Individual Financial Planning for Retirement: Empirical Insights from the Affluent Segment in Germany

Individual Financial Planning for Retirement

Contributions to Economics www.springer.com/series/1262 Further volumes of this series can be found at our homepage. Emilio Colombo/Luca Stanca Financial Market Imperfections and Corporate Decisions 2006. ISBN 978-3-7908-1581-8 Birgit Mattil Pension Systems 2006. ISBN 978-3-7908-1675-4

Lei Delsen/Derek Bosworth/Hermann Groß Rafael Muñoz de Bustillo y Llorente (Eds.) Operating Hours and Working Times 2006. ISBN 978-3-7908-1759-1 Pablo Coto-Millán; Vicente Inglada (Eds.) Essays on Transport Economics 2006. ISBN 978-3-7908-1764-5

Francesco C. Billari/Thomas Fent/ Alexia Prskawetz/Jürgen Scheffran (Eds.) Agent-Based Computational Modelling 2006. ISBN 978-3-7908-1640-2

Christian H. Fahrholz New Political Economy of Exchange Rate Policies and the Enlargement of the Eurozone 2006. ISBN 978-3-7908-1761-4

Kerstin Press A Life Cycle for Clusters? 2006. ISBN 978-3-7908-1710-2

Sandra Gruescu Population Ageing and Economic Growth 2007. ISBN 978-3-7908-1905-2

Russel Cooper/Gary Madden/ Ashley Lloyd/Michael Schipp (Eds.) The Economics of Online Markets and ICT Networks 2006. ISBN 978-3-7908-1706-5

Patrick S. Renz Project Governance 2007. ISBN 978-3-7908-1926-7

Renato Giannetti/Michelangelo Vasta (Eds.) Evolution of Italian Enterprises in the 20th Century 2006. ISBN 978-3-7908-1711-9

Christian Schabbel The Value Chain of Foreign Aid 2007. ISBN 978-3-7908-1931-1 Martina Eckardt Insurance Intermediation 2007. ISBN 978-3-7908-1939-7

Ralph Setzer The Politics of Exchange Rates in Developing Countries 2006. ISBN 978-3-7908-1715-7

George M. Korres (Ed.) Regionalisation, Growth, and Economic Integration 2007. ISBN 978-3-7908-1924-3

Dora Borbély Trade Specialization in the Enlarged European Union 2006. ISBN 978-3-7908-1704-1

Kerstin Groß Equity Ownership and Performance 2007. ISBN 978-3-7908-1933-5

Iris A. Hauswirth Effective and Efficient Organisations? 2006. ISBN 978-3-7908-1730-0

Ulrike Neyer The Design of the Eurosystem’s Monetary Policy Instruments 2007. ISBN 978-3-7908-1977-9

Marco Neuhaus The Impact of FDI on Economic Growth 2006. ISBN 978-3-7908-1734-8

Christian Roland Banking Sector Liberalization in India 2008. ISBN 978-3-7908-1981-6

Nicola Jentzsch The Economics and Regulation of Financial Privacy 2006. ISBN 978-3-7908-1737-9

Nicole Brunhart Individual Financial Planning for Retirement 2008. ISBN 978-3-7908-1997-7

Klaus Winkler Negotiations with Asymmetrical Distribution of Power 2006. ISBN 978-3-7908-1743-0

Bas van Aarle/Klaus Weyerstrass (Eds.) Economic Spillovers, Structural Reforms and Policy Coordination in the Euro Area 2008. ISBN 978-3-7908-1969-4

Sasha Tsenkova, Zorica Nedovi´c-Budi´c (Eds.) The Urban Mosaic of Post-Socialist Europe 2006. ISBN 978-3-7908-1726-3

Karin Luger Chinese Railways 2008. ISBN 978-3-7908-2001-0

Brigitte Preissl/Jürgen Müller (Eds.) Governance of Communication Networks 2006. ISBN 978-3-7908-1745-4

Christina Keinert Corporate Social Responsibility as an International Strategy 2008. ISBN 978-3-7908-2023-2

Nicole Brunhart

Individual Financial Planning for Retirement Empirical Insights from the Affluent Segment in Germany

Physica-Verlag A Springer Company

Series Editors Werner A. Müller Martina Bihn

Author Dr. Nicole Brunhart Kesslerstrasse 12 8702 Zollikon Switzerland [email protected]

This book is based on the dissertation ‘Individual retirement-specific financial planning behavior – with special consideration of the affluent segment in Germany’. It was submitted to the University of St. Gallen, Graduate School of Business Administration, Economics, Law and Social Sciences (HSG) as dissertation no. 3328 and approved in September 2007 on the application of Prof. Dr. Andreas Grünbichler and Prof. Dr. Beat Bernet.

ISBN 978-3-7908-1997-7

e-ISBN 978-3-7908-1998-4

DOI 10.1007/978-3-7908-1998-4 Contributions to Economics ISSN 1431-1933 Library of Congress Control Number: 2007942885 © 2008 Physica-Verlag Heidelberg This work is subject to copyright. All rights are reserved, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilm or in any other way, and storage in data banks. Duplication of this publication or parts thereof is permitted only under the provisions of the German Copyright Law of September 9, 1965, in its current version, and permission for use must always be obtained from Physica-Verlag. Violations are liable to prosecution under the German Copyright Law. The use of general descriptive names, registered names, trademarks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. Production: LE-TEX Jelonek, Schmidt & Vöckler GbR, Leipzig Cover-design: WMX Design GmbH, Heidelberg Printed on acid-free paper 987654321 springer.com

To my beloved parents Liz and Oskar Brunhart

Foreword

Individual long-term financial planning to ensure a secure financial situation in the old-age has gained substantial attention in the retirement discussion in industrialized countries. In the context of the shift of responsibility to the individual, the importance of personal retirement provision is not disputed. However, the questions often arise of whether the actual decisions and actions of individuals correspond to a theoretically ideal behavior and whether their attitudes and views mirror this new responsibility. To answer these questions, research needs to take a broader look at the topic of retirement provision and examine the perspectives and expectations individuals have for their pension-age financial situation as well as the actions they take in this respect. This is the path taken by the author of this work. Its results are not only of high relevance for the individual but also for the whole society, which ultimately is responsible for old-age provision and will have to bear its political and sociological implications. Based on a better understanding of the individual perspectives and the congruence or divergence between actual and ideal behavior, this work highlights the key considerations policymakers, financial planners and the individuals themselves should include in enabling, furthering and conducting retirement-specific financial planning. The significant contribution of this research is that it deals with both theoretical and empirical aspects of individual retirement provision. In the theoretical dimension, it presents an innovative framework for grouping insights from behavioral finance, allowing the consequent evaluation of their relevance to the issue of individual retirement-specific financial planning. Emerging from a convincing combination of insights into modern capital market theory, behavioral psychology and behavioral finance, the derived normative principles set a benchmark for individual retirementspecific behavior. With over 500 personal interviews – conducted among the German affluent segment – the author complements and tests this theoretical basis with empirical research. This novel approach empirically confirms and – to a large extent – even quantifies for the first time the generally presumed facts and typically human, irrational behaviors around individual retirement-specific financial

VIII

Foreword

planning. Therefore, this work provides very valuable insights for a future discussion on increasing individual responsibilities for retirement provision, the problems associated with longevity, and the reforms of state pension systems. This book is a must read for the financial planning community, policy makers and last but not least for all of us who sooner or later have to deal with this important issue. St. Gallen, September 2007 Prof. Dr. Andreas Grünbichler

Prof. Dr. Beat Bernet

Acknowledgements

This dissertation project has been a challenging but at the same time rewarding endeavor. Throughout the process, a number of individuals contributed to its development, progress and success. I would like to extend my gratitude to the many people and institutions that were involved in shaping and finalizing this work. First of all, I would like to thank my academic supervisor, Prof. Dr. Andreas Grünbichler, for supporting this project and specifically for the fast review that allowed for a timely publication. A special thank you also goes to my second academic supervisor, Prof. Dr. Beat Bernet. His support and valuable input helped to shape this study substantially. My appreciation also goes to Dr. Klaus Edel for his continuous help in econometric questions. I would like to thank my employer, McKinsey & Company, for giving me the opportunity to participate in the European “Retirement Initiative”. This work let me apply my academic retirement-specific behavioral finance knowledge in practice and allowed me to collect the raw data that served as the basis of this thesis. Also, I would like to thank McKinsey for supporting me in my educational leave while offering me the opportunity to work part-time. The person who deserves my deepest gratitude for his unconditional support and commitment is my future husband, Dr. Beat Bachmann. Our extensive discussions have proven to be very fruitful to this dissertation and have substantially shaped and advanced it. Apart from sacrificing a lot of our joint time to this effort, Beat supported me with love and comprehension and also kept an eye on my discipline when the going got though. A very big thank you goes to my editor, Carolyn Relihan. With her untiring, critical and constructive reading, she has substantially shaped the crispness of my messages and thus contributed significantly to the quality of this work. Many other individuals contributed to this thesis: Foremost, I thank my family, in particular my parents Liz and Oskar Brunhart. Besides supporting my education, they have always provided a loving and encouraging environment that allowed me to pursue my interests and to develop into the person I am today. Furthermore, I would like to express my gratitude

X

Acknowledgements

towards Renato Fasciati, Dr. Viola Markert and Prof. Dr. Thomas Berndt, who encouraged me along the way. I would also like to offer a big thank you to all my other friends who shared with me the “ups and downs” of my dissertation and on whom I could always count. Finally, I am deeply indebted to the Truss and Gerrit Van Riemdijk trust in Liechtenstein for the financial contribution to publish this dissertation. Zurich, September 2007

Nicole Brunhart

Abstract

Demographic shifts and behavioral changes are putting increasing pressure on today’s public pension systems. A new reality is emerging, characterized by a high level of uncertainty and a shift of responsibility to the individual. In this context the question arises whether people are assuming this responsibility and adopting adequate financial planning behavior (FPB) to secure their financial situation in retirement. The objective of this study is to investigate individual retirementspecific financial planning behavior of the German affluent segment. Specifically, this research aims for an improved understanding of individuals’ expectations regarding their life and their financial situation in retirement (FP perspectives). Furthermore, it explores how people actually carry out financial planning for retirement (FP actions) and whether their behavior corresponds to recommended principles. The study investigates whether individuals show adequate retirement-specific financial planning behavior and in which areas their behavior demonstrates limitations. Based on these findings, suggestions to improve individual retirement-specific financial planning behavior are derived for policy-makers, financial planners and the individual. This study centers on questions of personal finance, taking into consideration elements from behavioral finance, modern portfolio theory and other research. The empirical validation is based on standardized interviews with over 500 German affluent individuals, aged 45 to 70 years. The interviewees were grouped into different investor types, based on similar fundamental characteristics implying comparable financial situations and challenges in retirement. The results of the study indicate that the German affluent segment is meeting only some of today’s retirement challenges (e.g., they are prepared for compromises on the expense side, understand diversification benefits, and show high risk awareness). However, there are serious limitations that need to be addressed, such as a blurred perception of reality, unrealistic financial planning, belated start of financial planning, a lack of risk mitigation and sub-optimal portfolio choices. Differences occur between investor types: While wealthy and self-employed individuals show an active and more appropriate FPB, investor types with specific risks

XII

Abstract

(e.g., poor health, limited education) need content-related and motivational support. To improve individual FPB, policy-makers need to provide the appropriate background (e.g., a financial planning standard, mandatory retirement seminars) and the right incentives (e.g., financial planning support decreasing over time, confrontation with pension eligibility). Financial planners need to make limitations visible and illustrate possible solutions by incorporating typical human behaviors in the advisory process and supporting individuals in risk and asset management. However, it is the individual who needs to assume his responsibility and change his behavior by improving his knowledge, conducting conscious financial planning and adapting his vision of retirement flexibly to the respective needs.

Table of contents

1 Introduction.............................................................................................1 1.1 Motivation and background of the study .......................................... 1 1.2 Review of existing research..............................................................5 1.3 Knowledge aim and research questions............................................ 6 1.4 Research objectives and structure of the thesis ................................ 8 1.5 Demarcation and contribution ........................................................11 2 Frame of reference and conceptual approach for the analysis of individual retirement-specific financial planning behavior ............. 13 2.1 The individual financial optimization problem ..............................13 2.2 FP perspectives and FP actions: the components of individual FPB................................................................................................. 25 2.3 Conceptual approach for the analysis of individual retirementspecific FPB ................................................................................... 35 2.4 Summary of the frame of reference and the conceptual approach..42 3 Fundamentals of the retirement system in Germany ........................ 43 3.1 Demographic developments in Germany .......................................44 3.2 The German pension system...........................................................51 3.3 Summary of the fundamentals of the retirement system in Germany ......................................................................................... 73 4 Retirement-specific behavioral finance and derivation of benchmark behavior for FP actions ................................................... 75 4.1 Relevance of behavioral finance to the study of individual retirement-specific FPB.................................................................. 76 4.2 The standard economic theory of decision-making and its adaptation to behavioral finance.....................................................78 4.3 Behavioral finance adaptations of additional FPB relevant theories ......................................................................................... 114 4.4 Postulated benchmark behavior for individual FP actions ...........117 4.5 Summary of retirement-specific behavioral finance and the derivation of benchmark behavior for FP actions ........................ 134

XIV

Table of contents

5 Investor retirement survey and outlook on empirical analyses about individual retirement-specific FPB ........................................ 137 5.1 Operationalization of research-specific FP perspectives and FP actions........................................................................................... 138 5.2 Investor retirement survey as chosen observation instrument ...... 150 5.3 Identification of different investor groups with a particular capability for risk.......................................................................... 161 5.4 Structure of the empirical analyses for the examination of the conceptual approach ..................................................................... 175 5.5 Summary of introduction to investor retirement survey and empirical analyses ........................................................................ 176 6 Empirical analyses of individual retirement-specific FPB.............. 179 6.1 Pooling of investor groups and characterization of the newly defined homogenous investor types ............................................. 179 6.2 Analysis of investor type specific FP perspectives....................... 199 6.3 Analysis of investor type specific FP actions and comparison to benchmark behavior ................................................................. 250 6.4 Scenario analyses for adequate saving rates ................................. 277 6.5 Summary of the empirical analyses of individual retirement-specific FPB................................................................ 302 7 Review of empirical research and identification of suggestions for policy-makers, financial planners and the individual............... 305 7.1 Review of identified FP perspectives ........................................... 306 7.2 Review of gaps identified in individual retirement-specific FP actions........................................................................................... 311 7.3 Summary of individual retirement-specific FPB profiles for the five investor types................................................................... 313 7.4 Suggestions for policy-makers, financial planners and the individual...................................................................................... 322 7.5 Summary of the review of empirical research and identification of suggestions for policy-makers, financial planners and the individual...................................................................................... 354 8 Conclusion ........................................................................................... 357 8.1 Summary of results....................................................................... 358 8.2 Assessment and critique of this study........................................... 362 8.3 Further research questions ............................................................ 363

Detailed table of contents

Foreword ................................................................................................ VII Acknowledgements ................................................................................. IX Abstract ................................................................................................... XI Table of contents .................................................................................. XIII Detailed table of contents ...................................................................... XV 1 Introduction.............................................................................................1 1.1 Motivation and background of the study .......................................... 1 1.2 Review of existing research..............................................................5 1.3 Knowledge aim and research questions............................................ 6 1.4 Research objectives and structure of the thesis ................................ 8 1.5 Demarcation and contribution ........................................................11 2 Frame of reference and conceptual approach for the analysis of individual retirement-specific financial planning behavior ............. 13 2.1 The individual financial optimization problem ..............................13 2.1.1 Life-cycle hypothesis as theoretical basis for the intertemporal financial optimization problem ..............................14 2.1.2 Financial flows and risks relevant to individual retirementspecific FPB ..........................................................................19 2.1.3 Model for the individual inter-temporal financial optimization problem ............................................................ 22 2.2 FP perspectives and FP actions: the components of individual FPB................................................................................................. 25 2.2.1 General perspectives on financial planning........................... 25 2.2.2 Individual retirement-specific FPB and its two components as research focus.................................................................... 27 2.2.3 FP perspectives: the first component of individual retirement-specific FPB......................................................... 30

XVI

Detailed table of contents

2.2.4 FP actions: the second component of individual retirementspecific FPB .......................................................................... 34 2.3 Conceptual approach for the analysis of individual retirementspecific FPB ................................................................................... 35 2.4 Summary of the frame of reference and the conceptual approach.. 42 3 Fundamentals of the retirement system in Germany ........................ 43 3.1 Demographic developments in Germany ....................................... 44 3.2 The German pension system........................................................... 51 3.2.1 Overall set-up ........................................................................ 52 3.2.1.1 The first pillar: Compulsory state pension, also called statutory state pension (SSP) ...........................55 3.2.1.2 The second pillar: Occupational pension scheme (OPS) .........................................................................59 3.2.1.3 The third pillar: Voluntary personal pensions (VPP) .61 3.2.2 Status of pension reforms ...................................................... 62 3.2.3 The German statutory state pension benefit formula............. 67 3.3 Summary of the fundamentals of the retirement system in Germany ......................................................................................... 73 4 Retirement-specific behavioral finance and derivation of benchmark behavior for FP actions........................................................................ 75 4.1 Relevance of behavioral finance to the study of individual retirement-specific FPB.................................................................. 76 4.2 The standard economic theory of decision-making and its adaptation to behavioral finance.....................................................78 4.2.1 Standard economic theory of decision-making ..................... 78 4.2.2 Step 1: “Normal” perception of reality.................................. 80 4.2.2.1 Faulty probability assessments based on prominent past information........................................81 4.2.2.2 Positive bias ...............................................................84 4.2.3 Step 2: “Normal” decision making........................................ 87 4.2.3.1 Prospect theory...........................................................87 4.2.3.2 Limited cognitive abilities..........................................92 4.2.3.3 Portfolio segregation ................................................102 4.2.3.4 Complexity aversion ................................................105 4.2.4 Step 3: “Normal” implementation of actions ...................... 107 4.2.4.1 Passivity ...................................................................107 4.2.4.2 Lack of self-control ..................................................110 4.2.4.3 Home bias.................................................................112 4.2.4.4 Regret .......................................................................113

