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It’s a living thing

The world of retirement income planning is changing fast. On the surface, these changes are happening because of factors, including the closure of final-salary schemes, an extended period of market volatility and changing legislation. But a more fundamental and deep-rooted cause of these changes is taking place.

Across the world, people are living longer. To demonstrate how significant this development is, consider this. According to a study commissioned by HSBC, nearly half of the population of Western Europe will be over 50 by 2030 and have a life expectancy of over 90 years of age.

This means that people who retire in Western Europe at 65 can and will expect to live at least another 25 years. If people retire earlier, at 60, then the period of retirement planning will need to be over 30 years – roughly equal to three-quarters of an average working life.

Longer retirement is the core problem which governments, trustees of final-salary and DC occupational pension plans, pension providers and the man on the street must deal with. Governments, employers and insurance firms realise that they cannot easily cope with solving the core problem of generating enough long-term income for people in retirement.

The result is that there is an inexorable shift to push the responsibility for funding future income requirements increasingly towards the individual.

Living longer has created another problem. The longer people live and the better their health in retirement, the more people expect from their lifestyles in retirement. Active, retired people will spend more and need more income in retirement.

The combination of longer retirement and enhanced lifestyle expectations during retirement are not enough of a challenge. We also have the fast emerging issue of the costs of old-age healthcare to consider.

Modern medicine has helped to increase life expectancy but the requirement for periods of long-term care has added another requirement for enhanced income and capital access in retirement.

The complicated challenge cannot be solved easily. It seems to me that two key ingredients are essential to any viable long-term solution to funding these long-term income requirements – long-term saving rates must rise and savings must be actively managed to maximise the real returns required to provide long-term income security.

In the savings and investment arena, the active promotion of regular long-term savings seems to have been forgotten. Long-term savings, very often through regular contribution structures, allow two very powerful forces to combine:

l Savings become a habit and a savings culture developsl The power of compounded growthFor these two forces to become embedded, it is the responsibility of the fund management industry to provide real above inflation returns on savings.

There seems to be two key elements of providing real rates of return to long-term savers:

  • The need to retain equities as a key driver of performance in any long-term investment programme.

  • The ability to use modern financial engineering techniques to help limit the downside of shorter-term equity volatility.

    The case for equity investment seems very often to get drowned out by shorter-term performance and volatility arguments. Bonds and fixed-income investments have become more fashionable but we need to remind ourselves that over the medium and long term, equities have shown themselves as the key driver for real growth.

    In a world where the emergence of new economic powers and engines of economic growth are key, sharing in these developments through the equity markets is vital.

    Many people have real psychological problems with the downside risks during volatile times for equities. In the old days, with-profits solutions helped smooth these issues. Nowadays, we have a generation of structured product solutions to help cope with the dangers of volatility, timing and capital protection for the longer-term income needs in the modern world. The solutions are within our own hands.

    Robert Noach is director financial institutions group at Schroeders

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