Technology has a way of disrupting much in the world, and that includes retirement investing.
That was the topic that the Pension Research Council (PRC) explored during a recent symposium. Experts from around the world gathered to discuss how technological innovation is changing the retirement marketplace and insurance markets, and how retirement plan sponsors help shape workers' pension, saving, investment and decumulation plans.
In an interview, Olivia Mitchell, the executive director of the PRC at the Wharton School of the University of Pennsylvania, said fintech, (that is, the emerging services sector of financial technology) holds a great deal of promise, but it's not yet fully helping those saving for or living in retirement.
"It seems like fintech has a lot of potential that is not yet very well put in place," she said. "For example, we know that there are lots of people that need more access to saving and investment advice, people who might have small accounts, who financial advisers are not particularly interested in. So, access is critical, low cost is critical, and again, fintech has a lot of promise in that arena."
The most potential for fintech, however, is in the decumulation phase where fintech has not yet begun to tiptoe, she said. "Retirement-focused people and people in retirement need more advice on decumulation, on tax harvesting, on how not to run out of money in old age," said Mitchell. "All of these areas are areas where fintech needs to move next."
To be sure, the spending down or decumulation phase of retirement is more complicated than the saving for or accumulating phase of retirement. Among other things, those living in retirement need to address the many risks they will face, such as longevity and inflation.
The decumulation phase can be difficult for another reason as well. "Part of the difficulty with looking at the decumulation phase is that people typically only retire once," Mitchell said. "We only get old once. And so, we don't have a lot of practice making these very consequential decisions. For example, when we get to retirement age, and we have a lump sum in a 401(k) or 403(b) -- a lot of people don't know how much to try to invest, how much to potentially annuitize, how much to use to pay down their mortgage. There's all these very big decisions. And, yet, few of us get much advice and certainly very little practice doing."
At the moment, robo-advisers (I prefer to call them robo-investors) are not necessarily the solution because they don't have the tools to help people do that.
"Most robo-advisors are not focused on decumulation," said Mitchell. "I think partly because it's so complicated. Not only does it involve how to spend down your nest egg, but it also involves deciding when to claim Social Security and which Medicare plan to pick. How much long-term care insurance should you buy, if any? What do you do about bequest motives and your children and grandchildren? And, that takes a very integrated and holistic perspective that is very hard to program into computer software."
The Hybrid Model Might Be the Answer
Given that, working with human financial adviser or a robo-plus-human adviser might be the best path for those seeking advice for the decumulation phase of retirement. "At this conference, we had a number of fascinating psychologists, and people experienced in this arena," said Mitchell. "They make the point that the robo-advice edifice used to be completely computer-based. And now, there's a pendulum swing back in the other direction, where it's a hybrid situation, where you have a front-end software program that will elicit a number of questions and answers from participants.
"But then, at some point, especially older people, want a human to talk to, and say, well, am I really doing this right, give me confidence, or talk me off the cliff if I'm just about ready to sell all my assets at the bottom of a stock market crash. So, I think that the direction that robo is moving is more towards hybrid rather than pure software, even as appealing as software seems to many people."
Mitchell also noted that much work is being done to make retirement planning less complicated. "There's fascinating work going on in marketing, including here at Wharton by some of my colleagues looking at which medium is the most effective in informing people about things like risk and return."
Using eye tracker glasses, which reveal where people are looking when they're looking at a piece of paper describing the investment options versus a chart online, Wharton researchers have concluded that the most effective medium is still a piece of paper. "Now, that could depend very much on the age of the viewer," said Mitchell. "So, if you've grown up with a smartphones and iPads, then you may be in a very different receptive mode than if you're a baby boomer like myself."
Given that research, Mitchell said the industry needs to understand that people receive and digest information very differently. "And, honestly, a lot of it is too complicated," she said. "And, if we don't have an MBA, especially from Wharton, and even if we do, sometimes, people still call me up and say, well, what should I do?"
Mitchell noted, for instance, that she once advised her children (when they first entered the workforce and could start saving for retirement in an employer-sponsored plan) to invest in target-date funds "like everybody else."
Financial Education Works
During the symposium, one speaker questioned whether people could become more financially literate. Mitchell, along with Annamaria Lusardi of George Washington University, has studied financial literacy extensively. They have found that people in their 50s -- those getting close to and looking ahead to retirement -- were, Mitchell said, "woefully ignorant about things like compound interest, inflation, and risk diversification."
"Being fairly shocked at the result," as she put it, Mitchell said she and Lusardi replicated their studies in 24 countries around the world for younger people, middle-aged people, and older people. "And our finding is, they basically, everyone, is quite financially illiterate," she said.
"And what this means is if you don't understand the way interest works, you're not going to realize that if you don't pay off your credit card, you're going to get in big trouble."
And if you don't understand the way that percentages work, for example, on the decumulation side, "you're not going to understand that paying yourself 4% of your nest egg every year could mean you're going to run out" of money, Mitchell said.
She also noted that people don't understand interest rates. "It seems to me that the critical challenge is to figure out how to educate kids in school, how to educate employees in the workplace," Mitchell said. "We know that employees who are getting dunning calls from credit card companies or other entities are stressed. They're not able to be productive in the way that we would like our employees to work."
According to Mitchell, some basic lessons about key fundamental financial concepts can go a long way.
"Now, I certainly understand that given the nudge environment that we're in, there are many ways that employers and plan sponsors can help simplify the decision that we have to make," she said.
For example, Mitchell worked with one company that simplified its fund menu from about 140 fund choices, down to about 40, including many target-date funds.
"That, interestingly, ended up with a fund menu that was actually identical to the preexisting one that had the same choices, in a sense, but there were fewer very expensive ones," she said. "And the result was, as we projected, people in the new plan who were defaulted into target-date funds if they didn't get out of their expensive prior plans, are going to be saving millions of dollars over the next 10, 20, 30 years. I think plan sponsors have an obligation to understand that what they offer is important, that design architecture matters."
The Best Advice: Create a Retirement Budget
What then are the one or two things that those saving for or living in retirement must do?
Having a budget is the first priority. "I actually think that the right place to start is with a potential budget, an expected budget," said Mitchell. "And that seems to be such an obstacle because people say, 'How do I know what I want to do in retirement?' But I think that the first place to start with designing a potential future retirement budget is to take stock of what you spend now. A lot of people have no idea what they spend now."
In her case, Mitchell uses a credit card to pay all her bills and she pays off the balance every month so that there's no interest expense. And the best part of this strategy is that helps her track where her money goes. "And so as long as you can be fairly controlled about the use of your credit card, you can track where your money goes." Then at the end of the year you'll have a sense of how much you spend on housing, health care, transportation and other expenses.
Besides calculating projected expenses in retirement, it's worth estimating and tracking retirement income: how much will you get from Social Security, from personal assets, from earned income and so on. "So, a budget to me is the beginning place for all calculations," said Mitchell. "And if you can't meet your budget, then you can either work longer, or you can claim your Social Security later, or you can start saving more in your retirement account -- or all three."
For more on the conference highlights, visit @PensionResearch on Twitter to see the conference highlights. Also read RetireSecure. And read Retirement Daily where we'll be writing about some of the presentations from the symposium.