Detailed table of contents

XVII

4.3 Behavioral finance adaptations of additional FPB relevant theories ......................................................................................... 114 4.3.1 Behavioral finance adaptation of the life-cycle hypothesis .114 4.3.2 Behavioral finance adaptation of the modern portfolio theory................................................................................... 116 4.4 Postulated benchmark behavior for individual FP actions ...........117 4.4.1 Benchmark behavior: Start of financial planning activities 119 4.4.2 Benchmark behavior: Overall understanding of the individual financial situation in retirement ......................... 121 4.4.3 Benchmark behavior: Holding of classical pension savings products .................................................................. 124 4.4.4 Benchmark behavior: Diversification.................................. 127 4.4.5 Benchmark behavior: Risk-return profile of the personal asset portfolio ......................................................................130 4.4.6 Benchmark behavior: Risk mitigation .................................132 4.5 Summary of retirement-specific behavioral finance and the derivation of benchmark behavior for FP actions ........................ 134 5 Investor retirement survey and outlook on empirical analyses about individual retirement-specific FPB ........................................137 5.1 Operationalization of research-specific FP perspectives and FP actions...........................................................................................138 5.1.1 Operationalization and measurement specifications of socio-demographic and socio-economic attributes .............138 5.1.2 Operationalization and measurement specifications of FP perspectives.................................................................... 141 5.1.3 Operationalization and measurement specifications of FP actions ............................................................................147 5.2 Investor retirement survey as chosen observation instrument ......150 5.2.1 Choice of the target group ................................................... 151 5.2.2 Introduction of the observation instrument.......................... 155 5.2.3 Structure, content and formal characteristics of the questionnaire .......................................................................157 5.2.4 Realization of the investor retirement survey...................... 160 5.3 Identification of different investor groups with a particular capability for risk.......................................................................... 161 5.3.1 Introduction of investor groups with a lower than average risk capability ......................................................................164 5.3.2 Introduction of investor groups with a higher than average risk capability ......................................................................169 5.3.3 Assignment of individual interviewees to different investor groups .................................................................... 172

XVIII

Detailed table of contents

5.4 Structure of the empirical analyses for the examination of the conceptual approach ..................................................................... 175 5.5 Summary of introduction to investor retirement survey and empirical analyses ........................................................................ 176 6 Empirical analyses of individual retirement-specific FPB.............. 179 6.1 Pooling of investor groups and characterization of the newly defined homogenous investor types ............................................. 179 6.1.1 Suggested pooling of investor groups with a lower than average risk capability......................................................... 181 6.1.2 Suggested pooling of investor groups with a higher than average risk capability......................................................... 187 6.1.3 Characterization of the resulting five investor types ........... 191 6.2 Analysis of investor type specific FP perspectives....................... 199 6.2.1 Analysis of the planned life in retirement ........................... 200 6.2.1.1 Planned timing of retirement....................................200 6.2.1.2 Individual life plans..................................................202 6.2.1.3 Individual coping strategies .....................................205 6.2.1.4 Financial objectives in retirement ............................207 6.2.2 Analysis of the financial view on life in retirement ............ 209 6.2.2.1 Analysis of the expense side (income needs) in retirement .............................................................210 6.2.2.2 Analysis of the income side in retirement ................215 6.2.2.3 Analysis of the retirement gap based on individually estimated income and expense streams.........221 6.2.2.4 Comparison of retirement gap with feeling of financial preparedness for retirement.......................224 6.2.3 Analysis of the transaction preferences ............................... 228 6.2.3.1 Preferences for information gathering and decision making .......................................................228 6.2.3.2 Decision preferences in the family context ..............230 6.2.4 Analysis of the risk profile .................................................. 231 6.2.4.1 Analysis of self-assessed risk appetite .....................231 6.2.4.2 Analysis of risk sophistication .................................236 6.3 Analysis of investor type specific FP actions and comparison to benchmark behavior ..................................................................... 250 6.3.1 Comparative analysis: Start of financial planning activities .............................................................................. 250 6.3.2 Comparative analysis: Overall understanding of the individual financial situation in retirement ......................... 253 6.3.3 Comparative analysis: Holding of classical pension savings products .................................................................. 262

Detailed table of contents

XIX

6.3.4 Comparative analysis: Diversification................................. 264 6.3.5 Comparative analysis: Risk-return profile of the personal asset portfolio........................................................ 267 6.3.6 Comparative analysis: Risk mitigation................................ 273 6.4 Scenario analyses for adequate saving rates ................................. 277 6.4.1 Different conceptions of the retirement gap ........................ 280 6.4.2 Analytical derivation of the saving rates required to cover the wealth-adjusted statutory state retirement income gap..284 6.4.3 Scenario analyses for implications of different assumptions on the required saving rate.............................. 290 6.4.4 Scenario analysis combining impact of different levers on the financial situation of the Limited-wealth Risk-groups ..293 6.4.5 The longevity risk or the investigation of the duration of a secured retirement financing ............................................ 295 6.4.6 Comparative analysis with stated saving rates ....................298 6.5 Summary of the empirical analyses of individual retirementspecific FPB ................................................................................. 302 7 Review of empirical research and identification of suggestions for policy-makers, financial planners and the individual............... 305 7.1 Review of identified FP perspectives ...........................................306 7.1.1 Planned life in retirement .................................................... 306 7.1.2 Financial view on life in retirement..................................... 308 7.1.3 Transaction preferences....................................................... 309 7.1.4 Risk profile .......................................................................... 309 7.2 Review of gaps identified in individual retirement-specific FP actions...........................................................................................311 7.3 Summary of individual retirement-specific FPB profiles for the five investor types................................................................... 313 7.3.1 Key findings about the Retirees........................................... 313 7.3.2 Key findings about the Limited-wealth Risk-groups........... 315 7.3.3 Key findings about the Limited-wealth Self-employed.......317 7.3.4 Key findings about the High-potential ................................ 318 7.3.5 Key findings about the Wealthy .......................................... 319 7.3.6 Comparative positioning of all five investor types.............. 320 7.4 Suggestions for policy-makers, financial planners and the individual...................................................................................... 322 7.4.1 Key limitations in individual retirement-specific FPB........323 7.4.1.1 Limitation #1: Over-optimistic perception of one’s own financial reality.......................................323 7.4.1.2 Limitation #2: Unsophisticated planning of retirement cash-flows...............................................324

XX

Detailed table of contents

7.4.1.3 Limitation #3: Late start of financial planning for retirement ...........................................................326 7.4.1.4 Limitation #4: Low risk mitigation despite high risk awareness ..................................................326 7.4.1.5 Limitation #5: Sub-optimal portfolio choices ..........327 7.4.2 Guiding principles to enhance individual retirementspecific FPB ........................................................................ 329 7.4.3 Suggestions for policy-makers seeking to improve individual FPB .................................................................... 334 7.4.4 Suggestions for financial planners seeking to improve individual FPB .................................................................... 343 7.4.5 Suggestions for the individual seeking to improve individual FPB .................................................................... 348 7.5 Summary of the review of empirical research and identification of suggestions for policy-makers, financial planners and the individual...................................................................................... 354 8 Conclusion ........................................................................................... 357 8.1 Summary of results....................................................................... 358 8.1.1 Investor-type specific findings ............................................ 358 8.1.2 Most substantial limitations................................................. 360 8.1.3 Improvement levers for policy-makers, financial planners and the individual................................................................ 361 8.2 Assessment and critique of this study........................................... 362 8.3 Further research questions ............................................................ 363 Appendix................................................................................................. 367 List of symbols........................................................................................ 411 Abbreviations ......................................................................................... 413 Bibliography........................................................................................... 415 Index ....................................................................................................... 439

1 Introduction

1.1 Motivation and background of the study “How is it that people are motivated to go to a doctor, but not motivated to go to a financial counselor” if individuals are ultimately responsible for their own financial health? BOWDITCH 2005, p. 610 The quote above touches on two central and divergent aspects of individual financial planning behavior for retirement: The lack of motivation to engage in financial planning and the increasing responsibility of the individual for his 1 financial situation in retirement. These observations triggered the author’s interest in researching individual retirement-specific financial planning behavior (FPB); encompassing both the perspectives an individual has on his financial situation in retirement and the specific financial planning actions this individual takes. The simultaneous investigation of these two aspects of individual retirement-specific FPB is becoming increasingly important in the academic world and in practical life as the relevance of financial provision for retirement is rising for the individual, companies, policy-makers, and for society as a whole. The subject is growing in importance because the historical assumptions and realities that once ensured an adequate individual financial situation in retirement have changed. Specifically, public pension schemes based on Pay-As-You-Go (PAYG) systems that leverage a favorable demographic distribution are under pressure. The major driving force for this pressure is the demographic shift that influences population distribution and leads to a rapidly aging society. A primary cause of this demographic shift is a significant increase in life-expectancy: While in Shakespeare’s time at the be1

The masculine form has been used throughout the document to increase the easiness of reading but it relates to both men and women.

2

1 Introduction

ginning of the 17th century, a person could expect to live for 25 to 30 years, in 1950 life-expectancy for a German male at birth was 65 years. This figure had risen to 75 years in 2001, and will increase further to 81 years by 2050. 2 Another major influence on demographics has been fertility, which has decreased substantially and, in most societies, has even dropped below the replacement level: While a German woman had on average 2.1 children in 1950, this rate had dropped to 1.4 by the year 2000. These two effects have led to a substantial aging of the population and the latter will – if it persists – also cause the overall population to shrink in the future. 3 Migration, a third factor that influences population distribution, will not be able to compensate for this trend, even with the net migration flows in Germany ranking second in size world-wide. 4 As a consequence, the old-age-dependency ratio, i.e., the share of pension recipients (individuals aged 65 and older) relative to the contributors (individuals aged 20 to 64) has risen dramatically and will continue to rise. In Germany, this dependency ratio increased from 16% in 1950 to 28% in 2001. With the transition of the birth-intensive generation of the baby boomers into retirement, the dependency ratio will experience another boost and will reach 55% by 2050. This means that in the next 50 years, the ratio of workers to pensioners will be halved. Two social phenomena that reduce the working population and thus the pool of potential pension contributors further reinforce the problems associated with the demographic shift. On the one hand, people devote more time to education and thus enter the workforce later, while on the other hand they leave the workforce sooner due to early retirement. In Germany, for example, the average retirement age for men has dropped from 62.2 years in 1980 to 61.0 in 2000. 5 In combination with rising life-expectancy, the impact of a reduction in the average retirement age leads to a significant growth in the number of years spent in retirement and for which pension funding is needed. A historic example illustrates this: When Otto von Bismarck introduced old-age pensions in 1889, the retirement age was 70

2

3

4

5

For detailed indications about the demographic developments in Germany refer to sub-chapter 3.1. Base data is originally provided by the German Statistical Federal Office as well as PÖTZSCH/SOMMER 2003. The peak of the German population is expected for the year 2012 with 83m individuals. Thereafter, the population is expected to shrink. See STBA 2003a. The UNPD 2005 expects German migration to amount to 202,000 individuals annually, second only to the US. This corresponds to 2-3% of the population. In order to keep the working population constant until 2025, however, the net migration would have to be over 7%. See REIMANN 2006, p. 18. See WEF 2004, p. vi and xix.

1.1 Motivation and background of the study

3

and the expected time spent in retirement was six months. 6 In 2000, the average number of years people spent in retirement in Germany was 22 years and will rise to over 25 years by 2030. 7 The increasing pressure on the retirement systems has triggered a wide array of measures and reform proposals. They include steps to increase the pool of pension system contributors, 8 better leverage of capital markets 9 and recommendations for changes in the design of pension systems. 10 Overall, the growing pressure and the different measures and reforms underway lead to a shift of responsibility to the individual and increase the insecurities associated with the individual financial situation in retirement. Sociological research indicates that there are problems with such a shift of responsibility: To start with, ageing nowadays has very different characteristics as the new generation of retirees has a much more active lifestyle and thus requires more funding for retirement than its predecessors. 11 In addition, society’s average level of consumption has been increasing. This trend is caused partially by consumption-inducing financial innovations such as novel consumer credit and mortgage models, and partially by a change in lifestyle and an ever improving standard of living. 12 As a result, many individuals overstretch their financial means before retirement and thus do not save for their old age. Recent research supports these findings. 6

See DIA 2006f, p. 1 and BIEDENKOPF 2005. According to AXA 2006b the average life-expectancy at birth was 49 years in 1889. See AXA 2006b, p. 4. 7 See WEF 2004, p. vii. 8 These measures, for example, include increasing the retirement age or raising immigration levels, encouraging reproduction or fostering the preferential inclusion of new “people pools” (e.g., groups that traditionally have had low workforce participation such as working-age women, younger retirees, and young adults). See WEF 2004, p. xvii. 9 Examples for these capital market related measures include using capital market innovations such as structuring of products with derivatives and debt securitization or a wider asset allocation choice for pension funds that allow for risk sharing and the development of new solutions with enhanced risk and return characteristics. See for example the presentation by GRÜNBICHLER 2004b, SHILLER 2003 or the collection from MITCHELL/SMETTERS 2003. 10 For example, the increasing push for corporate and private pension provisions (pillar II and pillar III) or the change from DB to DC systems. 11 See DYCHTWALD 1999, DYCHTWALD et al. 2004, FRICK 2005, STAIB 2005 or BERNET 2005b. 12 KROEBER-RIEL/WEINBERG 1996 for example describe a trend to addicted shopping and consumption behavior that builds on an obsessive motivation to buy quickly but leads only to very short-term satisfaction feelings. It can be perceived in an unreasonable use of credit cards. See KROEBER-RIEL/WEINBERG 1996, p. 158f.

4

1 Introduction

It shows that individuals’ willingness to save has deteriorated and that an ever growing share of the population is relying more on inheritance 13 or social security as a retirement income stream than on the proceeds of their own savings. 14 In the US, for example, there has been a substantial reduction in the saving rate. From a level of 12.3 percent in 1950, the net saving rate declined to 3.5 percent in 1994, 15 decreased further until 2002 16 and has been negative since the third quarter of 2005. 17 Furthermore, the returns on savings are threatened as the large generation of retirees shifts away from risky assets and thus could potentially cause an “asset meltdown”. 18

13

Today’s generation of retirees owns a significant share of the capital stock (in the US, today’s mature are controlling $7 trillion, about 70% of the total capital stock). See DYCHTWALD et al. 2004, p. 50. They will transfer a significant amount of this to the next generation, expected to be the largest “money in motion” transfer ever known. See HUNT et al. 2005. However, the next generation is expected to consume most of their assets due to their high consumption level and as they have to finance part of their retirement with their inheritance money. Therefore, they might leave a minimal amount as inheritance to their descendants, which accordingly have been termed “the Lost Generation”. See BERNET 2005b, p. 56ff and BERNET 2005a, p. 27f. For Germany, BRAUN et al. 2002 illustrate that 15.1m households (corresponding to 40% of all German households) will inherit assets of 8.1m households in the range of €2.0 trillion. They expect values of bequests to decrease starting from about 2020. See BRAUN et al. 2002, p. 3f. 14 This effect is even more accentuated if the expected hike in health care costs that are only partially borne by the insurances is taken into consideration. 15 See GOKHALE et al. 1996, p. 1. 16 See COTIS et al. 2004, p. 21. 17 Partially induced by the negative wealth effect on the real estate markets, the latest numbers indicate an increase in the saving rate from -0.8% to -0.2% in August/September 2006. See HOFMANN 2006, p. 2. 18 An asset meltdown stands for the effect that the value of certain assets is distorted due to demographic developments. This phenomenon was observed initially in the housing market where the demographic shifts led to significant distortions in prices. Prices rose substantially when a large share of the population was in their 20-30s, as in that period, the demand for housing is most pronounced, increasing only modestly until 40. Since the focus on accumulation of financial wealth is most accentuated between 40 and 64, prices of financial goods might be similarly affected as the generation of the baby boomers falls in that age category. See BORGMANN 2005, p. 3ff and BERNET 2005a, p. 28. According to BÖRSCH-SUPAN et al. 2003 the macroeconomic return in Europe will be reduced by 1% due to this asset meltdown effect if diversification is maintained. See BÖRSCH-SUPAN et al. 2003, p. 4.

1.2 Review of existing research

5

The increase of the old-age-dependency ratio at the macro-level, combined with the sociological and behavioral changes at the individual level, lead to the conclusion that existing pension solutions are likely not to meet the needs of today’s society anymore. In short, those facing retirement will be challenged by new realities and associated risks. Here the central question emerges whether the individual assumes his increased responsibility for providing for his financial situation in retirement and whether he acts accordingly. Therefore, an analysis of how an individual thinks about his financial situation in retirement and how he carries out effective financial planning actions as well as the extent to which his actions correspond to how he should prepare for a secured financial retirement is of profound interest. This micro-level perspective on individual FPB is at the heart of this study.

