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Gregg McClymont: Is engagement really the key to long-term savings?

The argument for engagement is seductive but what really matters is the behaviours among individuals it could create

In my last column, I discussed the evolution of behavioural economics and its basic assumptions about the way individuals think (or not) about the long term and react to gains and losses.

Put simply, people place a much greater value on jam today than jam tomorrow – even if it is more. And people feel much more deeply about the prospect of loss than they do the prospect of an equivalent or greater gain.

Loss aversion and short-termism have obvious and significant implications for long-term savings, especially in the context of the unanimous focus across the industry and policymakers on increased individual engagement.

Engagement, we are told from every quarter, is crucial to building a more efficient, sustainable long-term savings culture in the UK. But is it?

One can see why the concept is seductive. Increasingly, the risks of retirement – longevity risk, inflation risk, market risk, investment risk – are being handed over to individuals. The guarantee provided by defined benefits is in inexorable decline, and the real value of the state pension is set to reduce over time as the deliberate result of government policy (the new flat rate state pension).

If individuals are now carrying the retirement risks, surely they should be intimately involved in the decisions which manage and mitigate these risks? If we are witnessing the democratisation of risk, then individuals must surely exert the decisive influence over their money?

At the most basic level, this is obviously true. Individuals always have the right in a market to exercise exit, voice or loyalty, as Albert O Hirschman’s seminal work of economic and political theory famously describes. That is, to change providers, complain to the provider and demand improvement, or indeed happily remain with the provider.

The individual consumer makes judgments about the value for money received by weighing up quality, price and the opportunity costs of switching providers and/or complaining to their service provider.

The market mechanism works perfectly well across a whole range of enterprise and business-to-business sectors. Just look at the extraordinary increase in quality and reduction in price which has characterised the consumer electronics market across the last two decades. Or look at retail distribution more widely, as the online revolution transforms shopping. Or indeed the market for regulated financial advice as pricing models evolve from ad valorem to fee based.

But will this consumer engagement work effectively in long-term savings? Remember those behavioural biases and the way they interact with long-term savings products, the value of which is very hard to measure at any given moment in time across the lifecycle, before retirement.

More narrowly, we simply do not know how an army of engaged individuals will react to, say, the kind of market drawdown we see periodically in markets whether 2008, 1997, 1982, 1931 and so on. But we do know that people generally think short term, and about avoiding losses rather than seeking long-term gains, potentially leading to value-destroying exits at the bottom of the market across the various tax wrappers, whether pensions, Isas, EISs or VCTs.

This is an even greater risk when we consider the behavioural implications of the obvious fact stockmarkets do not rise to new highs every single day. Most of the time, one is underwater relative to our portfolio’s high water mark. In a sense, stocks are always playing mind games with us. They generally go up (based on history) but not every day, week, month or year.

This offers plenty of scope for loss aversion and short-termism to kick in on an individual basis. Just look at China and other markets where retail investors predominate and the market is characterised by greater volatility. This is why the Chinese authorities are so keen to institutionalise their stockmarket along developed market lines as a means to a more rational allocation of capital.

It would be a curious tale indeed if the UK passed China travelling in the other direction. But a more retail investment market is one road down which the religion of individual engagement leads. With the defined contribution pensions market alone set to grow threefold to £1trn by 2035, a 15-million strong army of engaged individual investors could be in the offing 20 years down the line.

This perhaps would not be a problem if regulated advice was widely purchased – after all, advisers coach their clients to ride out market bumps and stay invested. It is one of the many ways in which advice adds real value. But with the advice gap so wide, the downsides of greater individual engagement in the mass market loom large: namely big swings in sentiment, over-trading and higher volatility than is associated with institutional investing.

This example reminds us that engagement in itself is not a good or bad thing. What matters is the behaviours it drives.

Gregg McClymont is head of retirement at Aberdeen Standard Investments


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There are 3 comments at the moment, we would love to hear your opinion too.

  1. Refreshing to hear a former Labour MP and Shadow Minister acknowledging the positive contributions of market forces and competition … somebody please tell John McDonnell.

  2. Of course it is. Maybe not on its own but it has to be the foundation for everything else. I bet this bloke wrote a really boringly dense, long-winded and abstruse thesis for his university degree.

  3. Full of common sense and as a result there is no definitive conclusion.

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