time anyway. Therefore they tend to be very much at risk of falling short in retirement.
Knowledge@Australian School of Business: Why women in particular? Why is that an issue?
Olivia Mitchell: That's a fascinating question and one that we have to look at in more depth. In many countries I think the explanation is that women – either by choice or by culture – have their husbands do all the financial management, and then if they're left widowed, as so often happens, they're up the creek. Also, in the past women earned less than men and, to the extent they earned less, then they cared less about financial outcomes.
Knowledge@Australian School of Business: How about ignorance about life expectancy, have you come up with any answers on that?
Olivia Mitchell: It's very interesting because retirement calculators are available now online, but one of the things they typically do is they ask for your age and your sex and then they say, "Bang! You have 16.4 years left to live." To my mind, that's exactly the wrong way to go about thinking about retirement security, because it doesn't emphasise how long you actually might live – to 99 or 102, or even 120! So we need to get people thinking more about the risk of surviving a very long time and how expensive that would be as well.
Knowledge@Australian School of Business: This tail risk is very significant, isn't it?
Olivia Mitchell: Absolutely. We find people have a fair idea of their chances of living to be, say, 75, but they become less and less realistic if we ask them about their chances of living to 85 or 95. Consequently, they might be likely to save too little, spend it too quickly and end up short.
Knowledge@Australian School of Business: We know what people don't know, if you like, but what's the impediment to people learning about this? Why don't people just do their own research?
Olivia Mitchell: As an economist, we encourage people to study more and take more responsibility. I think there are a couple of factors – one is that in the past governments and employers were very much protective, that is they said, "Don't you worry your pretty little head about it, we'll manage your retirement security for you." But governments and employers are less able to do that now, especially post financial crisis. The other problem is that it's complicated and many people are quite insecure about being able to invest and learn about what it takes to make sensible financial decisions.
A third reason might be that it's not so appealing to defer consumption. In other words, it's a lot more fun to go out and buy a new pair of shoes or a car, whereas saving for retirement requires one to defer consumption perhaps for many years, and kids have a hard time with that.
Knowledge@Australian School of Business: If people should be deferring consumption, then maybe they should be working a bit longer. Your research suggested 75 as the age where people may be considering early retirement in the future. This may horrify many who'd assumed that 55 or 60 were early retirement ages.
Olivia Mitchell: The reality in all developed countries – and in many developing countries – is that increasingly we're going to live to be very, very old. Some medical journals have now predicted that babies born today have a very good shot at living to be 100. That means it's extremely expensive to spend 40 or 50 years not working – it's simply not viable. What we have to do is encourage people to think about working longer, about extending their retirement date, perhaps to 75, if they possibly can. Of course, not everyone can. There will be those who suffer physical frailty or mental disability and cannot. But in this more technological world, it is possible for people to continue working longer. The most important outcome is to rethink the definition of retirement and not to think about sitting on the front porch on a rocking chair or playing golf, but remaining engaged for as long as possible.
Knowledge@Australian School of Business: How can people do that if they're not that well educated and at 45 or 50 they are looking for a new job but there's quite simply nothing for them other than retirement?
Olivia Mitchell: Certainly, this is a consideration and it means we have to start getting people from high school or even younger thinking about not a 20-to-30-year work career, but a 40-or-50-year work career.
Knowledge@Australian School of Business: And, there's the matter of where people put their money while they're working. Many retirement savers believe they have no connection with shares at all. They don't realise that much of the money invested in superannuation is put into equities. Again, is there a question of the need for education in retirement investment risks?
Olivia Mitchell: It's fascinating to get people thinking about the risk associated with investment in shares or other sorts of assets. Conventional wisdom is that, as you get close to retirement you should go into safer investments, but young people can take a lot of risk, and I think that's probably still accurate. On the other hand, if you're talking to a 60 or 65 year old, that person may have 25 or 30 years remaining and it's not necessarily sensible or economically viable for that individual to put zero into the share market. Of course, the Australian share market has been doing much better than the US share market, so I suppose people in Australia would have a more positive outlook on that.