1.2 Review of existing research Significant research has been conducted at the micro level, focusing on individuals’ financial preparation for retirement. Their saving and asset allocation behavior within pension plans such as 401(k) has been widely investigated. 19 Different design options for pension plans such as automatic enrollment or specific set-ups like the SMarT plan 20 have been evaluated for their effect on contribution and saving rates. Also, incentives for specific retirement behavior within existing pension schemes (e.g., early re19

This research was conducted mostly in the context of 401 (k) plans as well as the introduction of private accounts in Sweden. See the collection from MITCHELL/UTKUS 2004b, CHOI et al. 2002 or CRONQVIST/THALER 2004. 20 The SMarT plan is a concept for saving within DC plans defined by THALER/ BENARTZI 2004 in order to overcome shortcomings in the saving rate resulting from behavioral tendencies. The SMarT plan builds on four key elements that represent (re-)commitment devices: First, individuals are approached about committing savings with a time lag to the salary increase; second, the saving rate is increased for the first time with the pay raise; third, with every further pay raise, the saving rate is increased dynamically; fourth, all individuals have the option to opt out of the plan at any time. With these features it builds on the behavioral tendencies of lack of self-control, inertia, hyperbolic discounting and money illusion described in sub-chapter 4.2. THALER/BENARTZI 2004 found that participants who chose to join and stay in the plan had higher saving rates than everybody else, even those who did not contact the financial consultant and were (mostly) already saving a lot, or those to whom the financial consultant had suggested an individual, initially mostly higher, saving rate based on their needs. See THALER/BENARTZI 2004, p. 174.

6

1 Introduction

tirement) have been analyzed. 21 Most of this research uses US data, whereas European evidence is rather limited. Notable exceptions are the analysis of individual allocation choices in the context of second-tier mandatory individual accounts, the Premium Pension in Sweden 22 and A. Börsch-Supan’s extensive research on the saving behavior of the German population. 23 Overall, these findings have been used to improve the design of pension products and programs, to evaluate proposed reforms and to create incentives for individuals to save more. However, this research reveals an incomplete picture since it focuses mostly on saving and asset allocation choices and does not provide a holistic understanding of people’s behavior with regard to financial provision for retirement. For example, it does not simultaneously address individual perspectives and world views on life in retirement, the acknowledgment of personal responsibility for retirement provision as well as timing aspects of the financial planning process. To fill out the picture and close this research gap, the present study takes a more widely defined and integrated perspective on individual FPB. It complements findings from behavioral finance with sociological research and modern portfolio theory on the basis of an empirical survey conducted with over 500 individuals in Germany.

1.3 Knowledge aim and research questions “There is a worldwide trend toward defined contribution saving plans and growing interest in privatized Social Security plans. In both environments, individuals are given some responsibility to make their own asset allocation decisions, raising concerns about how well they do at this task.” BENARTZI/THALER 2001, p. 79 This thesis expands the focus of existing behavioral finance research in the area of retirement provision and centers on the analysis of a more broadly researched individual retirement-specific FPB. This investigation, using theoretical and empirical sources, encompasses two elements: Financial 21

See for example BÖRSCH-SUPAN et al. 2004. See CRONQVIST/THALER 2004. Other relevant research includes PALME et al. 2004 or CRONQVIST 2003. 23 See for example BÖRSCH-SUPAN/WILKE 2004, BÖRSCH-SUPAN/ESSIG 2002, BÖRSCH-SUPAN et al. 2003, BÖRSCH-SUPAN et al. 2005. 22

1.3 Knowledge aim and research questions

7

Planning (FP) perspectives and FP actions. The FP perspectives stand for the expectations and mental constructs individuals have about their life and, specifically, their financial situation in retirement. The FP actions relate to process decisions and portfolio choices in the context of financial planning for retirement. The perspective of this study is the micro-level and individual behavior as opposed to macroeconomic implications. Since individual behavior varies substantially depending on the social background and circumstances of the individual, the focus of this study is limited to the 45- to 70-year-old German affluent segment (i.e., individuals with investable assets between €150k and €1,400k). Since different fundamental characteristics such as education, employment status and wealth are assumed to influence individual behavior, the analyses are conducted separately for various investor types with distinct profiles. The knowledge aim 24 of this study is to investigate the behavior of individuals with regard to financial planning for retirement and to identify levers to improve it via an understanding of the different FP perspectives as well as FP actions. Particularly as regards the latter, the knowledge aim of this study is to examine the extent to which effective FP actions correspond to the principles for retirement-specific financial planning, derived from findings from behavioral finance, modern portfolio theory and practitioners’ advice. For the most pronounced deviations between FP actions and behavioral benchmarks or the most important limitations in the FP perspectives, the thesis aims at outlining measures that policy-makers, financial planners and also the individuals themselves can take to improve individual retirement-specific FPB. On the basis of this knowledge aim, the following research questions that determine the flow of the analyses and the structure of the thesis are put forward: 1. What inter-temporal financial optimization problems do individuals face with regard to their retirement?

24

The knowledge aim sets out the aim of the research as well as the expected research results. According to BERNET 1982, research aims can have a theoretical and a pragmatic part, both of which are closely linked and relevant to this study. While the theoretical part focuses on the description of the research object, its elements, structures and processes, and then integrates them in a cause-effect relationship, the pragmatic part seeks to transfer the knowledge gained into actionable recommendations and thus shape human reality. See BERNET 1982, p. 18ff.

8

1 Introduction

2. What are the key elements of FPB and its two components, FP perspectives and FP actions, that influence an individual’s financial situation in retirement? 3. Which investor types with similar socio-demographic and socioeconomic characteristics can serve as vehicles for analysis? 4. Which principles and thus behavioral benchmarks for individual FP actions can be derived from established concepts such as behavioral finance and modern portfolio theory and also from practitioners’ advice? 5. What do actual FP perspectives and FP actions of the different investor types look like and how do they differ from the derived behavioral benchmarks? 6. What levers exist to improve individual FPB at the level of policymakers, financial planners and the individual? Overall, the study is positioned in the area of finance research, accentuated by the inclusion of modern portfolio theory and practitioners’ advice. With its elements of behavioral finance and complemented as it is by empirical trend analysis, it also touches on aspects of psychological and sociological research. In terms of methodology, the study is set in the area of social empirical research. 25

1.4 Research objectives and structure of the thesis To accomplish the knowledge aim and answer the research questions above, the study is organized along three research objectives. These three research objectives build on each other and determine the overall structure of the study. The first research objective is to develop the frame of reference for individual FPB, introducing the study-specific definitions and a conceptual approach to accomplish the knowledge aim. Furthermore, it gives an overview of the macroeconomic background in which this study is set. The second research objective is to establish the normative basis for 25

This placement in empirical and application-oriented research determines the quality standards and exigencies for this research study. The term “empirical” – with its original Greek meaning “based on experience” – indicates that the systematic analysis of experiences is central to this study since generally acceptable results can be verified or falsified based on experience. See BORTZ/DÖRING 2002, p. 7 and STIER 1996, p. 4ff. The quality of these generally acceptable results depends on their practical applicability and how well they can be used in actual decision processes. See ULRICH 1981, p. 4f, 10.

1.4 Research objectives and structure of the thesis

9

the study, by identifying retirement-specific findings from behavioral finance and deriving principles for FP actions that can be considered as behavioral benchmarks. Building on this normative basis, the third research objective focuses on the empirical dimension of the study. It consists of the empirical analysis of retirement-specific FPB for different groups of individuals with homogenous characteristics. It aims to illustrate actual individual FPB and identify the gap between recommended and actual FP actions. It also strives to derive suggestions for improvements of individual FPB at the level of policy-makers, financial planners and the individual. Fig. 1.1 illustrates the structure of the thesis. Introduction

1. Introduction to the research study

Frame of reference for the analysis of individual retirement-specific FPB (Research objective I)

2. Conceptual approach for the analysis of individual retirement-specific financial planning behavior 2.1 Characterization of the individual financial optimization problem

2.2 Introduction of FP perspectives and FP actions as two pillars of individual FPB

2.3 Conceptual approach for an enhanced understanding of retirement-specific FPB

3. Fundamentals of the retirement system in Germany Derivation of benchmark behavior for FP actions (Research objective II)

4. Retirement-specific behavioral finance and derivation of benchmark behavior for FP actions

Empirical analysis of actual individual retirement-specific FPB and derivation of implications: Similarities between investor groups, analysis of FP perspectives and comparison of actual and recommended FP actions for different investor types, identification of levers to enhance FPB (Research objective III)

5. Introduction to empirical analyses and investor survey on individual retirement-specific FPB

4.1 Relevance of behavioral finance for retirement-specific FPB 4.2. Decision theory

5.1 Operationalization of attributes

4.3. Behavioral life-cycle hypothesis and portfolio theory

5.2 Investor retirement survey

4.4 Principles and thus behavioral benchmarks for individual FP actions

5.3 Investor groups with particular risk capability

5.4 Overview of analysis structure

6. Empirical analyses of individual FPB (Empirical part) 6.1 Pooling of investor groups to investor types and description of socio-demographic and socioeconomic profile

6.2 Analysis of investor type specific FP perspectives

6.3 Comparison of investor type specific actual FP actions with behavioral benchmarks

6.4 Scenario analyses for adequate saving rates

7. Review of research and implications for different stakeholders 7.1 Review of FP perspectives

7.2 Review of FP actions and gaps

7.3 Investor type specific findings

7.4 Implications for policy-makers, financial planners and individuals

Conclusion

Fig. 1.1

Structure of the thesis

Chapter 1 provides an entry point to the topic of individual retirementspecific financial planning behavior (FPB) and gives an overview of the study. Chapter 2 corresponds to Research Objective I. It represents the basis for this research study since it aims to establish the frame of reference for individual retirement-specific FPB. To achieve a common understanding of the kind of decisions individuals face about their financial situation in retirement, the individual inter-temporal financial optimization problem is characterized first. Then the study’s definition of individual retirementspecific FPB is explained with its two elements, FP perspectives and FP

10

1 Introduction

actions. The third part of this chapter discusses the analytical model that highlights how the research questions are addressed and which research areas influence this thesis. It represents the conceptual approach to accomplishing the knowledge aim. Chapter 3 then presents the fundamentals of the retirement system in Germany with a specific focus on the demographic situation, the three pillars and the statutory state retirement benefits. This sets the stage for the later discussions of theoretical and empirical findings. Chapter 4 is dedicated to Research Objective II and provides the normative base for the study as it leads to the formulation of principles for FP actions. First, it establishes the relevance of behavioral finance for the topic of individual retirement-specific FPB by highlighting the different behavioral tendencies in the context of the decision theory. Then it presents the behavioral adaptation of the life-cycle hypothesis and the modern portfolio theory. Combined with selected elements of modern portfolio theory and practitioners’ advice, the findings from behavioral finance are leveraged to derive principles for FP actions that are used as benchmark behavior in this study. Chapters 5 to 7 focus on Research Objective III, encompassing the empirical analysis of actual FP perspectives and FP actions and the extrapolation of corresponding suggestions. Chapter 5 starts with the operationalization of the research questions and introduces the measurement specifications for the research-specific understanding of FP perspectives and FP actions. Then the introduction of the investor retirement survey establishes the base for the empirical analysis with a detailed discussion of the target group of this study. After that, the logic for group classification of investors is put forward and the application of these rules to individual interviewees is discussed. Finally, an outlook is presented on the structure of the empirical analyses that follow. Chapter 6 sets out the results from the empirical analyses of individual retirement-specific FPB. It starts with the description of the different investor groups and pools them into homogenous investor types based on similar socio-demographic and socio-economic attributes. Next, the actual FP perspectives of the different investor types are highlighted, before actual FP actions are analyzed and compared to the behavioral benchmarks for FP actions from the normative part. To establish the link to the individual financial optimization problem, the financial situation of the average representative of each investor type is simulated to determine the adequate saving rate and compare actually stated and recommended saving rates. Chapter 7 builds on these results and reviews the empirical research. It starts by summarizing the key insights from the FP perspectives and the gaps identified in FP actions. Furthermore, it gives a short overview of the

1.5 Demarcation and contribution

11

FPB-profile of each investor type. Drawing on this knowledge, the five most critical areas of individual retirement-specific FPB are highlighted together with a few examples of adequate behavior. Then guiding principles are defined that describe the overall approach for improving individual retirement-specific FPB. Building on these guiding principles, measures are set out that policy-makers, financial planners and the individual can leverage to improve the quality of individual retirement-specific FPB. Chapter 8 concludes this research study with a short summary of the findings, offers an assessment and critique of the study and gives an outlook on potential further research questions.

1.5 Demarcation and contribution Focusing as it does on the micro-level, this study does not intend to evaluate different pension systems or give macro-level recommendations for their improvement. Neither does it strive to compare individuals in different macro-economic environments. Furthermore, since the focus of this study is on the characteristics of individual behavior rather than external stimuli, the effect of different regulations, tax regimes and also specific pension products will not be analyzed in detail. The topic of health system is excluded since this warrants a study of its own. The intent of this research is to help policy-makers, financial planners and the individual to better understand the characteristics and limitations of individual retirement-specific FPB. Specifically, the aim is to identify typical patterns in human behavior with regard to financial planning for retirement, the corresponding pitfalls and the deviations between recommended and actual behavior. By increasing the awareness of these human behaviors and their limitations, making them more transparent and illustrating ways to overcome them, this thesis hopes to give an indication of the areas where policy-makers, financial planers and the individual can improve the process of individual financial provision for retirement. Furthermore, the study aspires to increase the understanding of investor types and so to foster the development of tailored support for their retirement provision. Ultimately, this research strives to improve individual retirement-specific FPB and thus to contribute to a better financial situation in retirement for the individual and correspondingly the society as a whole. Finally, a cautionary note needs to be made regarding the applicability of the research results to the individual. All findings of this research have been developed for investor types that represent an aggregation of many different individuals. Therefore, the findings cannot be applied directly to

12

1 Introduction

an individual without a detailed assessment of his relevant personal situation. Specifically, the model used for deriving the retirement gap and recommended saving rates (i.e., the simulation model presented in subchapter 6.4) relies on a number of assumptions and is purely illustrative. In order to get a clear picture of the economics of the individual financial situation in retirement and to determine the extent of a possible retirement gap, a detailed analysis of an individual’s (financial) situation, his perspectives and actions as well as the respective tax, regulatory and macroenvironment is required. Such a detailed analysis however represents the logical outcome of individuals assuming responsibility for providing for their retirement, e.g., by assuming a conscious financial planning approach, and policy-makers and financial planners supplying the adequate support that this study will advocate.

2 Frame of reference and conceptual approach for the analysis of individual retirement-specific financial planning behavior

“If a large subset of the working population fails to take an active interest in retirement planning, retirement plans that rely on participants’ voluntary decisions will be limited in their ability to assure retirement security.” MACFARLAND/MARCONI/UTKUS 2004, p. 114 The frame of reference for this study provides the background for the analyses and statements about individual retirement-specific FPB. It consists of three elements: First, the inter-temporal financial optimization problem that individuals face with regard to financial planning for retirement is introduced. Second, financial planning as the major tool for financial provision in retirement and the study-specific definition of FPB with its two components, FP perspectives and FP actions are discussed. Finally, as a third element, the conceptual approach of the study is presented. It illustrates the overall analytical concept to accomplish the knowledge aim of this study.

2.1 The individual financial optimization problem The analysis of individual retirement-specific FPB is closely linked to the understanding of the problems and trade-offs individuals face with regard to their financial situation in retirement. The basic trade-off between consumption of assets before and after retirement through saving builds on the life-cycle hypothesis and the corresponding budget constraint. The first section of this sub-chapter derives the theoretical basis of the inter-temporal financial optimization problem. It introduces the life-cycle hypothesis with its budget constraint and utility optimization criterion. The second section discusses the specific financial flows and risks that are relevant for the specific inter-temporal financial optimization problem at

14

2 Frame of reference and conceptual approach

the center of this research. Finally, the third section presents a model that combines the logic of the budget constraint of section one with the financial flows introduced in section two. This model of the inter-temporal financial optimization problem is used in sub-chapter 6.4 for the simulation analysis to quantify a potential retirement gap for specific groups of individuals and accordingly derive the saving rate required to cover the gap. 26 2.1.1 Life-cycle hypothesis as theoretical basis for the intertemporal financial optimization problem Differences in timing of an individual’s income and expense streams make it necessary to shift income between periods in order to finance consumption. As a consequence it is necessary to consciously manage and plan financial flows across the different life stages. At the heart of this financial planning stands the life-cycle hypothesis with its budget constraint that leads to an inter-temporal financial optimization problem. The standard life-cycle hypothesis, dating back to the work of ANDO/MODIGLIANI 1963, is based on the concept that the different in- and outflows need to even out over the life-time of an individual. Therefore, the sum of an individual’s life-time income – called life-time wealth (LW) – sets the limit for his life-time consumption and thus represents his budget constraint. 27 If an individual’s lifespan extends to L periods (with L being the expected life-time), the income stream during this time is given by yt = (y1,y2,…,yL). Life-time wealth is then the sum of these incomes. L

LW = ∑ yt

(2.1)

t =1

Life-time wealth calculation With LW yt

Life-time wealth Income stream in period t

Source:

SHEFRIN/THALER 1988, p. 612

26

Such a model could also be used for the analysis of how individuals ought to take decisions to solve their financial retirement issues. This research stream, which lies out of scope of this study, is known as “decision theory” and has, among others, been followed by LINDLEY 1990. 27 For simplification, a perfect capital market and zero real interest rates are assumed. See SHEFRIN/THALER 1988, p. 611.

