The statistics speak for themselves. More than half of Australia’s superannuation members are not engaged. Eighty per cent go into their super’s default investment option at sign up – and stay there. Funds are constantly looking for new ways to get members more involved with their super. They spend significant time and resources developing communications strategies and educational tools. But, despite their best efforts, the problem of member engagement persists.
Two out of three working Australians do not think they will have enough money to live comfortably beyond age 70 – and that’s just the tip of the iceberg. We have one of the longest and fastest-growing life expectancies in the world. Yet, when we asked Australian retail investors what steps they are planning to take over the next 10 years to prepare for retirement, 27 per cent said “none”, and 13 per cent “didn’t know”. The extent to which Australians are active participants in their super is a critical component of their retirement readiness. Why are they disengaged from the scheme that could help them achieve a secure financial future?
This is the question we sought to answer in a recent survey of retail investors in Australia. We wanted to identify the barriers to healthy decision-making and understand the emotional forces driving their behaviour. What we found provides valuable insights that can help supers reframe the way they tackle the issue of member engagement.
Perception versus reality
One of the most striking observations from our study is the extent to which members’ perceptions of their financial knowledge are at odds with the investment choices they make. Fifty per cent of respondents describe themselves as “sophisticated”, and 49 per cent consider themselves an “involved investor”.
The majority says they have access to the information and tools they need to make informed decisions and 68 per cent credit their primary investment provider with giving them “enough information to make good decisions”.
One might conclude from these self-assessments that Australian retail investors consider themselves financially well informed. But there is a chance that this confidence is simply a manifestation of the “overconfidence effect”, the very human and well documented tendency of individuals to define themselves as above average. We took a look at their investment decisions to get a better idea.
Cash is king
When asked what asset classes they are invested in now, the top response was “cash”, and the average amount of the allocation was significant at 39 per cent. This is not surprising, given that 51 per cent of respondents also described themselves as “risk averse”. But other lower risk asset classes, like fixed income and inflation-protection securities, took a back seat to more aggressive options like equities and alternatives, which tied for second place with an average allocation of 24 per cent each.
The picture didn’t change much when we asked investors to project their asset allocation 10 years from now. Cash was still king with a 40 per cent allocation, followed by alternatives (24 per cent); equities (20 per cent); fixed income (8 per cent); commodities (5 per cent) and inflation-protected securities (4 per cent).
This conservative behavior may be justifiable, given the volatility in the global markets and the large pre-retirement population. However, what was most surprising was the high level of asset class convergence across all ages of retail investors.
For example, when we analysed investor behavior by age groups, cash was the top current allocation across all groups up to age 41. Between ages 42 and 51, cash fell slightly behind equities and alternatives, but then rebounded to more than 50 per cent allocation in the 52 to 56 demographic. The pattern was similar in the 10-year projected allocations, where cash persisted as the dominant asset class for participants aged 52 to 80.
Most interestingly, when we asked what steps respondents would need to take over the next 10 years to be prepared for retirement, the highest response was to become “more aggressive”.
Even for the most risk-averse investor, such a consistent preference for cash seems out of synch with a long-term goal of becoming a more aggressive investor. Cash may not generate adequate levels of replacement income to see Australia’s investors comfortably through retirement. Its dominant place in Australian investors’ asset allocation plans now and in the future does not seem aligned with their best interests.
What would drive retail investors — young and old, wealthy and of modest means — to flock to cash when they know they must be more aggressive to prepare for retirement? Could the answer provide keys to why super members remain disengaged, despite evidence that to do so is not in their best interest? We looked to some principles of behavioral finance for more insight.
Many of us learned about the concept of inertia in basic physics, the property of matter by which it retains its state of rest or its velocity along a straight line so long as it is not acted upon by an external force. In simple terms, inertia means taking no action unless someone or something forces you to.
It seems an apt descriptor of today’s disengaged super member ¾ falling into the default option and staying there. When we consider that there are 200 public-offer funds with more than 20,000 investment options, perhaps Australian investors are simply overwhelmed by too many choices and confused by the complexity of the superannuation landscape.