Knowledge@Australian School of Business:In Australia we have mandatory retirement saving in the form of superannuation – and the stock market seems to be doing well. Are people around the world looking at the Australian system and thinking that legislating to force people to save is the way to go?
Olivia Mitchell: A few years ago, I served on the presidential commission to restructure social security in the US and the Australian model was one that we discussed very vigorously and several of us encouraged it. Now, in the US we have a mandatory contribution to an old age social security scheme run by the government, which is not investment based. While we proposed a (mandatory superannuation) model as you have in Australia, at the time there was a lot of pushback. Then – of course – the stock market and the war hit, and so here we are several years later with no solution to the social security problem. But I would say everybody does recognise the value of the Australian system and holds it up as a wonderful model.
Knowledge@Australian School of Business: How about lessons from around the world in terms of annuities? The UK, for example, has the annuities model in which a large proportion of people put cash into annuities that will pay them for the rest of their lives.
Olivia Mitchell: Trying to protect against longevity risk is a challenge because people don't understand the risk and underestimate their survival chances. They worry that if they put their money into an insurance payout product, if they die too soon then the insurance company gets all the money. That's not strictly true; what happens is the assets of the individual who passes away young go to protect someone who lives to be very, very old. But the Australian system has a challenge in getting people to think about annuities and protecting against longevity.
One of the countries that has taken a great step forward in this regime is Singapore because it has recently mandated the purchase of deferred annuities, that is, at age 55 you buy a promise that you will receive an annuity for the rest of your life should you be still alive at 75 or 80 years old. It's not very expensive but it protects you against that catastrophe of living a very long time and running out of money.
Knowledge@Australian School of Business: There's the risk of your cash not lasting when you do reach old age, and there's political risk as well. Look at Argentina, for example, where the government recently decided that private schemes weren't such a good idea and a government IOU was a much better plan.Have you done some research in that area?
Olivia Mitchell: It's certainly the case that many countries in Latin America have looked to the country of Chile where they mandated a defined contribution scheme back in 1981, so it's been a number of years now, and that's been an enormously popular and very successful plan, quite similar to the Australian plan actually. One of the countries that has fared less well in that regard is Argentina; they followed the Chilean model in mandating a pension, but at one point when the Government was running short of cash, they decided to use the pension reserves to pay back their foreign debt. I don't want to advocate that but it definitely highlights the role of political risk – even in the best of all circumstances, your money can be confiscated.
I do believe, however, that personal accounts where individuals own their retirement pot, that's much safer against political risk than some of the other alternatives such as having the government spend it, as we do in the US with our Pay-As-You-Go system.
Knowledge@Australian School of Business: Previously, many who wanted to control their retirement savings considered property as a safe investment, but the old expression "as safe as houses" isn't appropriate anymore in many parts of the world, is it?
Olivia Mitchell: Having a single house is not a diversified asset and that's something that we've learned in the US with quite a rude shock, with some locales experiencing declines in housing prices of 30% or 40%. And they haven't popped back, even though the stockmarket is performing much better now. That's not to say that real estate as an asset class is undesirable. Most financial advisers will say that perhaps you should have up to 10% of your total wealth in real estate – that is, in a diversified real estate fund, not necessarily in a single house.
I'm a baby boomer (the generation born between 1946 and 1964) and the problem many of us face is that we have put pretty much all of our liquid savings over the years into the house. The good news is you get to live in it, but the bad news is (in the US) it's very hard to raise equity against it should you need to now. I think that's changed people's perception of the role of the house in the retirement portfolio.
Knowledge@Australian School of Business: What else can we learn from the global financial crisis?
Olivia Mitchell: It's about risk management and I think what needs to be emphasised is the point about deferring retirement. As long as you're able to continue to work, even half time or in a post-retirement job that offers you an income, it means that you don't have to draw down your assets as quickly in retirement. Recent research shows that delaying retirement is good for your mind. In other words, people who delay retirement tend to be more mentally acute longer than people in countries where retirement is very early. This is another piece of new insight that we need to build into our planning.