2.1 The individual financial optimization problem

15

Analogously, the consumption or expense stream is given by ct = (c1,c2,…,cL). Based on the assumption that the life-time wealth sets the limit for the consumption stream, Equation 2.2 describes the budget constraint. L

L

t =1

t =1

LW = ∑ ct = ∑ y t

(2.2)

Budget constraint for life-time consumption With ct

Expense stream in period t

Source:

Analog to Shefrin/Thaler 1988, p. 612

Individuals are facing an inter-temporal optimization problem when they have to allocate their life-time wealth to consumption in the different periods and to determine the required period-specific saving rate. The problem’s optimization criterion is to maximize the utility from the consumption pattern over the entire life-time. In the standard life-cycle theory “households are assumed to want to smooth consumption over the life-cycle and are expected to solve the relevant optimization problem in each period before deciding how much to consume and how much to save.” 28 Here, smoothing does not mean “keeping consumption or expenditures constant […] Rather, smoothing means that agents try to keep the marginal utility of money constant over time, which may involve quite variable expenditures.” 29 As a consequence, the model predicts that an individual should borrow prior to labor market entry, accumulate wealth – or save – during working life and dissave in retirement. 30 In that sense, the life-cycle model is thought to do a reasonable 28

THALER/BENARTZI 2004, p. 165. BROWNING/CROSSLEY 2001, p. 4. 30 ROSENBERG 2004 provides a comprehensive definition of saving as the mechanism that allows shifting consumption possibilities between periods: Saving is “the difference between disposable personal income and personal consumption expenditures; [it] includes the changes in cash and deposits, security holdings, indebtedness, reserves of life-insurance companies and mutual savings institutions, the net investment of unincorporated enterprises, and the acquisition of real property net of depreciation.” Rosenberg 2004, p. 311. This definition highlights that an increase in net real estate assets is considered as saving, an aspect that should be kept in mind in comparing saving rates between different countries. Furthermore, it is important to note that an increase in credits leads to a reduction of the saving rate, whereas paying off credits is considered as saving.

29

16

2 Frame of reference and conceptual approach

job of explaining patterns of household saving behavior even if research shows that the assumptions of the homo economicus 31 inherent in the standard life-cycle theory do not hold. 32 The idea of a smooth consumption profile and a life-time consideration that induces individuals not to take their consumption decisions based on their actual income but on their expected life-time income can also be found in the permanent income hypothesis dating back to FRIEDMAN 1957. 33

The saving rate is defined as the ratio of personal saving to disposable personal income. Disposable personal income is specified as personal income less personal tax and non-tax-payments. See DOWNES/GOODMAN 1998, p. 534. 31 The homo economicus is used in traditional economic analyses. He is assumed to be a calculating, unemotional maximizer that is self-interested and rational. Without taking fairness, loyalty or the framing of decisions into consideration, he takes optimal decisions by rationally analyzing only the risk and reward profile. Building on the utility function of VON NEUMANN/MORGENSTERN 1947 that assigns different levels of utility to the various possible outcomes, the homo economicus always chooses the action with the highest expected utility. Optimization is thus his most powerful tool, deferral of consumption his sole motive for saving. See MULLAINATHAN/ THALER 2000, p. 1, THALER 1995, p. 9 or KAHNEMAN et al. 1986, p. 285. 32 It has been shown that the standard assumptions about the homo economicus do not hold as individuals show deviations from rationality in terms of actions and judgments. For example, research has shown that individuals are not frame-invariant (e.g., the success of automatic enrollment plans for the saving rate shown by MADRIAN/SHEA 2001) or that they are acting on the basis of mental accounts and are not invariant to the self-control problem. See SHEFRIN/THALER 1988, p. 610. Also, they do not discount exponentially with a constant discount rate but apply hyperbolic discounting functions. See LAIBSON 1997. With regard to the specific assumptions of the standard life-cycle theory, it has been shown that post-retirement consumption is lower than pre-retirement consumption and thus households do not manage to smooth consumption across the retirement threshold. See BANKS et al. 1998. Furthermore, the assumption that saving rates are “independent of income […]is completely unsupported by the data, which shows that consumption very closely tracks income over individuals’ life-cycles.” MULLAINATHAN/THALER 2000, p. 8. Furthermore, it has been shown that deferral of consumption is not the only motive for saving but rather leaving an inheritance is also an important motive. 33 The idea of the permanent income hypothesis is that individuals will smooth their consumption based on their permanent (i.e., the anticipated, expected) income, which encompasses both the physical and human income streams. If individuals get an unexpected transitory income increase, this will not influence their consumption in the long run. See FRIEDMAN 1957.

2.1 The individual financial optimization problem

17

Fig. 2.1 illustrates the typical development of income and consumption streams as well as the accumulation of wealth over the life-cycle of an individual. It gives a more realistic perspective than that of the standard lifecycle theory and can be considered as largely representative for the individuals analyzed in the context of this study. Monetary units (scale for income and consumption)

Monetary units (scale for wealth) Consumption level (alternative scenario) Consumption level (traditional scenario) Income

Wealth (traditional scenario) Wealth (alternative scenario) Life-time 0

10 Youth

20

30

Post adolescence

t = 1,2,…, R Saving period

Fig. 2.1

40 Establishment

50

60

Family R phase

70

80

Pension life

t = R+1,…,L Dissaving period

L

R = Retirement age L = Expected life-time

Illustration of financial flows and development of wealth stock over the life-cycle of a typical individual

The figure depicts the income stream starting with the first job, the consumption level (in the traditional scenario a smoothly increasing and thereafter decreasing line) and the accumulation of wealth over time. 34 These three elements correspond to the typical financial flows as an individual progresses through his life-cycle. While the wealth level is typically zero during youth, it becomes negative in the post adolescence phase when individuals tend to borrow money to buy a home and consumption thus exceeds income. In the establishment and family phases, individuals typically increase their consumption level, but since the income is growing over proportionately in this time, they manage to save (e.g., through paying

34

The individual lines have to be seen as conceptual and do not presume the same scale.

18

2 Frame of reference and conceptual approach

back mortgages or investing in stocks) and thus build their wealth stock. 35 Saving generally rises with income and age and is also positively associated with education and total wealth. 36 With the advent of retirement, income typically drops substantially. 37 In parallel, consumption usually decreases due to, for example, reduced expenditures for transportation and clothes. 38 An important factor is also that children are out of the home and no longer require support for education. 39 In most cases the decrease in consumption is lower than the drop in income. As a consequence, consumption in retirement generally exceeds income and thus makes it necessary to use the wealth stock to finance the resulting consumption gap, which corresponds to dissaving. In reality, this form of model-like dissaving used to be less common in recent history for two reasons. First, due to favorable macroeconomic and demographic conditions, the drop in income at retirement has historically not been as pronounced as the graph indicates and as is expected for the future. 40 Second, the drop in consumption during retirement used to be more pronounced and showed a decreasing profile over time due to a more modest and less active lifestyle of retirees. Such a decreasing consumption pattern is displayed with the traditional scenario. As a consequence, in the past it was not unusual that retirees were even able to continue to save and further increase their wealth stock. 41 35

The finding that the saving rate increases with the income level has also been demonstrated by DIAMOND/HAUSMAN 1984, DAVIES 1981 and MIRER 1979. 36 See MITCHELL/UTKUS 2006, p. 83. 37 Work income is then replaced with retirement income. Considering the income from statutory state pension as sole income stream, the replacement rate of state pension income originally designed as corresponding to 70% of pre-retirement income and dropping to 52% of net income by 2050 (as illustrated in Figure 34) largely determines this drop. 38 The distribution of expenses by age cited by REIMANN 2006 shows that relative to the expenses in the age groups 34-45, the expense profile for individuals aged 65 and older shows an increase in healthcare costs and hobby-related expenses, while the expenses for transport, education and clothes are reduced. See REIMANN 2006, p. 33. 39 See EISENBERG 2006, p. 35. 40 Certain individuals have historically even reached income levels that corresponded to their average pre-retirement income levels. An OECD survey has shown that in Germany in the mid 80s the disposable income of individuals aged 65 to 74 was over 80% of the income of the entire adult population (individuals aged 18 and over) and that this ratio increased to over 90% by the mid 90s. See OECD 2001, p. 27. 41 Evidence for continuing saving activity of retired individuals has been demonstrated by MIRER 1979 and DIAMOND/HAUSMAN 1984. German evidence can be found at BÖRSCH-SUPAN et al. 1999.

2.1 The individual financial optimization problem

19

In light of the new realities for today’s retirees (e.g., the decrease of state retirement provision, and the changes in saving patterns and consumption behavior), an alternative scenario for the financial situation in retirement needs to be considered. In such a scenario, consumption in retirement is rising, 42 and exceeds retirement income even more, leading to a much faster decline of the wealth stock. As a consequence, the share of the wealth stock that was historically not consumed and thus left over for inheritance gets used up and eventually individuals even run the risk of oldage poverty. The probability of this unconventional scenario is increased if individuals plan tightly (i.e., intend to leave only a minimal reserve or inheritance at the end of the expected life-time and correspondingly determine their yearly “expense allowance”) and at the same time substantially underestimate their life-expectancy. Especially the latter phenomenon is increasingly observed in Germany, where a survey has revealed that 60year-old men tend to underestimate their life-expectancy by around 5 years on average and women by around 5.5 years. 43 2.1.2 Financial flows and risks relevant to individual retirementspecific FPB This study breaks the individual life-time into two periods; pre- and postretirement. According to the typical financial flows described above, the pre-retirement period is called saving period, while the post-retirement period is called dissaving period. Due to the increase in life-expectancy in combination with the trend to a decrease in the retirement age, the dissaving period nowadays makes up almost a third of an individual’s life. Thus, the time horizon for which financial planning for retirement is required has been extended substantially. 42

HÖLLGER/SOBULL 2001 emphasize the increase in consumption in retirement as they state that today’s generation of retirees, the so-called “young old”, are part of the “consumption society”: When they still have a good health, they have a lot of time for traveling, cultural and social activities that are quite costly given that they have gotten used to a certain level of comfort and convenience. When the health level decreases, costs will increase due to medications and treatments as well as the use of special care and all kind of services. See HÖLLGER/SOBULL 2001, p. 39. The impact of a higher standard of living on an increasing consumption pattern is also confirmed by an empirical survey that states that “higher standards of living mean that what had been a satisfying retirement in the past may be viewed as insufficient in the future.” AXA 2006b, p. 21. 43 See BÖRSCH-SUPAN et al. 2005, p. 18. For younger individuals this effect is less pronounced.

20

2 Frame of reference and conceptual approach

The income and expense streams in the saving and the dissaving periods need to be analyzed to come up with an optimal plan to secure the financial situation in retirement. Analogous to the findings from the life-cycle hypothesis, these income and expense streams determine the budget constraint. The nature of the different flows is shown in Fig. 2.2. Saving period

Expense streams/use of wealth and investments

Fig. 2.2

Ongoing income streams, e.g., • Work income • Other income sources (e.g., second job) • Income from assets (e.g., financial investments, rental property) Singular income streams/sources of wealth, e.g., • Inheritance, donations, etc. • Proceeds from the sale of property or from maturing of financial products (e.g., structured or fixed income products)

Dissaving period

• State pension income • Private/corporate pension income • Income from other sources (e.g., savings, continued work, property, investments)

• Pension capital/lump sum payments • Proceeds from the sale of property or from Retirement

Income streams/ sources of wealth

•

RetireOngoing expense streams/investments, e.g., ment • Steady living expenses • • Temporarily increased living expenses (e.g., support of children’s education) • • Regular savings • Singular expense streams/investments, e.g., • Discretionary spending (e.g., buying property, large holidays, surgery, presents) • • Investments (e.g., buying of life insurance) •

maturing of financial products (e.g., life insurance) Inheritance, donations, etc.

Steady living expenses Temporarily increased living expenses (e.g., retirement home) Continued savings Discretionary spending (e.g., donations) Investments (e.g., buying of insurance against longevity)

Overview of financial flows in the saving and dissaving period to be included in individual retirement-specific financial planning

Fig. 2.2 highlights the income side with the different kind of income streams and sources of wealth as well as the outflow side with the expenses and use of wealth or investments that are relevant for the intertemporal financial optimization model developed below. In order to account for differences in the frequency of financial flows, regular ongoing financial streams are distinguished from singular financial flows or changes in the wealth level. This distinction is also relevant with regard to the propensity to consume associated with different “mental accounts”. 44 44

Mental accounts stand for cognitive activities that individuals engage in to serve the same function that regular accounting serves in an organization. Mental accounts lead to different propensities to consume certain mental pots of wealth. SHEFRIN/THALER 1988 have found that “the elderly appear to spend money from their income account more readily than they draw down their assets, especially their housing wealth. Again this appears to represent voluntary behavior rather than capital market imperfections” as adequate products such as reverse

2.1 The individual financial optimization problem

21

Besides flows and assets, another important consideration with regard to financial planning for retirement needs to be addressed: Financial flows can only be planned or estimated with a certain probability since they are subject to macro-economic conditions as well as various risks. Therefore, the respective income and expense streams need to be assessed according to the Value at Risk concept including considerations about the impact of various risks. 45 Three risk types can influence the financial position of an individual in retirement: First, financial risks need to be taken into consideration. These risks are related to the development of capital markets (e.g., inflation, market performance) or individual factors such as the lack of sufficient diversification of a portfolio. Second, system inherent risks such as the changes of the pension systems or other alterations in the regulatory environment can become relevant. The illustrations about the German pension system in Chapter 3 will show the substantial impact reforms of an existing regulatory framework can have. The agreed increase in the official retirement age to 67 years, as well as the planned decrease in retirement income will, for example, substantially reduce an individual’s income from statutory state pension and need to be considered accordingly. A third risk type treats personal risks. These risks include issues about the health status and correspondingly the need for special care of the individual or persons for whom the individual is responsible. Also, a person’s health status can influence his ability to work. 46 The most important personal risk however is associated with an individual’s life-time. The above illustrations show the importance that the estimated life-time plays in planning for retirement, as it determines the duration of the dissaving period and, thereby, the time for which financial security is needed.

mortgages are available. SHEFRIN/THALER 1988, p. 633. See sub-section 4.2.3.3 on mental accounting. 45 Value at Risk can be understood “to mean the maximum loss or lowest gain which could occur at a given confidence level over a specified horizon, and it is based on both expected return and standard deviation.” KRITZMAN 2003, p. 173. 46 The model of life-cycle investing illustrated in SPREMANN 1995 explicitly includes an individual’s human capital (future income from work) besides the financial capital (wealth stock and its growth) as part of his total assets and also considers his liabilities to provide for his retirement. See SPREMANN 1995, p. 120.

22

2 Frame of reference and conceptual approach

2.1.3 Model for the individual inter-temporal financial optimization problem As demonstrated by the life-cycle hypothesis, income and expense streams represent the two sides of the budget constraint. Combining this logic with the financial streams presented in Fig. 2.2, the study-specific model for the inter-temporal financial optimization problem can be derived. It is described in Equation 2.3. Expense/ consumption side

L

⎛

t =R

⎝

CPI R

∑ ⎜⎜ e * CPI t

* (1 + rt ) −(t − R ) + Δwt *

t

Discounted value of expenses during retirement

Income side

L

⎛

t=R

⎝

CPI R

∑ ⎜⎜ sp * CPI t

⎞ CPI R CPI R * (1 + rt ) −(t − R ) ⎟⎟ + wL * * (1 + rt ) −( L − R ) = CPI t CPI L ⎠

Discounted value of wealth reductions during retirement

* (1 + rt ) −( t − R ) + opt *

t

Discounted value of state pension income

Discounted value of wealth at the expected end of life (inheritance)

Asset flows during retirement

⎞ CPI R CPI R * (1 + rt ) −( t − R ) + Δwt * * (1 + rt ) −( t − R ) ⎟⎟ CPI t CPI t ⎠

Discounted value of other pension income

Discounted value of positive changes in wealth (e.g., inheritance) (2-3)

Discounting Life

R 0

10

20

30

40 50 Forecasting

60

70

80

L

R −1 ⎞ ⎛ CPI R CPI R CPI R * (1 + rt ) R −t + ost * * (1 + rt ) R −t + wt * * (1 + rt ) R −t ⎟⎟ + ∑ ⎜⎜ as t * CPI t CPI t CPI t t =1 ⎝ ⎠

Future value of annualized and other investments during work life

Asset flows during work life

Future value of wealth in t (t
Individual inter-temporal financial optimization problem as model for retirement-specific financial planning With t R L CPIt rt et ast ost wt spt opt

Year t Retirement age Expected life-time Consumer price index for year t Real discount rate or forecasting rate for year t Nominal expenses (ongoing or singular) for year t Annualized savings for year t (labor incomet – consumptiont) Other savings/investments for year t (labor incomet – consumptiont) Wealth level in year t or changes of wealth ( ) in year t Nominal state pension income for year t Nominal other pension income for year t (e.g., private pension, employer-based retirement income, or income from wealth)

2.1 The individual financial optimization problem

23

The first line of the equation represents the expense side while the second and third line stand for the different sources of income that can be used to finance expenses in retirement. The expense side of the equation depends on the different outflows highlighted above. They are, on the one hand, driven by the life goals an individual has for his retirement. These life goals include an individual’s general living costs, specific activities he plans for retirement and also compromises in lifestyle he is willing to make (e.g., cutting back expenditures in some areas) (et). On the other hand, the planned outflows depend on the financial aims an individual envisages for retirement. If, for example, someone wants to leave an inheritance (wt) or make a donation ( wt), this represents part of the planned expenses and thus needs to be covered with corresponding financial assets. The means required to realize the life goals as well as the financial aims in retirement represent thus the expense side of the equation that can be considered as consumption. A total of four income streams and wealth pots can be used to finance consumption in retirement. They represent the income side of the equation. The first source of financing is the individual wealth stock that has been accumulated during work life and is available upon retirement (wt, ast, ost). This pot of wealth encompasses e.g., specific saving products (e.g., unitlinked life-insurance), financial investments or property. It usually represents the most important source of financing for individuals who were able to save during their work life. 47 The second source of financing is an increase in the wealth stock during retirement through e.g., donations, inheritances received or support payments from younger members of the family ( wt). Bearing in mind that – as mentioned above – in Germany 15.1m or 40% of all German households will inherit the asset base of 8.1m households, amounting to approximately €2.0 trillion, 48 this represents a substantial source for financing the expenses in retirement for the next generation of retirees. The third and fourth sources of financing are ongoing income streams in retirement. The third source relates to employer-based pensions or private pension programs (opt). While in Germany the importance of these income streams on the total average retirement income is still limited to 5% and 47

As it is the purpose of this study to derive how much individuals are required to save annually in addition to their (already invested) wealth level in order to secure their retirement financially, the “annualized savings” (ast) have been introduced as separate measure in addition to the more irregular savings (ost). 48 See BRAUN et al. 2002, p. 3f. The fact that an unprecedented amount of wealth is projected to change hands is especially important for the HNWI since the aging in that segment is particularly pronounced.

