Longevity and the financial race to outrun it
Originally written June 2, 2015. Updated October 15, 2017.
Defining the longevity problem
Longevity (in terms of life expectancy) is increasing across much of the world. But there is a critical disconnect between existing models of retirement planning and unfolding changes in long term economic trends. Most people don’t save anywhere near enough to retire upon.
There is a long term problem brewing here, based upon Industrial-Age assumptions. Firstly, pensions were brought in when most of us did hard physical labour of some sort for a living. However, most of us died before we ever got to retirement age. Now people are routinely living a generation longer than that age in many nations around the world. Such longevity is a positive thing for humankind, but it does bring new challenges.
Defined benefit or defined contribution plans alike share these obsolete assumptions. The first one is that people will stay with one company or industry over their lifetimes. The next assumption is that people will have work for at least a 40-year time frame over their working lives. And this comes to the crux of why learning about financial topics is so important.
How did we get here?
There are a number of reasons for this. Firstly, people generally have a poor understanding of the trade-off between consuming now and consuming later. When we are young, retirement feels like a long way off. Even though putting even a little money aside early would really help, we tend to spend rather than save. Many cultures also behave as if our lives only matter between the ages of 15 and 25.
Secondly, public knowledge of financial concepts like compound interest, or understanding a set of financial accounts is usually poor. Many families don’t know these things either – and the schools often teach little to nothing about such topics. If people perceive finance as some sort of black magic, it’s no surprise that they don’t understand it. Also, especially after the financial crash of 2008, who would want to associate themselves with the “dirty” topic of money?
It's time to learn - and to act
The fact is, though, we’re going to have to collectively engage with the topic in a big way. Much of the developed world is suffering heavy debt, with little scope of getting rid of it. Shifting demographics is hampering economic growth, which is making the situation worse.
Just as younger people tend to spend too much on average, older people tend to consume less on average. And it makes sense for all sorts of reasons. First of all, many people understand the value of saving, even if we don’t know much else about investing. Secondly, some of us are close, if not finished, to having paid off our mortgages. When we do, if we are still working, then there is a lot more money no longer leaving our pockets. We also tend to spend less on appliances, furnishings, and other big-ticket items once we’ve replaced them upon retirement.
We do, naturally, tend to spend more on health care, and on things related to family, especially grandkids.
However, one of the major reasons we spend less is out of fear. Even to those who have saved a fair bit, the modern world can seem to be an intimidating place. Few of the certainties we grew up with exist anymore. For those in defined benefit contribution schemes, what happens if the company due to pay us our pensions goes bankrupt?
In countries like mine (Australia) with defined contribution schemes, there are other challenges. Of course our private retirement providers (called superannuation funds), banks and other financial institutions can go bankrupt too. In many countries around the world, retirement savings end up invested in both share markets and bond markets. And even with the best will in the world, politicians cannot help but to fiddle with the rules.
How do things stand at present?
In recent years, the yields (returns) on government bonds in some markets have gone negative, which is unheard of. What it means is that for five year or longer, market expectations are for interest rates not to change. People are willing to pay someone a little bit of money to keep the majority of the bond’s face value. They are doing this even though they are actually losing money in doing so. This outcome reflects people’s current fears about future economic growth and prosperity.
For average investors, there are two equally scary choices out there at the moment. Invest in bonds that pay a miserably small yield, or buy shares that gyrate even more wildly than usual. There is a flood of money around the world at present looking for decent returns, and (generally) not finding it. Those people already in retirement, and relying on pensions, are unlikely to see things improve for the foreseeable future. Governments cannot afford to lift pensions by much, because of crippling health care costs. People are terrified of investing in shares, just in case we have another crash. In Australia, people are deluding themselves that residential property is a bullet-proof investment, and that “this time will be different”.
How do we win the longevity race?
For younger people in a world full of temporary, project-based roles, then we can’t just assume things will be OK. Merely saving the “standard” amount of money (currently 9.5% in Australia) is not going to be enough to retire upon. Nor can we assume that there will be a government pension available to us upon retirement. We need to actively look for investments beyond government bonds in order to activate the magic of compound interest. And it should be soon, because the Baby-Boomer induced boost to various asset markets will retreat over the next decade.
For older people, there are perhaps fewer options, and I am not qualified to suggest what they could be. I know that some people choose to downsize, and that’s a good idea in some situations. After all, who wants to pay taxes and rates on a 5-bedroom house when we’re using only one bedroom? I have also heard that moving offshore can be a smart move for many –but obviously has its downsides too.
Set your sails - and teach others how to do so too
Again, however, making these types of decisions requires us to understand financial principles around risk and return. We need to understand what we can afford to live on, and to have a contingency plan against unexpected setbacks. Reading the fine print is also incredibly important – if you don’t understand something, then don’t sign up to it.
For those of us who are well off, congratulations, and I hope you enjoy retirement. However, I’d ask you to think about the future of your friends and family, and that of your communities. If you have financial expertise, I beg of you to share it as far and as wide as possible. Our descendants are going to have to live with the consequences of decisions made today. They will need to have as many tools at their disposal as possible to adapt to whatever comes next. We are, in the long run, all in this together.