Lingering Doubts?
In this book, I have set out a decumulation strategy that will keep you solvent even if you experience poor investment returns or live longer than you expected. And even if neither of these things happen, you will still do well with the enhancements I have described.
Yet, you might still have that small voice in the back of your head telling you this doesn’t feel quite right. After all, if these strategies are supposed to be so effective, why haven’t you heard about them before now? I hope this chapter puts your mind to rest.
If you put yourself in the shoes of Nick and Susan, you know you should be feeling much better about your retirement prospects after seeing the effect of the enhancements, but maybe that isn’t the case. Some of the enhancements admittedly go against the grain — especially CPP deferral and purchasing an annuity. As a result, you might be inclined to look for a reason to reject them. This could be true even if you cannot refute the arguments I have made in their favour. It is sort of like witnessing a magic trick that you cannot explain but still leaves you incredulous.
If this is where you’re coming from, the framing effect may have something to do with it. We all have preconceived notions of right and wrong. These notions are often useful in our lives, but sometimes they get in the way of our acting in our best interests. When it comes to decumulation, we should always make decisions that produce the best outcome, but this is often not what happens. The way a question or a problem is framed can dramatically affect how we respond to it.
Consider a classic experiment by psychologists Daniel Kahneman and Amos Tversky, two giants in the field of behavioural science. In the experiment, test subjects were told that 600 people have a disease for which there are two possible treatments: Treatment A and Treatment B. The subjects were divided into two groups and each group was given a different explanation of the treatments.
The subjects in Group 1 were told that Treatment A would save 200 lives. As for Treatment B, there was a 33-1/3-percent chance that everyone would be saved and a 66-2/3-percent chance that no one would be saved. Based on this explanation, 72 percent of the subjects in Group 1 chose Treatment A.
In the case of the subjects in Group 2, it was explained that 400 patients would die under Treatment A, while Treatment B offered a 33-1/3-percent chance that no one would die and a 66-2/3-percent chance that everyone would die. Given these facts, only 22 percent chose Treatment A!
Take a minute to wrap your mind around the question. The explanations are presenting precisely the same facts; they differ only in the choice of words. In theory, Group 1 and Group 2 subjects should respond the same way whether they heard the first explanation or the second, but that isn’t what happened. How a question is asked can fundamentally change our decision, even though the basic underlying facts are the same.
The framing effect has some major implications for retirement planning. Consider, for example, the natural aversion almost everyone has to annuities. Annuities don’t offer any flexibility if an emergency comes up and you need extra cash. In addition, they are a terrible choice if you die soon after buying one.12
Neither of these facts is in dispute. But consider members of public unions and their feelings about their defined benefit (DB) plans. Virtually every union member swears by his DB plan and wouldn’t give it up for the world. Non-union employees wish they had a DB plan and pension experts bemoan the fact that employers are shutting down the DB plans they used to offer. Everyone loves DB plans because they provide a completely predictable amount of income and they will pay that income for life.
The thing is, a DB plan is essentially the same thing as an annuity. The only difference is the words used to describe the two vehicles. This is another example of the framing effect at work.
Over time, we develop strong feelings about certain concepts, institutions, or products. Some we perceive as intrinsically good and others as equally bad. If your financial advisor asked you point-blank if you want to buy an annuity or defer your CPP pension, your answer would almost certainly be no. Alternatively, if she asks if you want to be sure you never run out of money during your lifetime, your answer would be yes. Her solution, though, might involve buying an annuity or deferring your CPP pension. By this point, the readers of this book should be able to get past the framing effect and be prepared to make use of all the available tools to achieve their financial goals.
If the decumulation ideas presented in this book are so effective, you might be wondering why you don’t hear much about them in the articles you read or from the financial advisors you know. That could be because there is a great divide between the academics and the practitioners in the field. The academics accept these ideas, but they tend not to communicate directly with the general public.
The Stanford Center on Longevity, in collaboration with the Society of Actuaries, prepared a guide for plan sponsors to help them implement defined contribution (DC) retirement programs.a While this was an American paper, the basic principles apply equally in Canada. The guide points out the value of deferring government-provided pensions and the role of annuities, two of the basic enhancements that we have analyzed at length in this book.
The Canadian Institute of Actuaries and its representatives have long recognized the importance of keeping fees low when saving for retirement (Enhancement 1). The Association of Canadian Pension Management (ACPM) has taken a leadership role in decumulation. In one paper, the ACPM addresses the issues of high investment fees in retail products, the purchase of annuities, and the merits of delaying CPP benefits.b Beyond that, a number of other Canadian academic papers deal with these issues and come to very similar conclusions.
The trouble is that these professional bodies and academics don’t seem to be connecting with retirees and so the message has not filtered down to the general public. This book is an attempt to change that.