24

2 Frame of reference and conceptual approach

10% respectively, their importance is expected to increase in the future as the income from state pension is reduced and more responsibility is shifted to the individual. 49 The fourth income stream is the statutory state pension provision (spt). While this source makes up around 80% of an average earner’s retirement income, its overall amount is limited and an income of €2,000 per month should be considered as high. Since all these different inflows and outflows occur in different periods, they need to be translated into monetary values at one specific moment in time. This moment is set at the beginning of retirement, R. As a consequence, all income streams and expenses in the post-retirement period need to be discounted back to R, while all the income streams and elements of wealth in the pre-retirement period need to be projected to R. To show the impact of inflation and allow for the illustration of later flows in real terms relative to today’s buying power, the base model distinguishes explicitly between real discount and growth rates and the effect of inflation measured through the change in the Consumer-Price-Index (CPI). As mentioned above, the different risk types (capital market, personal and regulatory) need to be taken into consideration, for example, through a Monte Carlo Simulation that helps to determine the probability distribution of certain outcomes and can be integrated in a Value at Risk concept. The model derived in this sub-chapter needs to be considered under the criterion of maximization of perceived utility: On the one hand, a secure financial position in retirement leads to a perceived level of utility. A financial situation can be considered as secured if the income allows covering the living expenses of the planned lifestyle (i.e., helps to realize the life goals) and at the same time ensures the achievement of the financial aims given the different risks as well as the personal and macro-economic circumstances. On the other hand, saving in the saving period is linked to the deferral of consumption and thus a reduction in the perceived utility. Therefore, an optimal financial plan takes into consideration this reduction in perceived utility, compares it to the utility derived from the secured financial position in retirement and determines the saving requirements so that the resulting overall utility is maximized. The model displayed in Equation 2.3 represents a quantitative perspective on an individual’s financial situation in retirement and will also be used in the simulation of a possible retirement gap in sub-chapter 6.4. With an understanding of the inter-temporal financial optimization problem in place, the topic of the next sub-chapter is the derivation of the studyspecific understanding of FPB and the definition of these elements through 49

See for example STIEFERMANN 2005, p. 8 and PEAPE 2004, p. 24f.

2.2 FP perspectives and FP actions: the components of individual FPB

25

which individual retirement-specific FPB will be analyzed. In that analysis, the quantitative perspective is complemented with qualitative elements.

2.2 FP perspectives and FP actions: the components of individual FPB This sub-chapter provides a general introduction on the concept of financial planning. Based on the obtained findings, it then derives the studyspecific understanding of individual FPB and its two components, FP perspectives and FP actions. 2.2.1 General perspectives on financial planning There are a variety of commonly acknowledged definitions of financial planning. Since they all highlight different aspects, it is essential to give an overview of the most important components of financial planning. The key purpose of financial planning is described by the Certified Financial Planner (CFP) Board of Standards, the governing board of the world-wide association of financial planners: “Financial planning is the process of meeting your life goals through the proper management of your finances. […] Financial planning provides direction and meaning to your financial decisions.” 50

This statement highlights the achievement of individual life goals as the ultimate objective of financial planning. At the same time, these life goals represent the key starting point for financial planning activities. So, identifying individual life goals and complementing them with the respective financial objectives, as describe above, should ideally initiate each financial planning process. According to the Dictionary of Personal Finance, the financial objectives will differ for each person, depending on his circumstances, goals, attitudes and needs. SIEGEL/SHIM/HARTMAN 1992 list the following broad categories of financial objectives:

50

CFP 2004, p. 1.

26

2 Frame of reference and conceptual approach 1. “Protection against financial loss from personal risks such as death, disability, or unemployment 2. Capital accumulation for emergencies 3. Provision for retirement income 4. Reduction of taxes 5. Estate planning 6. Investment and property management“ 51

Building on these financial objectives, also called economic goals, the Dow-Jones Irwing dictionary of Financial Planning describes the process of financial planning used for the realization of these goals. “[Financial planning is] a systematic organization of an individual’s financial and personal condition towards achieving his or her specific economic goals. It generally entails writing down all financial objectives, designing a plausible plan, setting up detailed budgets, implementing the plan, and periodically reviewing and evaluating the system as a whole.” 52

In reality, financial planning is a very complex task with which most people are not able to cope. Hence, very few individuals come up with an adequate financial planning program by themselves. Therefore, financial planning has emerged as an important new profession within the financial services industry. An individual’s cooperation financial planners can be seen as a consulting process performed at a holistic level, as opposed to sporadic problem solving. The high level of interaction and trust requirements between individual and financial planner also make it a process with a high relationship value. 53 The advantages of financial planning for the client include quantitative and qualitative elements. On the quantitative side, financial planning should lead to a reduction of expenses (e.g., through reduced insurance premiums) or an improvement in the expected risk-return profile. On the qualitative side, the fact that clients are asked to think about their life goals and financial objectives induces them to take a more proactive approach towards the design of their financial lives. Explicitly addressing their asset and liability situation also helps to overcome fears associated with not knowing (enough) about the personal financial situation or knowing it only

51

SIEGEL et al. 1992, p. 230. RICHARDS 1986, p. 127. 53 See TILMES 2001, p. 37. 52

2.2 FP perspectives and FP actions: the components of individual FPB

27

ambiguously. 54 Furthermore, apart from getting an overview of the financial situation, the illustration of solutions for their financial concerns and ways to realize life objectives can lead to an improvement in quality of life. The disadvantages lie in the uneasiness felt by many people at having to put all their cards on the table and to disclose intimate financial details. Also, financial planning is time-intensive and costly. 55 And ultimately, facing one’s financial situation from an objective perspective might also reveal one’s own level of ignorance or even naivety. These aspects hint at a host of subjective elements in the form of psychological barriers that prevent individuals from undertaking financial planning activities or realizing the recommendations of a financial plan. They will be discussed further in the sub-chapter 4.2 on behavioral finance. CHIEFFE/RAKES 1999 have developed a model that allows the structuring of the different financial planning events in a concise way: They propose a matrix with two dimensions. The first dimension is the time frame, which distinguishes between current period (short-term) and future period (medium/long-term) events. The second dimension is “whether or not the occurrence of or the date of the financial event can be foreseen” 56 and distinguishes between planned and unplanned financial events. In the context of the present study, planned events are defined as financial events that are expected from today’s perspective and whose corresponding income and expense streams can be estimated with a sufficiently good probability. Unexpected financial events are related to events such as emergency situations or other extraordinary circumstances whose probability and extent of financial implications cannot be assessed from today’s perspective. 2.2.2 Individual retirement-specific FPB and its two components as research focus Building on the general findings about financial planning, this section narrows the understanding of financial planning to the research focus of this study. In particular, a study-specific definition of financial planning behavior will be provided and the two components that make up retirementspecific FPB – FP perspectives and FP actions – will be illustrated. The definition of financial planning used in this study can be described along four dimensions: the time horizon, the extent of financial planning 54

This effect is also called the ambiguity aversion and described in sub-section 4.2.3.4. 55 See WYDER 2002, p. 35f. 56 CHIEFFE/RAKES 1999, p. 263.

28

2 Frame of reference and conceptual approach

activities it encompasses, the focus on the individual and finally the process of executing financial planning. Measured along the time horizon dimension of the CHIEFFE/RAKES 1999 model, the research focuses on the future since it relates to the retirement period of people that are still in their working life today. However, as CHIEFFE/RAKES 1999 have illustrated and as the details about the individual financial optimization problem have shown in sub-chapter 2.1, financial security in the future (retirement period) needs to be initiated in the working and saving period. Therefore, in order to understand how today’s generation of pre-retirees prepare financially for retirement, the study examines their actual perspectives and actions with regard to their future financial situation. To illustrate inter-generational differences, selected aspects of these pre-retirees are compared with the respective views and actions of current retirees. With regard to the extent of financial planning activities, the study takes a rather broad perspective. This also distinguishes it from other research projects like the SAVE study conducted by A. Börsch-Supan that takes an in-depth look specifically at the saving behavior in Germany. 57 Building on the wide array of problems and concerns described as financial objectives requiring financial planning by SIEGEL/SHIM/HARTMAN 1992, the title “retirement-specific financial planning behavior” could indicate at first sight that the financial planning activities examined relate only to the provision for retirement income. But as illustrated in the individual optimization problem, ensuring the financial security in retirement that allows realizing individual life goals and financial objectives is linked to various financial inflows and outflows. Therefore, the financial planning activities do not exclusively deal with retirement income but also encompass other financial objectives such as optimizing estate planning as well as investment and property management in retirement. Furthermore, thinking along the lines of CHIEFFE/RAKES 1999, the study does not only touch on planned financial events (i.e., life goals) that can be expected confidently from today’s perspective. This research explicitly also takes into consideration unplanned events that are driven by individual risks or insecurities, such as health issues or longevity. As a consequence, “providing for emergencies” 58 that could result from these unplanned events in retirement is also within the ambit of this study. With the focus on the individual and specifically on individual behavior as to financial provision for retirement, this study distinguishes itself from 57

See for example BÖRSCH-SUPAN/WILKE 2004, BÖRSCH-SUPAN/ESSIG 2002, BÖRSCH-SUPAN et al. 2003, BÖRSCH-SUPAN et al. 2005. 58 SIEGEL et al. 1992, p. 230.

2.2 FP perspectives and FP actions: the components of individual FPB

29

the large amount of research conducted to examine how financial planning activities are or should be performed by financial institutions. 59 Thinking about the execution of financial planning, it follows the logic of a continuous and systematic process “complete with feedback loops and monitoring and adjustment” 60as described in an official publication of the Institute of Chartered Financial Analysts and implemented in practice by the four-step-advisory-process of UBS: Starting with the definition of the investor profile, the development of an investment plan, then putting this plan to work and finally reviewing the underlying assumptions, the investment plan and the results periodically. 61 As an investor profile is largely driven by an individual’s perspectives, a financial plan should explicitly take the plans and expectations an individual has into consideration. Building on these considerations about financial planning, the term “individual retirement-specific financial planning behavior” is illustrated. In this context, “behavior” does not only encompass the program an individual follows or how he arrives at such a program but comprises also the perspectives and views of the life in retirement that are to be explored at the outset of a retirement-focused financial planning process. Therefore, this research does not aim only at answering the question of whether individuals are able to solve the mathematical optimization problem described in sub-chapter 2.1 and which is at the center of the financial planning process. Rather, that problem is demonstrated in order to show the quantitative context of retirement-financial planning and illustrate the different levers available. The investigation of individual retirement-specific financial planning behavior as defined in this study looks beyond that equation. Specifically, this study examines the perspectives individuals have with regard to their life in retirement and the specific actions they take. These two components are termed FP perspectives and FP actions and in their entirety make up individual retirement-specific FPB. They are both required for adequate planning for the financial situation in retirement: First, the individual needs to have a sufficient understanding of the problem at hand 59

WYDER 2002, for example, gives an overview of financial planning from a banking perspective. RICHTER 2001 focuses on the identification of general rules of guidance for performing financial planning activities. TILMES 2001 focuses on the determinants of demand for financial services and the corresponding requirements for the offer of financial planning while GEBISTORF 2004 analyzes the determinants of different financial planning pricing schemes. 60 MAGINN/TUTTLE 1990, p. 1-3. 61 See UBS 2005, p. 30. The different steps in the definition of financial planning have been designed to reflect also the different elements described by TILMES 2001, p. 31 or RICHARDS 1986, p. 127.

30

2 Frame of reference and conceptual approach

(i.e., the dynamics associated with the inter-temporal optimization problem, his restrictions, his own responsibility and correspondingly the need for action). Building on this understanding he requires the ability to have a sensible perception of reality and make adequate assumptions about the different input factors (e.g., assessment of his own financial situation and preferences, qualitative and quantitative vision of his life in retirement, awareness about possible risks on capital markets, the personal side or changes in the regulatory environment). Second, the individual needs to have an adequate plan and implement the required actions consistently. The description of the different elements through which these two components are investigated is the topic of the next two sections. Fig. 2.3 illustrates the different elements of these two components to give a first overview. FP perspectives

• Planned life in retirement •

•

•

– Retirement age, life plans, coping strategies and financial objectives Financial view on life in retirement – Expected financial needs as a share of income prior to retirement – Expected income in retirement including different sources of pension income – Existence of a retirement gap – Feeling of financial preparedness for retirement Transaction preferences – Preferences for information gathering and general decision taking behavior with regard to advisors and within the family Risk profile – (Objective risk capability) – Subjective risk appetite – Subjective risk sophistication (self-assessed financial sophistication, risk awareness and interest for protection against risks)

Fig. 2.3

FP actions

• Start of financial planning activities •

• • •

• •

– Age, at which individuals start to think about their financial situation in retirement Overall understanding of the individual financial situation – Use of an advisor – Interest in holistic advice leading to an integrated financial plan – Use of information sources Holding of classical pension saving products Level of diversification Risk-return profile of the portfolio – Share of equity investments – Real estate leverage (mortgage/property value) Mitigation of risks that the individual has acknowledged as important Readiness to save (indicated saving rate)

Study-specific definition of individual retirement-specific FPB with its two components FP perspectives and FP actions

2.2.3 FP perspectives: the first component of individual retirement-specific FPB FP perspectives represent the mental constructs and expectations an individual has with regard to his financial situation in retirement. These perspectives are driven by realistic expectations and assumptions about the

2.2 FP perspectives and FP actions: the components of individual FPB

31

different parameters that determine an individual’s financial situation in retirement (qualitative and quantitative views on life in retirement). They also depend on an adequate assessment of his own profile with regard to risk and transactions preferences. To develop realistic assumptions about the different parameters that drive the financial situation in retirement, an individual needs to have a basic grasp of the overall issues at hand. This encompasses understanding the dynamics associated with the inter-temporal optimization problem, recognizing the increasing individual responsibility for the provision of retirement income, and accepting the corresponding need for individual action. Building on this, FP perspectives focus on the mental constructs and expectations about the individual financial situation in retirement. Specifically, life goals and financial objectives as starting point for financial planning need to be investigated. Therefore, it is essential that the individual starts to picture his life in retirement to understand what “financial circumstances and objectives […] [and correspondingly which] assets and liabilities” 62 can be anticipated. Individuals are required to visualize their life in their sixties, seventies and eighties and to focus on lifestyle and activities rather than just a preordained date when they can stop working. It is essential to “go to the heart and soul of the sort of lifestyle they will be content with in their ‘retirement’ years.” 63 It is thus important to identify what someone wants, with what priorities, by when, and what the corresponding costs are. If, for example, someone aims to continue working after reaching the retirement age, this will lead to an additional revenue stream; whereas if someone is planning to travel the world, this requires significant additional funding. Furthermore, since an individual’s expectations will also depend on how life evolves during work life, assumptions also need to be made for the income up to retirement. These life plans correspond to the expected financial events as described by CHIEFFE/RAKES 1999. They will be investigated in this study with both a qualitative and a quantitative perspective. The qualitative perspective is derived directly from the life goals and financial objectives. It captures the individual perspective on the planned life in retirement. This encompasses aspects such as the anticipated age of retirement, the activities individuals plan for retirement but also the “coping strategies” they envisage. These coping strategies describe steps individuals are prepared for to cope with a reduced income or to decrease expenses. Furthermore, the planned life in retirement also captures the

62 63

SEC 2005, Advisors Act Release No 1092, Supra Note 4. DILIBERTO/ANTHONY 2004, p. 30.

32

2 Frame of reference and conceptual approach

overall financial objectives individuals have, such as leaving an inheritance, keeping a reserve or planning a large discretionary expenditure. The quantitative perspective analyzes the financial view on life in retirement. On the one hand, it analyses the expense streams needed to fund life in retirement (defined as a share of the income prior to retirement). On the other hand, it examines the nature and weight of the different income sources expected during retirement. From these two elements, a potential retirement gap can be calculated and contrasted with the subjective feeling of financial preparedness. In addition to these qualitative and quantitative perspectives on the planned life in retirement, the FP perspectives also depend on one’s profile with regard to transactions and risk preferences. An examination of how individuals like to collect information and take decisions determines the transaction preferences profile. This perspective is driven by social factors such as family roles but also by personal factors such as personality and self-concept and gives a hint about the desired delegation of decisions. The risk profile describes the overall perspectives of an individual with regard to risk. As understanding the individual risk profile is a key element of understanding individual retirement-specific behavior, this aspect is analyzed in detail. Individual risk profiles are investigated based on three elements: an individual’s objective ability to bear risk (risk capability), his attitudes with regard to the risk-return trade-off (risk appetite), and the understanding of risk (risk sophistication). Here, this research goes further than traditional approaches where the definition of a risk profile only focuses on two risk dimensions. 64 The herein used definition of the risk profile with the three different elements is illustrated in Fig. 2.4.

64

UBS distinguishes between “risk capability”, the objective ability to bear risk, and “risk tolerance”, an expression used to describe the subjective perspective on risk. See PEIJAN 2006, p. 28f. Bank Leu also recognizes these two elements and additionally defines a clear rule determining the overall “risk profile” by taking the lower of “risk ability” and “risk capability”. While “risk ability” is driven by wealth, income and expenditures, professional and social environment as well as the investment horizon, the “risk capability” depends on the reaction to risk, maximum acceptable losses, past experiences and the type of investor. See LEU 2006, p. 6.

