Here is how I framed the problem, and the solutions I suggested.
1. The consumption-savings puzzle
Whether we are talking about employees of large or small firms, an individual’s decision to participate in a work place retirement savings program is about the age-old decision by an individual to consume more now, or, save/invest more now and consume more later. This decision applies to more than just the decision to save for retirement. A theory of rational consumer behaviour would involve each individual analyzing the trade-off between the two and making an appropriate decision. In real life, people need help to make good decisions and a good decision in this context involves balancing a large number of variables.
2. More financial advice and knowledge
To make good spending/savings/investment decisions, the individual needs knowledge, both about the potential consequences of making various decisions, and, just as important, about how to implement the decision(s) that are made around consumption/saving/investment. A good decision about how much to save for retirement becomes less so if the same person runs up unmanageable debt in order to finance current consumption, or consumes much less than they need to.
I reminded the audience that several suggestions have been made for improving the retirement system by limiting the number of investment choices and making enrolment mandatory with the option of opting out of an employer’s plan. These are good suggestions, but implementing them across the third pillar of Canada’s retirement system would not reduce or eliminate the need for financial advice. I also pointed out that in all of Fidelity’s research, people who get financial advice are better off and are more confident about their financial situation than those who don’t.
To this end, I acknowledged the broader dissemination of financial advice in Canada – one of the goals of the federal government’s task force on financial literacy – is to be encouraged. But to effectively enhance retirement planning at small and medium-sized enterprises, it will need to be focused on the individual’s specific situation, come from or be associated with the plan sponsor, and involve some prodding of the plan members to actually get financial advice. It may be necessary to make advice an essential part of enrolling in a work place retirement savings plan and should be mandatory before an employee can exercise the right of opting out of the plan.
Better savings vehicles and more of them
However good a consumption/saving/investment decision may be, the individual needs the appropriate vehicles to implement the decision. The ready availability of effective retirement savings vehicles is crucial. And, whatever side of the argument you may be on regarding the ideal solution, the gap needs to be filled. There are three important requirements these vehicles must meet:
• Returns Balanced with Risks: Whatever the ultimate retirement savings solutions that are introduced or modified, those solutions are going to have to deal sufficiently with financial market risk. Risk exists, it always has and it always will. However, risk can be dealt with – by assessing it, pricing it and making carefully considered decisions about how much risk to take. Surely we have learned this from the global financial crisis of 2007-08. Education about risk and reward will be essential. An effective approach to this is to do market projection scenarios with at least two sets of probabilities, approximating both average (or “normal”) and extended-bear market conditions. Fidelity’s retirement income planning research makes extensive use of both Monte Carlo simulations and a wide range of historical market analyses.
• Reasonable Costs: Clearly, costs need to be reasonable and in line with services provided. And clearly, competitive costs of managing and administering retirement savings are helpful in ensuring the best possible net investment returns. But there will be costs – for investment management, for record-keeping, for providing financial advice and tailoring retirement savings plans to individual needs.
• Administrative Simplicity: Expanded coverage will need to be sufficiently administratively simple and cost-effective that SME owners will be prepared to embrace them.