As psychologist Barry Schwartz writes in The Paradox of Choice, “At this point, choice no longer liberates, but debilitates. It may even be said to tyrannise.”
Fear of failure, or of making a wrong choice, is a powerful inducement to procrastinate decision-making and preserve the status quo.
Reaching the right information
The super member is faced with complexity on a variety of levels. Retirement planning and saving requires an understanding of one’s basic and discretionary needs today, and the ability to project those needs out decades into the future. Investors are bombarded 24/7 with information about the share markets and much of it is contradictory. Indeed, 16 per cent of our survey respondents listed “skepticism about the markets” as their main barrier to becoming more involved with their investments. It was the third most commonly cited reason, following lack of knowledge and lack of money to pay fees.
Change and mistrust
The superannuation system itself adds to the complexity. Members must understand and keep up with frequent changes in contributions and tax levels, and retirement ages. As one super manager told us, “Constant change creates mistrust.” This is a sentiment echoed by our survey respondents, less than one-third of whom believe their primary investment provider is acting in their best interests. Meanwhile, confusing investment options can complicate matters. For example, a senior advisor to the Super System Review observed, “The relationship between price and quality [of financial products] is not easily established, often requiring substantial research by financial experts.” If the experts have difficulty determining the value of investment options, it’s unlikely that the retail investor will be able to.
From good to best
When investors are presented with an overwhelming amount of conflicting or ambiguous information, and they have a finite amount of time to consider it in, they will attempt to make a satisfactory decision, but not necessarily the best decision. This is the concept of “bounded rationality,” and it is one factor that helps explain why so many super members accept the default option and why so many of Australia’s retail investors choose cash as their primary asset class. It’s familiar, it’s safe and it’s good enough for now.
There is a disconnect between retail investors’ perceived level of knowledge and their investment choices. Their behavior is consistent with several well documented phenomenon, including overconfidence, suboptimal decision making in response to bounded rationality, and procrastination and inertia in the face of a complex and changing investment landscape.
As the super industry struggles with ways to re-engage its members and help Australians prepare for a secure retirement, these insights can help shape effective responses.
Super funds can advance efforts to provide members with well targeted, affordable financial help and advice. One fund sponsor has had success with an interactive tool that guides members into groups according to their investment risk profile and learning/decision-making styles. Communications are then customised for each group, right down to the timing, frequency and presentation of information.
This plays into the idea that people are more alike than they think. Since no one wants to be “average”, peer-group comparisons of savings rates, fund choices and other relevant points can help spark action. The use of peer-group comparisons is gaining traction – a recent test of retirement-plan participants in the US found that 64 per cent of application users chose to take some action after using the tool.
Despite best efforts at boosting financial literacy, some funds are turning to product design to help members be better prepared for their post-retirement years. The idea of reducing member choice and providing a more retirement-ready investment default option is reflected in the MySuper program that will roll out later this year.
There are many variations on the theme, however. One approach is to accept members’ preference for the default investment until they approach age 50 and then offer highly customised investment solutions at a time when members will likely be more concerned with retirement. Another is to offer better default options at the outset, like target date or lifecycle funds. While each of these approaches has their pros and cons, the focus on product, not education, may have some validity. As one retirement expert says, “Investment education has zero chance of making the average person an expert investor.”
Focusing on income replacement
Another option for increasing engagement is to move away from a lump-sum mentality toward an income-stream payout system. This gives members a concrete and quantifiable goal to work toward – an annual replacement income requirement that they can relate to as the future “salary” they will need to be financially secure in retirement. Just asking people to imagine the future consequences of their retirement investment decisions can increase their willingness to engage in their super.
Ready for retirement
Inertia and a disconnect between perceived and actual levels of investment sophistication are driving Australian retail investors to make unhealthy retirement investment decisions. The low levels of member engagement in their supers are one manifestation of these unhealthy decisions. Fund sponsors will need to consider the forces shaping member behavior if they are to help them be retirement-ready in the future.
Suzanne Duncan is global head of research at the Centre for Applied Research, Lochiel Crafter is head of State Street Global Advisors (SSgA) Asia Pacific and Daniel Cheever is vice president and head of superannuation at State Street Global Services, Australia.