2.2 FP perspectives and FP actions: the components of individual FPB

33

Risk sophistication

• Self-assessed • •

financial sophistication Awareness about risks Interest for risk protection Risk appetite

Risk capability

• Socio-demographic attributes • Socio-economic attributes

Fig. 2.4

• Subjective attitudes towards risk-return trade-off

Three-dimensional risk profile

The individual risk capability stands for the objective ability to bear risk. It depends on personal situation variables, captured in the sociodemographic and socio-economic attributes. The individual risk appetite represents the subjective willingness to accept a possible loss if on the other hand the return expectations can be enhanced. This is a very relevant factor since a more pronounced risk aversion 65 leads to a higher discounting rate for future cash flows and thus increases the myopic behavior of individuals. 66 The third factor, the so-called risk sophistication, is an expression for the individual understanding of risk matters. 67 As described by CHIEFFE/RAKES 1999, a retiree’s financial situation in retirement will depend on some developments he cannot entirely influence (for example his health) or which differ from his expectations (e.g. capital market developments). Therefore, with regard to these future unforeseeable financial 65

“Risk aversion implies that if the expected return is held constant, people prefer the prospect with the smaller spread or variance. In particular, people always prefer a sure outcome over a risky prospect with the same expected value.” TVERSKY 1990, p. 73. 66 See ANDERHUB et al. 2001, p. 246f. 67 The term “risk sophistication” is a new concept that has been introduced in this study to reflect those subjective elements that are not caught in the “risk appetite” that follows directly from an individual’s willingness to accept a certain loss given specific return expectations. The elements caught in the “risk sophistication” represent a relevant perspective of an individual on risk as it is driven by his awareness about specific risks, his self-assessed level of financial sophistication and the interest for products to protect against specific risks.

34

2 Frame of reference and conceptual approach

events, this third dimension of the risk profile will analyze individuals’ awareness of certain risks identified as relevant in the context of the intertemporal financial optimization problem. Specifically, the awareness of financial risks (such as stock market or inflation risk), regulatory risks (such as change in state provision) and personal risks (such as health issues) are examined. Lastly, the interest individuals express for products to protect against specific risks will be analyzed in the context of this risk sophistication. In order to assess the overall risk profile of an individual, all risk factors need to be taken into consideration. If, for example, an individual’s personal situation points to an elevated level of risk capability and the same individual has also a very high risk appetite, but is ignorant about the different risks that could impact his situation, then the risk strategy of this person should not only reflect the high risk-taking behavior based on the risk capability and risk appetite, but should also include a more conservative and perhaps educational angle due to the missing awareness about risks. Therefore, as an overall rule “conservatism in financial planning is recommended, so that there is an aversion to high risk.” 68 2.2.4 FP actions: the second component of individual retirement-specific FPB The second component of retirement-specific FPB captures the financial planning actions (FP actions). It looks at how individuals put together their financial plan and to what extent they implement the required investment decisions in their portfolio. The seven constructs displayed in Fig. 2.3 are analyzed in detail: While the first two relate to the process of financial planning, the following five describe the choice of investment vehicles and thus correspond to the implementation of the chosen program. The first construct, the timing of the start of financial planning activities investigates the age at which individuals start to think about their financial situation in retirement. The second construct sheds light on the overall understanding of the individual financial situation in retirement by analyzing whether individuals have a specialized retirement advisor, if they see financial planning as a holistic task and therefore attribute a high level of importance to an integrated financial plan and which information sources they consume with what frequency. The third construct answers the question whether the individual holds any of the classical retirement saving products such as annuities, unit68

SHIM/SIEGEL 1991, p. 238.

2.2 FP perspectives and FP actions: the components of individual FPB

35

linked life or an employer-based contributory pension insurance. In the fourth and the fifth construct, the most important recommendations from modern portfolio theory are examined by testing the level of diversification and the riskiness of the portfolio (through the share of equity and the real estate leverage). As a sixth element, the consequence in action is evaluated by investigating to which extent individuals who assess a specific risk as important for them also undertake something to mitigate the respective risk. Finally, the last construct investigates the share of their income that individuals are prepared to invest (i.e., save) until retirement to secure their financial situation in their old age.

2.3 Conceptual approach for the analysis of individual retirement-specific FPB This study’s knowledge aim is to understand individual FPB and identify areas where the behavior of individuals with regard to financial planning for retirement shows adequate approaches and corresponds to the behavioral benchmarks derived from behavioral finance and modern portfolio theory (MPT, implicitly caught also in practitioners’ advice). Where it deviates from these principles, the thesis aims to draw out suggestions for what the individuals themselves but also financial planners and policymakers can do to improve individual retirement-specific FPB. In order to achieve this knowledge aim, the following seven research questions, introduced in sub-chapter 1.3, have been put forward: 1. What inter-temporal financial optimization problems do individuals face with regard to their retirement? 2. What are the key elements of FPB and its two components, FP perspectives and FP actions, that influence an individual’s financial situation in retirement? 3. Which conceptual approach allows for the description and analysis of retirement-specific FPB for different kinds of investors? 4. Which investor types with similar socio-demographic and socioeconomic characteristics can serve as vehicles for analysis? 5. Which principles and thus behavioral benchmarks for individual FP actions can be derived from established concepts such as behavioral finance and modern portfolio theory and also from practitioners’ advice?

36

2 Frame of reference and conceptual approach

6. What do actual FP perspectives and FP actions of the different investor types look like and how do they differ from the derived behavioral benchmarks? 7. What levers exist to improve individual FPB at the level of policymakers, financial planners and the individual? The first two questions are answered by the description of the intertemporal financial optimization problem (sub-chapter 2.1) and the breakdown of the definition of FPB into the FP perspectives and the FP actions (sub-chapter 2.2). This sub-chapter focuses on the third question as it describes the overall conceptual approach that guides this study. It also introduces the different disciplines influencing this study and presents the structure of the subsequent analyses. Two relevant academic disciplines have been identified for this study. They both are assumed to influence principles for FP actions as well as actual individual FPB: behavioral finance and modern portfolio theory (MPT). Moreover, the marketing-based stimulus-organism-response (SOR) model helps to identify the vehicles for analysis and thus complements the analyses. Behavioral finance looks at human traits in the behavior of individuals on capital markets. It is “the application of psychology to financial behavior”. 69 It can be useful to recognize one’s own errors as well as the errors of others. Applied to individual retirement-specific FPB, findings from behavioral finance can be used to explain psychological influences and patterns in individual behavior. Therefore, behavioral finance contributes to the development of principles for those elements of FP actions that are influenced by psychological biases and human affections. Behavioral finance will also help to explain FP perspectives and empirical FP actions. The elements from behavioral finance that are deemed relevant for the study of individual retirement-specific FPB are described in Chapter 4. Modern portfolio theory is the umbrella term for a stream of research that builds on the findings of H. Markowitz 70 and W. Sharpe 71, and has been complemented by numerous theoretical and empirical studies on capital markets. It focuses on questions such as risk-return profiles, asset allocation or leverage. This research area also encompasses a number of 69

SHEFRIN 2002, p. 3. With his paper on portfolio selection MARKOWITZ 1952 examined the optimization of the choice of the individual constituents of a portfolio given a set of beliefs about the future performances of these securities. He did not investigate how these beliefs are formed. 71 SHARPE 1964 lays the basis for the CAPM. 70

2.3 Concept for the analysis of individual retirement-specific FPB

37

quantitative financial models that describe financial flows. The intertemporal financial optimization problem developed in this study and illustrated in sub-chapter 2.1 is an example of such a financial model. This research area is used to derive behavioral benchmarks for FP actions, e.g., for specific elements of an individual’s wealth portfolio such as the share of equity or the required saving rate that can be derived from individual characteristics and corresponding financial models. To increase the practical relevance of this study, the statements from these two disciplines are complemented with practical advice, mostly stemming from the Institute of Chartered Financial Analysts. 72 The SOR model on the other hand represents the theoretical basis for identifying the vehicles for analysis. It has been put forward by MEFFERT 2000, KOTLER/BLIEMEL 1995 and KOTLER 1999 as a means of understanding how different stimuli result in an individual’s specific buying behavior. Even if the analysis of individual FPB is not the analysis of a buyer’s response to certain marketing stimuli, the factors influencing individual buying behavior are universally applicable and can thus be transferred to this study. Given the fact that this thesis analyzes the micro-level of individual FPB, it can build on the distinction that the SOR model makes between factors influencing on the macro-level (economic, technological, political and cultural environment of an individual) and factors that are relevant on the micro-level. These micro-level factors represent the characteristics of the “buyer” and can be broken down into cultural, social, personal and psychological factors. 73 72

See for example, TVERSKY 1990, MAGINN/TUTTLE 1990, SHARPE 1990 or KAISER 1990. 73 Cultural factors encompass the culture, sub-culture and social class. Culture determines the basic behavior of an individual, his attitudes and beliefs. Social factors include the reference group, family, social status and roles as well as the impact of opinion leaders. Social factors determine an individual’s behavior due to the interaction with specific groups and individuals as well as the role the individual plays in the different contexts. These cultural and social factors can be seen as external to the individual. Personal factors encompass observable elements that characterize an individual’s immediate situation, such as socio-demographic or socio-economic attributes (e.g., age and stage in the life-cycle, occupation and economic circumstances). They also include less observable aspects such as lifestyle, personal traits and self-perception. Psychological factors, finally, include activating elements such as motivation, with its sub-constructs, needs, emotions, mood and self-involvement, as well as cognitive elements such as learning and perception and beliefs and attitudes.

38

2 Frame of reference and conceptual approach

From the micro-level of the SOR model, it can be concluded that different individual characteristics have an influence on individual retirementspecific FPB and need to be taken into consideration in performing the analysis. This emphasizes the focus on individual behavior of this thesis, which in return makes it necessary to define the term “individual” more closely: While an individual is a single human being, this study aims at developing generally-applicable knowledge. Therefore, findings on individual retirement-specific FPB are not limited to the analysis of the behavior of a single person. On the contrary, they refer to the attitudes, mental constructs and behaviors of specific groups of individuals that have comparable characteristics and thus a similar situation and related challenges with regard to their financial position in retirement. If these groups are intuitively graspable, the aggregation of the findings for different groups of individuals improves the understanding of the study and allows coming up with concrete group-specific profiles. This enables an easier transfer of research results into the actual decision processes. Therefore, groups of individuals are defined as the vehicles for analysis building on the logic of the SOR model. Within the world of financial matters, the aggregation of individuals to such “groups of individuals” in the form of “investor segments” has proved promising. Financial institutions, for example, have successfully used market segmentations in order to tailor the product and service offering as well as the corresponding marketing approaches directly to the needs and preferences of a group of customers. Segmentations of clients in the area of financial services can be based on asset size, geography or domicile, nature of investments (e.g., onshore versus offshore), sources of wealth (e.g., professionals and entrepreneurs versus “old money” heirs). Furthermore behavioral segmentations along the lines of, for example, the objective an individual has for his wealth (buy and hold versus trading), the type and style of dialogue (self-directed versus delegation), product preferences or the level of financial sophistication are common. Finally, a segmentation matrix can combine different segmentation dimensions (e.g., wealth preserver who likes to delegate the management of his finances versus young entrepreneur and active trader). Across different financial institutions, one dimension of segmentation has proven central: the grouping of customers according to their position with regard to risk, commonly known as the distinction between risk Personal and psychological factors are internal elements. For a detailed description of the model or individual elements see KOTLER/ BLIEMEL 1995, p. 279ff, KOTLER 1999, p. 161ff or MEFFERT 2000, p. 98ff and also TROMMSDORFF 1998, p. 47ff or KROEBER-RIEL/WEINBERG 1996, p. 53ff.

2.3 Concept for the analysis of individual retirement-specific FPB

39

averse and risk friendly investors. This segmentation, which takes different shapes for various financial institutions, is traditionally used to determine the recommended asset allocation for a customer. 74 Furthermore, this differentiation of individuals with regard to their willingness to take on risks is also frequently used in academic research. For example, economists distinguish between individuals who are risk averse, risk neutral or risk seeking. Furthermore they distinguish between relative and absolute risk aversion. 75 The position with regard to risk will also determine the “groups of individuals” that will be used as vehicles for analysis for this study. The section on FP perspectives (2.2.3) has emphasized that an individual’s risk profile constitutes an important element of the FP perspectives and depends on three factors: risk capability, risk appetite and risk sophistication. The risk appetite and the risk sophistication are subjective perspectives, while the risk capability can be derived from objectively measurable characteristics. These objective characteristics can easily be determined for an individual. They are not affected by any subjective perception biases and are intuitively understandable. The subjective dimensions of the risk profile, however, are very difficult to examine, not intuitively attributable to types of individuals and not that easy to grasp. Therefore, only the objectively measurable element of the risk profile has been chosen as the basis to identify groups of individuals. As mentioned above, the risk capability depends on an individual’s actual financial and wealth position, his financial outlook as well as the fam-

74

Credit Suisse for example distinguishes between individuals who need a balanced portfolio, those needing an income portfolio and finally those needing a capital gains portfolio. See KEATING/TSCHANZ 2006, p. 5. UBS on the other hand speaks about conservative, moderate and aggressive investors. See UBS 2005. 75 KRITZMAN 2003 describes a risk averse person as someone who would reject a fair game, a risk neutral person to be indifferent to such a game and a risk seeker to seek a fair game. Absolute risk aversion relates to the amount of wealth one is willing to expose to risk as one’s potential wealth increases. An absolute decreasing risk aversion indicates that this amount will increase with an increase in the overall potential wealth level; the constant absolute risk aversion means the amount will remain unchanged and an increasing absolute risk aversion means that the amount will decrease. Similarly, relative risk aversion refers to the percentage of wealth one is willing to expose to risk as wealth increases. He also states that most investors are indeed risk averse. See KRITZMAN 2003, p. 21ff.

40

2 Frame of reference and conceptual approach

ily background and responsibilities. 76 These factors represent the overall economic and social situation of an individual and correspond to those elements that the proponents of the SOR model, like MEFFERT 2000, KOTLER 1999 or TROMMSDORFF 1998, capture in the socio-demographic and socio-economic attributes of an individual.77 These attributes are therefore used to describe the different groups of individuals. The precise prescription for attributing an individual to a specific group of individuals will be discussed in sub-chapter 5.3. For the overall concept it is relevant to state that there will be groups of individuals with an objectively higher and an objectively lower risk capability than the average investor in the German affluent segment. These groups will be used as vehicles for analysis and they represent the answer to research question four. Building on these vehicles for analysis, enhanced with findings from behavioral finance, the MPT and selective practitioners’ recommendations, the empirical individual behavior will be analyzed to get a better understanding of actual individual retirement-specific FPB and the differences between actual FP actions and recommended FP actions. Fig. 2.5 highlights the conceptual approach this study takes with the different elements that are examined in this research as well as the overall structure of the analyses. It answers research question 3 and is detailed below. In order to achieve the knowledge aim of this study and determine the areas where actual retirement-specific FPB is inadequate and specifically the FP actions deviate from the benchmark behavior, the principles need first to be set up. The derivation of principles and thus behavioral benchmarks for FP actions corresponds to the fifth research question. To this end, behavioral finance and modern portfolio theory but also other practical considerations will be used. As these principles stand for the “norm or standard” of “how a person ought to behave”, 78 they represent the normative part of this study and are documented in sub-chapter 4.4. In the empirical part, these behavioral benchmarks are then contrasted with the actually measurable FP actions to determine existing gaps (sub76

If, for example, an individual has very rich parents and is the only heir, his financial outlook is rather bright and his capability to assume a riskier strategy is heightened. If on the other hand, someone has four children that need financial support, a limited income and no prospects of inheritance, his capability to assume risk is rather limited. 77 The socio-demographic attributes are composed of genuine characteristics such as age, gender and familial links. The socio-economic attributes on the other hand reflect an individual’s economic characteristics and depend on his actual and potential future wealth and income situation (e.g., income and wealth level, education, job status). 78 LINDLEY 1990, p. 4.

