Taken at face value, Dr David Blake’s claim that people should not start saving until age 35 may sound facetious but IFAs should warm to the theories of the professor of pension economics at the Cass Business School. This is because the starting point for his rigorous assault on DC pensions is that in an ideal world, we would all get access to top-class independent financial advice every time we needed to make a financial decision.
Blake’s ideas have on occasion been presented as outlandish and breaking with convention because his starting point is a theoretical one. His approach is to show what a rational investor, what he calls “a rational lifestyle financial planner”, would do if they made the right decision at every point in their life. He then sees what outcomes that produces and tries to create structures that can get as close to replicating that as possible.
His papers end up effectively describing what an individual would do if they had the world’s best IFA sitting on their shoulder every second of the day, forcing them to be rational.
In your 20s, therefore, he argues that you should spend and enjoy life because you have not got much money anyway and not doing so will not make much difference. But the flip side is that you have to pay 35 per cent of income into your pension from age 55. Just because nobody is ever going to do this does not mean it is not the optimal strategy, and according to Blake, his numbers suggest it is.
But it is probably his views on asset allocation that are more significant, in particular, how the millions of people relying on DC pensions for their retirement are currently being served by what the industry has to offer them. He argues that the move out of equities should start much earlier than the five to 10 years typical under current lifestyling arrangements. Yes, equities should outperform over a long period but the risk that they will not is a risk most people cannot afford to take, he argues.
People in their 40s, therefore, should have at least a small amount of bonds, which should increase gradually. But, unlike traditional lifestyling, they should not then go too far the other way and be put 100 per cent into bonds at the target retirement date. Instead, 20 to 50 per cent should be left in equities, depending on the individual’s attitude to risk.
So, once in the decumulation phase, the portfolio should be a mix of annuity, increasing with age as mortality drag increases, and equities that reduce with time. To this end, individuals should be signed up to products that phase annuitisation gradually but this should be done years in advance so they are pre-committed to the strategy rather than be forced to make complex decisions at retirement.
IFAs should also be feeling comfortable with Blake’s words on portfolio construction as his approach sounds rather like the blend of fixed interest and equities that many advisers would recommend to their drawdown clients.
But if the basic numbers behind Blake’s theory of how to achieve optimal investment outcomes are correct then members of DC pension schemes are being severely let down.
Of course, not everyone can afford to see an IFA. But with DC set to become the primary channel of retirement saving, it needs to be able to offer something closer to what advised clients are currently getting. Should employees with pots north of £100,000 be starting the wholesale switch into bonds in their 50s? Not without someone at least mentioning the alternatives.
New thinking is required in both the accumulation and the decumulation areas. Nest has already stirred things up in the pre-retirement phase and may do the same in decumulation. But product providers should not be waiting for a state-sponsored body to set the pace.
John Greenwood is editor of Corporate Adviser