2.3 Concept for the analysis of individual retirement-specific FPB

41

chapter 6.3). The empirical picture is further complemented by the actual FP perspectives (sub-chapter 6.2). The description of individual FP perspectives will be substantiated with findings from behavioral finance and rounded off with other trend research and empirical surveys that have examined selected aspects of individual FPB. This part corresponds to the sixth research question, what actual FP perspectives and FP actions look like and how they differ from the derived principles. Based on the comparison of actual and recommended FP actions, complemented with an enhanced understanding of the empirically observable FP perspectives, the most important limitations in individual FPB will be identified. Furthermore, this research aspires to characterize specific behavior of the different “groups of individuals”, later to be called “investor types”. Finally, suggestions for policy-makers, financial planners and the individual will be derived based on the findings obtained. With this part, to be found in Chapter 7, the study will focus on the seventh research question, which asks what levers exist to improve individual FPB at the level of the policy-makers, financial planners and the individual. Micro level of SOR model

Behavioral finance, MPT, practitioners' advice

"Groups of individuals" with a comparable risk capability

Normative part

Groups with a higher risk capability

Empirical part

Recommended FP actions

• Start of financial Groups with a lower risk capability

Complementation with behavioral finance and other empirical surveys

Actual FP actions

• Start of financial

planning activities

• Understanding of

planning activities

• Understanding of

financial situation

financial situation

• Holding classical

• Holding classical

saving products

saving products

• • • •

Diversification Risk-return profile Mitigation of risks Saving rate

• • • •

Diversification

Actual FP perspectives

• Planned life in retirement

• Financial view on life in retirement

• Transaction preferences

• Risk profile

Risk-return profile Mitigation of risks Saving rate

• Identification of areas where the gap and limitations is most pronounced • Investor type specific findings • Implications for policy-makers, financial planners and individuals

Fig. 2.5

Conceptual approach of the study

42

2 Frame of reference and conceptual approach

2.4 Summary of the frame of reference and the conceptual approach This chapter establishes the frame of reference of the study and helps to better understand the focus of the research by providing definitions for the different elements analyzed in it. Furthermore, it illustrates the conceptual approach describing the idea behind the analyses and the structure by which the different research questions are answered. The following results are central to the development of the study: • Individuals are facing an inter-temporal financial optimization problem that implies trade-offs between consuming before retirement and saving during work life to finance consumption in retirement. This model is based on the life-cycle hypothesis where life-time wealth represents an upper border for life-time consumption. To give a more detailed picture of the various financial flows an individual is confronted with, the model takes into account the different income and expense streams as well as wealth pots individuals are facing in their saving and dissaving period and specifically also discusses the relevant types of risk (capital market related, personal and regulatory). • The knowledge aim of the study is to get a better understanding of individual retirement-specific financial planning behavior (FPB). Therefore, a study-specific definition of its two components, the FP perspectives and the FP actions is provided. FP perspectives build on four constructs: the planned life in retirement, the financial view on life in retirement, transaction preferences and the risk profile. The FP actions distinguish between process related questions (start of retirement-specific FP, overall understanding of retirement-related issues) as well as portfolio choices (classical retirement saving products, diversification, risk-return profile, risk mitigation level, indicated saving rate). • The idea behind the study that drives the conceptual approach is to empirically analyze individual FPB and identify a potential gap between actual and recommended FP actions. Based on the most pronounced gaps and limitations in FPB, the different levers that policy-makers, financial planners or the individual have to enhance individual FPB are identified. As behavior is substantially influenced by personal background, the analyses are conducted for different investors types with either a below average and with an above average risk capability. To implement this conceptual approach the study builds on an empirical survey as well as behavioral finance, the MPT, practitioner’s advice, the marketing based SOR model and other kinds of trend research.

3 Fundamentals of the retirement system in Germany

“The German public pension model is under siege, and there appear to be two main culprits for this: negative incentive effects of the system […] and the aging population.” Börsch-Supan et al. 2004, p. 286 As documented in the SOR model, 79 individual behavior is influenced by macro-level elements (e.g., economic, technological, political and cultural) and by micro-level factors such as an individual’s socio-demographic and socio-economic attributes but also his personality and psychology. The focus of this study is the micro level. However, in order to assess the different micro-level financial planning perspectives and actions of an individual, an understanding of an individual’s macro environment is required. This chapter aims to shed light on the key characteristics of the German retirement system that influence the retirement-specific financial planning behavior of German affluents, the target group of this research. As mentioned in the introduction, the current statutory state retirement pension scheme in Germany is built on a pay-as-you-go (PAYG) system. With the demographic shift underway, this system is increasingly under pressure since its stability depends on the ratio of the working relative to the retired population, the so-called dependency ratio. Therefore, the description of the macro-level environment of the individuals analyzed in this study will start with an illustration of the demographic developments in Germany. Specific aspects of the German pension system will then be introduced in the second sub-chapter. It illustrates the three pillars the system is based on and reviews the most recent pension reforms. The chapter concludes with the introduction of the German benefit formula, the basis for the derivation of the individual income from statutory state pension. 79

See KOTLER/BLIEMEL 1995, p. 279ff, KOTLER 1999, p. 161ff or MEFFERT 2000, p. 98ff and for individual aspects of involvement and activation TROMMSDORFF 1998, p. 47ff, or KROEBER-RIEL/WEINBERG 1996, p. 53ff and the introduction of the model in sub-chapter 2.3.

44

3 Fundamentals of the retirement system in Germany

3.1 Demographic developments in Germany The demographic characteristics and developments of a population can best be visualized with the shape of its age distribution. In Germany, this distribution has changed substantially in the last 100 years and is projected to undergo further shifts in the future. Fig. 3.1 shows the development of the German population distribution over time as well as the anticipated shape of the population pyramid in 2050. –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Age in years 1910 Men

1950 Women

750

500

Men Total: 65m

90 80

80

70

70

60

60

50

50

40

40

30

30

20

20

10

10

250

250

500

750

750

500

250

2001

500

250

Total: 82m

80

70

70

60

60

50

50

40

40

30

30

20

20

10

10

Thousand individuals

500

750

250

500

750

Thousand individuals

Total: 75m

90

80

250

Total: 69m

2050

90

750

Women 90

750

500

250

Thousand individuals

250

500

750

Thousand individuals

–––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Fig. 3.1

Age distribution of the German population 1910 to 2050

Source:

Data from the German Statistical Federal Office STBA 2003a and Pötzsch/Sommer 2003

3.1 Demographic developments in Germany

45

While the German population distribution had a pyramid shape in 1910, the Great Depression, wars, epidemics (e.g., the Spanish Flu) as well as other factors led to a significant reduction of mostly the younger generations in the first half of the twentieth century. Fig. 3.1 illustrates the substantial reduction in the base of the pyramid in 1950, and displays that as of 2001 the highest frequency occurs at the age groups 37 to 55, which represent the “Baby Boomers”. This birth-intensive generation, born from 1946 to 1964, 80 amounts to 21m individuals in Germany. It will start to reach its regular retirement age of 65 in 2011. Then, most of the burden of providing for the retirement income of the Baby Boomers will fall on the next generation, i.e., the so-called “Generation X” born 1965 – 1980. But since Generation X comprises only about 15m individuals, the transition of the Baby Boomers into retirement will inevitably be linked with challenges regarding the provision of their retirement funding. The change in population shape from a pyramid to a mushroom in 1950 and later a “spinning top” in the last 100 years can be explained by significant changes in the three key drivers for the system: life-expectancy, fertility rate and net migration. The assumptions about the future development of these three levers determine the estimated population distribution in 2050, the shape of which can best be described as a cruise ship’s hull. The most striking change relative to 1910 is the increase in lifeexpectancy. In the last century, life-expectancy for a new born boy rose from 45 years to 75 years at the turn of the millennium. 81 At first, medical breakthroughs such as antibiotics, vaccines and the x-ray technique helped to fight diseases like smallpox, malaria, polio or tuberculosis and so increased life-expectancy. 82 This trend was further supported by social developments such as better hygiene and safer labor conditions. Lately, further medical progress (e.g., transplantation medicine) and lifestyle factors (e.g., more healthy nutrition and increased physical exercise) have contributed to a further increase in life-expectancy. Table 3.1 illustrates the development of life-expectancy at birth and the expected life-time for individuals at the age of 60 (distant life-expectancy). As the incremental changes suggest, the increase in overall life-expectancy was caused first by a rise in the life-expectancy of the young generations whereas, lately, the change is driven more by an increase of the distant life-expectancy. As a consequence, the median age, which amounted to 35 in 1950, was 40 years in 2000 and is expected to rise to 47 years by 2050. 83 80

Definitions for different generation types according to FRICK 2005, p. 15f. This corresponds to an increase of almost four months per year. 82 See WEF 2004, p. iii. 83 See UNPD 2005, p. Germany country profile. 81

46

3 Fundamentals of the retirement system in Germany

Table 3.1

Development of the life-expectancy of a newly born and a 60-yearold in Germany 1901 -1910

1932 -1934

1949 -1951

1960 -1962

1970 -1972

1980 -1982

1991 -1993

1998 -2000

2020

2035

2050

44.8 48.3

59.9 62.8

64.6 68.5

66.9 72.4

67.4 73.8

70.2 76.9

72.5 79.0

74.8 80.8

78.1 83.8

79.7 85.4

81.1 86.6

73.1 74.2

75.1 76.1

76.2 77.5

75.5 78.5

75.3 79.1

76.5 80.8

77.8 82.1

79.2 83.5

N/a N/a

82.7 87.1

83.7 88.2

Life-expectancy at birth in years Males Females Life-expectancy at the age of 60 in years Males Females

Source: Remark:

PÖTZSCH/SOMMER 2003, p. 15f; STBA 2003a Base for calculation: 1901/10 and 1932/34: Deutsches Reich, 1949/51 until 1980/82: Old Bundesländer, from 1991/93 onwards: Germany, from 2020 onwards: 10. coordinated population projection

The projections regarding the future development of life-expectancy in Germany depend on several assumptions and are not undisputed. On the one hand, life-expectancy could further increase considerably, if remedies are found for those illnesses that cause most of the deaths today (such as cancer or cardiovascular diseases). On the other hand, epidemics such as HIV or social trends like obesity could lead to a decrease in expected lifetime. Furthermore, some scientists argue that cell-aging will determine a natural biological age limit for the human body. But overall, the theory of a further increase in life-expectancy is dominating. 84 The second lever of population development is the fertility rate. In 1950, Germany had a fertility rate of 2.1 children per women, which corresponds to the minimum required level for reproduction. At the same time, the world fertility rate amounted to five children per woman. 85 Since 1950, the German fertility rate declined to below 1.4, a level that is among the lowest in Europe. This decrease has mostly been driven by the inclusion of the numbers of the new Bundesländer where the fertility rate was signifi84

Between the DAV (Deutsche Aktuars Vereinigung – Germany actuary association) tables published in 1994 and 2004, the life-expectancy of a man born in 1940 increased from 86 to 89 years. For a girl born in 2005, the estimates range from 95 years (in the 1994 DAV table) to 102 years (in the 2004 DAV table). See GDV 2004, p. 2. 85 See WEF 2004, p. iv for the indications for Germany and UNPD 2005, p. xvii for the world observation.

3.1 Demographic developments in Germany

47

cantly lower than in the old Bundesländer. Despite an expected recovery, several projections do not estimate fertility rate to be higher than 1.9 by 2050, thus remaining below the replacement level. 86 Table 3.2

Development of the fertility rate in Germany 1950

1960

1970

1980

1990

2000

2004

Forecast until 2050

2.10

2.37

2.02

1.44

1.45

1.38

1.36

1.40

Fertility rate Average number of children per woman

Source: Remark:

STBA 2003a, BMAS 2006b, p. 13 Fertility rate measured for women aged 15 to 50. Base for calculation: until 1980: Old Bundesländer excluding the Saarland and West Berlin. From 1990 onwards: Germany, forecast: 10. coordinated population projection

Even if a population is not reproducing itself, it can still grow through migration, the third factor of population development. This effect is measured through the net migration rate, which corresponds to the number of immigrants minus the number of emigrants, per 1,000 inhabitants. Table 3.3

Development of the net migration level in Germany 1950

1960

1970

1980

1990

2000

2004

Forecast until 2050

17,992

176,442

547,085

296,791

681,872

167,120

82,543

~200,000

0.35

3.15

8.97

4.81

8.55

2.03

1.00

2.40

Net migration rate Balance of migrations Difference between immigration and emigration per 1,000 inhabitants

Source: Remark:

STBA 2003a, own calculations Base of calculations: Old Bundesländer until 1990. 1950 without Saarland; thereafter Germany, forecasts: 10. coordinated population projection

Germany is one of the world’s most important net receivers of migrants, second only after the US. Going forward, the UNPD 2005 expects a net

86

See for example indications from the German Statistical Federal Office, with its 10. coordinated population projection (STBA 2003a), the BMAS 2006b, p. 13, or the medium variant from the UNPD 2005.

48

3 Fundamentals of the retirement system in Germany

migration of over 200,000 individuals, an estimate that is in line with the assumption of the German Statistical Federal Office. 87 The combination of these three factors will lead to a significant shift in the demographic distribution of the German population illustrated in Fig. 3.2: The total population of 75m in 2050 is expected to be lower than today after having reached a peak of 83m in 2012. –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Total in thousand individuals, percent

64,992 0.5 4.5

Individual age: Older than 80

69,346 1.0

82,440 4.0

82,196 7.1

75,117

16.8

12.1

13.1

8.7

Between 65 and 80 17.5

Between 20 and 65

51.1

59.9

62.0 58.7 54.3

Younger than 20

43.9

30.4 20.9

1910

1950

2001

17.4

16.1

2025

2050

Fig. 3.2

Development of the total population and the share of different age groups 1910 to 2050

Source:

Calculations based on data from the German Statistical Federal Office, STBA 2003a Base for calculation: Germany, forecasts: 10. coordinated population projection

Remark:

Fig. 3.2 also illustrates the increasing percentage of individuals aged 65 and older. This group is expected to develop from a share of 17% in 2001 to almost 30% in the year 2050, which corresponds to an absolute increase from 14m to 22m individuals. The share of the working population (indi87

The German Statistical Federal Office bases its calculations on a net balance of foreign immigrants of about 200,000 yearly and assumes that the net immigration of Germans is reduced from a level of 80,000 in 2002 to zero in 2040. 10. coordinated population projection (STBA 2003a), see BMAS 2006b, p. 13 or PÖTZSCH/SOMMER 2003, p. 22.

3.1 Demographic developments in Germany

49

viduals aged 20-65) will fall from 62% to 54% in 2050, an absolute decrease of about 11m. As a consequence, while in 2001 there were 51m working individuals for 14m retirees, there will be just about 40m for 22m retirees in 2050. In other words, the number of individuals in retirement will grow by almost 60% whereas the numbers of the working population will shrink by 20%. This development is critical for the pension system as the relationship between pension income recipients and contributors represents an economy’s dependency ratio and significantly influences the stability and sustainability of a PAYG system. While the impact of this development is not completely clear yet, it is undisputed that pension reforms are required. As the OECD 2001 puts it “there are sensitivities in public opinion that need to be taken into account in framing reform agendas, but […], equally, there is nothing in public option today that would present impossible barriers to the development of an informed consensus. People may not welcome change in the mix of retirement income resources, but they expect it. They may not welcome having to work longer, but the main concern is likely to centre on the availability of suitable jobs for older people.” 88 To get a better picture of the pressure on the German system, the dependency ratio is further investigated. It is commonly defined as the sum of the people older than 59 as a fraction of the individuals aged between 20 and 59. These parameters take into consideration that longer education delays entry into and early retirement options allow an earlier exit from the workforce. 89 Despite the fact that the actual retirement age currently is around 60 90 one has to bear in mind that the official German retirement age is 65 and that the German pension system is set to increase the retirement age and reduce the attractiveness of the early retirement options. Therefore, the dependency ratio is also calculated for a border of 65 and 67 years in Fig. 3.3. 88

OECD 2001, p. 141. Although there is only vague understanding of the details of the existing pensions systems, for many individuals the basic attitudes are realistic. This can be seen in the fact that individuals like existing arrangements, because they have worked in the past. Furthermore, there is empirical evidence that they lack confidence in the sustainability of the systems (due to the demographic pressure), and that they are suspicious of a later retirement age (because up to the 1990s, jobs for old workers were difficult to find). “This suggests that if the debate is sensibly framed and if good empirical evidence is available, discussions about pension reform need not be as polarized as is often feared.” OECD 2001, p. 141f. 89 See BORGMANN 2005, p. 45. 90 See BÖRSCH-SUPAN et al. 2005, p. 19.

50

3 Fundamentals of the retirement system in Germany

Percent

55 40 27

25

37

20

21

10

1910

1950

1970

1995

8

Individuals aged over 60 rel. to individuals aged 20-59

28

25

16 13

17

33 28

36

55

53 47

46

44

78

73

71

47

47

39

31

23

2001

2010

Individuals aged over 65 rel. to individuals aged 20-64

2020

2030

2040

2050

Individuals aged over 67 rel. to individuals aged 20-66

Fig. 3.3

Development of the dependency ratio based on calculatory retirement ages of 60, 65 and 67

Source:

Calculations based on data from the German Statistical Federal Office, PÖTZSCH/SOMMER 2003, p. 32

Based on a retirement age of 65, the dependency ratio is expected to increase from a level of 28% in 2001 to 55% in 2050. This means that if in 2001 3.6 contributors were financing one receiver, only 1.8 contributors will be left per receiver in 2050, doubling the pressure on the individual contributor. If, due to a rise in the official retirement age and disincentives for early retirement, the average retirement age were to rise to 67, the dependency ratio between 2001 and 2050 would shift from 23% to 47%. In this scenario, the relationship between contributors and recipients would only change slightly from 2.3 to 2.1. This illustrates the significant impact that the already agreed-upon increase in the retirement age has on the dependency ratio. However, as with the actual difference between the official and the average retirement age, the question arises about the real effect this increase will have on the average retirement age in the future. With regard to these drivers of the population distribution, it is also noteworthy that the assumptions about and changes in fertility will only impact the dependency ratio 20 years from now, while the net migration rate as well as the life-expectancy have an immediate impact. The demographic developments described above lead to increasing pressure on a state’s pension expenditures and thus the sustainability of its

3.2 The German pension system

51

budget. 91 On top of these system immanent problems, the pressure on the state budget might be further accentuated by changing majorities in the political process that might significantly impact any democratic changes with respect to social security legislation. Further, the danger of old-age poverty increases the call for action or intervention from the state. If the ratio of pension contributors to recipients declines, the state can choose to go into debt or raise social contributions from a shrinking work force. However, these measures have a limit. An indicator of a state’s remaining degree of freedom is the ratio of state pension expenditure to GDP. With a level of 11.8% of GDP in 2000, this pension burden is already high in Germany. 92 Indeed, Germany has the second largest pension budget ratio in the OECD, surpassed only by Italy with 14.2% of GDP. Compared to the UK or the US, Germany’s pension budget ratio is larger by a factor of 2 relative to the UK and a factor of 2.5 relative to the US Social Security System. 93 Given that the remaining measures available to the German state are limited and reforms are already underway that substantially reduce the statutory state benefits and shift responsibility for retirement provision to the individual, the question arises whether individuals in Germany assume their share of responsibility by adopting adequate retirement-specific financial planning.

3.2 The German pension system In order to ensure a general understanding of the German retirement system, this sub-chapter will highlight selected aspects. First, the overall setup of the German retirement system with its three pillars is discussed. Then, the Riester Reform and the proposals of the Rürup Commission as the two most prominent reforms underway are illustrated. In the last sub91

Besides the increasing pressure on the state pension system resulting from the growing inequality between contributors and recipients of state pension, the demographic shift will also have other implications for the economy. Apart from the pension insurance, health insurance will also be dramatically squeezed as health care expenditures exhibit an age-profile sharply increasing with age. This is specifically problematic, if the health care contributions are dependent on the salary as is the case in Germany. Under these conditions, the expenses for health care will increase and the receipts from insurance premia will decrease, again putting more pressure on the working population. 92 The World Economic Forum has estimated a ratio of 16.9% for 2050. See WEF 2004, p. vi. However, the new reforms are supposed to lead to a reduction in this number. 93 See OECD 2001, p. 106ff.

52

3 Fundamentals of the retirement system in Germany

chapter, the German benefit formula that determines an individual’s income from statutory state retirement income is presented. A detailed understanding of this formula is essential as it is used for the simulation of an individual’s statutory state retirement income and thus the derivation of an existing retirement gap in sub-chapter 6.4. 3.2.1 Overall set-up Under Bismarck, Germany was the first country in the world to introduce a compulsory public old-age pension provision system for workers. Induced by the danger of social turmoil, the legal health insurance was introduced in 1883, followed by accident insurance in 1884. In 1889, the Reichstag adopted the “law on invalidity and old-age insurance”. 94 This law is the foundation of today’s state pension provision and covers practically all employees. It is a contract where individuals are insured collectively against possible bad realizations of future states of the economy and of themselves (e.g., adverse impacts of possible downturns in the economy and in their own circumstances). It provides coverage for income during retirement, insures the inability to work or implications from accidents and, furthermore, supports descendents of insured members. Apart from being the world’s first pension system, three characteristics are noteworthy. First, in Bismarck’s time, the duration for which individuals would receive retirement income was very limited as the payout started only at age 70 with a very short remaining life-expectancy of about 6 months. Second, the system was originally designed as a funded system. It was replaced by the PAYG system only in 1957 when the benefits of the pension scheme were indexed to the growth rate of labor income. The basis of such a PAYG system represents an inter-generational contract where workers pay their parents’ pensions in exchange for the promise that their own children will pay theirs. 95 Since PAYG systems become steadily 94 95

See DIA 2006f, p. 1f. The function of the pension system was originally a consumption allocation mechanism where a portion of the output (goods and services) produced by the worker is distributed to the elderly who have already accomplished their working careers. This should ensure that productivity improvements would be shared with the elderly and that the standard of living could be maintained. See WEF 2004, p. v. This aspect underlines the two-generation aspect of a pension scheme. Furthermore, since the pension system also takes into consideration the socially beneficial effect of raising children (e.g., through accumulating pension entitlements), it can be considered even as a three generation contract where the working population supports both the old and the young.

3.2 The German pension system

53

cheaper as birth rates rise, the favorable demographic conditions at that time (i.e., the “Baby Boomer” generation) made it possible to shift the system to the PAYG logic without imposing a disproportionate tax burden on the workers. Furthermore, the low interest rates under the favorable economic conditions of the 1960s (“Wirtschaftswunder”) benefited the PAYG systems. 96 At the same time, the PAYG system also allowed German individuals who had lost most of their savings during the war to participate in the economic growth. Third, the system was originally designed as a monolithic, one pillar system, aimed at extending the standard of living that was achieved during work life to the time in retirement. This stands in contrast to a Beveridgian social security system such as in the UK or the Netherlands that was only providing a base pension to everyone and was mostly financed through taxes. Unlike these countries’ systems, the German scheme is roughly proportional to labor income averaged over a lifetime and features only a few redistributive elements (with the exception of additional pension provisions for low income workers). Therefore, the contributors also see it more as insurance than a tax, which is reflected in the term “retirement insurance” (Rentenversicherung) rather than “social security” as in the United States. 97 Since its initiation, the German pension scheme and, specifically, the compulsory state pension system, have seen various reforms with the conversion to the PAYG system in 1957, the extension of its benefits in 1972 – which made it one of the most generous systems in the world – and the contracting reforms thereafter. A comprehensive historical analysis of the development of the German pension scheme can be found at BÖRSCHSUPAN/WILKE 2004, BORGMANN 2005 or EHRENTRAUT/HEIDLER/ RAFFELHÜSCHEN 2005. Today, the German pension system is built on three pillars of varying importance and popularity. Individuals in Germany still rely heavily on the compulsory state pension provision (Statutory State Pension or Gesetzliche Rentenversicherung – pillar I), and the importance of the supplementary voluntary occupational pensions (Berufliche Vorsorge – pillar II) and voluntary personal pensions (Private Vorsorge – pillar III) is only modest. 96

If both the funded and the PAYG system base the benefits on earnings levels during worker’s careers, they are more expensive if the underlying wage rate is growing faster compared to a lower salary growth scenario. However, while the PAYG systems are not sensitive to interest rates, the costs of the funded system are influenced by the interest/return rates. Therefore, the costs of a funded system are driven by both salary growth and interest/return rates. See WEF 2004, p. x. 97 See BÖRSCH-SUPAN/WILKE 2004, p. 3ff.

54

3 Fundamentals of the retirement system in Germany

This is illustrated by the fact that the income of an average pensioner is composed of around 85% compulsory state pension contributions, 5% occupational voluntary pension and 10% voluntary private pension income. 98 This is similar to France, Italy, Spain and Portugal, where about 85% of retirement income also stems from compulsory state pensions. On the other hand, this contrasts sharply with other retirement systems such as, for example, the British or the American system, where compulsory pensions are used only to provide a basic level of retirement income and reliance is placed on voluntary, private or employer-based provision. In spite of different systems, it is interesting to note in Table 3.4 that the overall net replacement level – the share of retirement income actually received relative to the national average earnings for the average earner – stemming from mandatory and voluntary pension savings and other savings, is similar with Germany at 60% and the UK at 63%. 99 One of the reasons for this similarity is that the values actually received from the more “generously” designed German state pension vary quite substantially from the value of retirement income theoretically available, due to the strict requirements for eligibility of full pension income, which is described later in this chapter. Furthermore, it needs to be noted that the amount stemming from voluntary personal savings is low as many individuals who paid into this pillar have not yet retired. Table 3.4

Breakdown of average retirement income according to different income sources Germany

UK

- Compulsory pension - Voluntary occupational pension - Voluntary personal pension - Other savings

50 2 3 5

31 21 3 8

Total replacement rate

60

63

as % of national average earnings for the average earner

Source:

98

Approximate sources of retirement income, 2003; PEAPE 2004, p. 14

See STIEFERMANN 2005, p. 8, PEAPE 2004, p. 24ff or DIA 2006a, p. 1. Since the German state pension is digressive, the relationships are somewhat different for high-income earners. They have to cope with a very low replacement level and thus have more incentives to have additional private pension. Consequently, a higher share of their income stems from private and occupational voluntary pensions. The digressive character of the state pension system is shown in Fig. 3.5. 99 See PEAPE 2004, p. 11ff.

3.2 The German pension system

55

Due to their historical separation, the pension schemes between the old and the new Bundesländer also contain differences in the level of pension provision and the importance of the different pillars: Even before the reunification, financial security in the old Bundesländer was provided by several schemes; therefore, beneficiaries tend to have an accumulation of benefits in various forms. In the new Bundesländer, however, financial security was almost solely based on the benefits of the statutory state pension scheme. Therefore, accumulation of several benefits for single persons is very rare. 100 This thesis aims at using the indications for the whole of Germany wherever possible. In other cases, the indications relate to the old Bundesländer or are marked explicitly for the new Bundesländer. To get a better understanding of the characteristics of the German system, the three pillars are described below. 3.2.1.1 The first pillar: Compulsory state pension, also called statutory state pension (SSP)

The mandatory German SSP system does not only aim for the insurance of old-age, but also covers disability and accidents as well as surviving dependents. Therefore, it has the function of insuring medical and occupational rehabilitation measures, too. 101 The different forms of pension include: regular old-age pension, early retirement pension options, such as, for example, pension for the long-term insured, 102 pensions due to a reduction in earnings capability (i.e., invalidity) as well as pension resulting from death (i.e., survivorship pension). Of the new benefit recipients, 60% 100

See KORTMANN et al. 2005, p. 29. Table 3.5 gives an overview of the different types of pensions possible under the SSP scheme. Certain conditions have to be met before pensions can be drawn: First, the insured individual must have reached a minimum age (“Altersgrenze”), second, they must have paid contributions for a certain amount of time (“Wartezeit”) and third, they have to apply for the pension. 102 Individuals born before 1948 can apply for this form of retirement pension if they have turned 63 and meet the criterion of 35 “waiting years” (Wartejahre). Individuals born after November 1948 can also apply for this sort of pension if they have accomplished their 62 anniversary and meet the criterion of 35 “waiting years” (Wartejahre). Apart from this early retirement form the German system also featured the old-age pension for women or the old-age pension due to unemployment or “Altersteilzeit”. These pension types have been abolished and are not available anymore for individuals born after 31.12.1951. For all the early retirement options the cRVt (the value of the pension entitlement) of the year in which an individual retires is relevant. However, the early retirement will be linked to a reduction in retirement income of 0.3% per month relative to the regular retirement age. See DIA 2006c, p. 1f.

101

56

3 Fundamentals of the retirement system in Germany

receive pensions due to age, 12% due to reduced earnings capability and survivor pensions account for the remaining 28%. Within the 60% pension due to age, just under 30% correspond to a regular old-age pension, which highlights the surprisingly low importance of this insurance type and the popularity of other options (i.e., over 11% are early retirement options for women, over 8% are pensions due to unemployment, over 5% are pensions for heavily handicapped individuals and long-term insured individuals account for almost 6% of newly retired individuals). 103 This structure also illustrates the incentives inherent in the German statutory state pension system. All wage earners and salaried employees whose monthly income is above €400 104 as well as apprentices with a lower salary are liable for the SSP. Furthermore, individuals aged over 16 can pay voluntary contributions to this system and self-employed individuals can also participate. Individuals covered by another, officially permitted, pension scheme are not obliged to contribute: Doctors, lawyers, notaries, advisors on tax matters but also farmers who operate either as specifically self-employed or employed and who are organized in associations that allow having their own pension fund. 105 Furthermore, civil servants are covered separately by an insurance that provides both a standard and supplementary scheme (Civil Servants’ Pension scheme). 106 On this basis, the SSP system can be assumed to cover between 82% and 85% of the population. 107 The SSP consists of an insurance for wage earners and salaried employees (Arbeiter- und Angestelltenrentenversicherung) – since January 1st 2005 called the “general pension insurance” (Allgemeine Rentenversi103

Numbers relate to the total number of new retirees in the Old Bundesländer in 2004. The shares of early retirement for women or individuals receiving contributions for unemployment are still high as these forms of benefits are still available for older generations. See VDR 2005, p. 46f. 104 This “Geringfügigkeitsgrenze” represents about 15% of the average gross wage and is relevant for only about 5.6% of all workers. See BÖRSCH-SUPAN/WILKE 2004, p. 11. 105 Many of these funds are still in the process of maturing. Therefore, the payouts have not reached the desired full level yet. However, already now, members of these schemes may opt for an exemption from compulsory membership in the SSP. See KORTMANN et al. 2005, p. 22. 106 According to the German Statistical Federal Office, 6.3% of the entire working population are operating as civil servants. See STBA 2005b, p. 1. The Civil Servant’s Pension Scheme is designed to guarantee a gross pension of 75% of the last “pensionable” earnings after 35 years of “pensionable” service. See KORTMANN et al. 2005, p. 14. 107 See PEAPE 2004, p. 24 and BÖRSCH-SUPAN/WILKE 2004, p. 10.

3.2 The German pension system

57

cherung) – as well as the social miners’ and mine-employees’ insurance (Knappschaftliche Rentenversicherung). The SSP is built as a PAYG system and allows individual and economic risk-sharing between different generations. Its original set-up would ensure a net replacement rate of 70% of net income after 45 years of contribution to the so-called “Eckrentner” (standard retiree). A standard retiree is a fulltime employee who has 45 years of contribution, has always earned exactly the average gross income during his work life 108 and paid contributions accordingly. Furthermore, he retires at the regular retirement age of 65 years. Such a set-up was chosen as a replacement level of 70% was deemed to be sufficient to cover one’s living expenses in retirement. 109 In an international comparison, a replacement rate of 70% has to be considered as very generous. However, two points need to be highlighted here. First, few former employees in Germany have worked long enough and fulfill the other conditions necessary to earn a full pension, since the average number of years of contributions amounts to only 38 years. This effect however is partially offset by the fact that many pensioners with short earnings histories tend to have above-average earnings. 110 Overall, only 40% of individuals in the group comprising contributors and unemployed matched the standard retiree profile in 2005. 111 Therefore, the effective replacement rates from statutory state pensions are much closer to 50%-60% than 70%. 112 Second, the most recent pension reforms, which will be discussed in section 3.2.2, lead to a substantial decrease in this replacement rate over time: The security level – the gross replacement level which has been used instead of the net replacement rate in the legislation after the reforms – will decrease from a level of 46% in 2004 to a level of 43% in 2030 according to the law on sustainability of the pension insurance. Projections estimate this gross replacement level to decline further to 38% by 2050. 113 108

Gross earnings are before deduction of the individual contribution to health insurance, any other contributions to social security as well as taxes. In the year 2003, the gross average salary amounted to €28,978, equivalent to a monthly net income of €1,536. The net pension income was then €1,077, corresponding to a replacement level of 70%. See VDR 2005, p. 29. 109 See for example the “Rentenschätzer” (online application to estimate one’s pension income) from the DIA. See DIA 2006b, p. 1. 110 According to BÖRSCH-SUPAN/WILKE 2004 about half of all entrants to the system have 45 earnings points or more. See BÖRSCH-SUPAN/WILKE 2004, p. 15. 111 See VDR 2005, p. 63. 112 See PEAPE 2004, p. 6. 113 See KORTMANN et al. 2005, p. 13 for indications up to 2030 and DIA 2005a, p. 1 for estimates for 2050.

58

3 Fundamentals of the retirement system in Germany

The pension system is financed via direct contributions and additional payments from the federal budget (Bundeszuschuss). 114 The direct contributions are flat-rate contributions on wage income and amount to 19.5% 115 for the general pension insurance and 25.9% for the social miners’ and mine-employees’ insurance. This charge is borne equally by the employee and employers. 116 However, there is a contribution ceiling (Beitragsbemessungsgrenze) which corresponds to about 210% of average earnings. Any income over this is not subject to compulsory insurance but at the same time cannot be used to gain eligibility for statutory state pension income. This illustrates the digressive character of the pension system, which makes it necessary for individuals with a higher income to supplement their state retirement income with other income sources in order to reach a comfortable replacement level. The second source of financing, the payments from the federal budget, makes up over a quarter of the income according to the Rentenversicherungsbericht 2005. 117 According to the calculations of BÖRSCH-SUPAN/WILKE 2004 the charge raised in total through the pension insurance and related taxes amounts to roughly 28% (of which 19.5 percent direct contributions with a substantial impact on the salary costs and 8.5% indirect contributions through state subsidies financed by taxes). 118 From an economic point of view, the SSP cannot claim to be effective even if the additional provisions for invalidity, accident and survivorship are taken into consideration. The financial picture worsens if the proceeds from the federal budget required to top up the direct contributions are taken into consideration. But, the system can be seen as quite effective in ensuring that very few pensioners are poor. This is reflected in the fact that 114

Taxes as an element of financing were originally thought to be dedicated only for these parts of the SSP for which there is no income source (e.g., contribution free but eligible years – such as raising children or educational times – as well as burdens stemming from war times). However, an ever increasing share of regular pension expenses is financed through taxes as the dependency ratio increases. See OTTNAD/WAHL 2005, p. 3. 115 The contribution rate varied from 14% in 1960 to 20.3% in 1998 and stands at 19.5% in 2005. See DIA 2006g, p. 2. Going forward, the reforms set the limit for contributions at 19.9% for 2009. See BMAS 2006b, p. 31. 116 In case self-employed individuals choose to contribute to state pension as well, they pay the entire contribution rate (19.5%) and are charged the so-called norm contribution (Regelbeitrag of €477.75 in 2006) which is calculated on the basis of the average gross income. See DRV 2006d, p. 9. 117 See BMAS 2006b, p. 27. Other authors mention a rate of 30%. See BÖRSCHSUPAN 2004, p. 11. 118 See BÖRSCH-SUPAN/WILKE 2004, p. 53.

3.2 The German pension system

59

only 6% of pensioners have an income of less than 50% of the median income (compared with a European average of 12%). 119 Therefore, the SSP should be seen as a system with a social mandate for collective insurance and social balance. However, as an investment vehicle it is not appealing. 120 Furthermore, it becomes obvious that this system only works since it is institutionalized by the government, which also assumes its management. 3.2.1.2 The second pillar: Occupational pension scheme (OPS)

The occupational pension scheme is a voluntary system in Germany. It covers only around half of the male population (46%) and a lower share of the female population (9%). Overall, the occupational pension scheme contributes around 5% of pension income, which is lower than in any other industrialized country 121 and illustrates that the corporate pension scheme is the least important pillar of the pension scheme in Germany. An important change for the corporate pension scheme occurred with the implementation of the Riester reform in January 2002, reversing the corporate pension scheme’s trend of decreasing importance. Since then all employees have the right to corporate pension provision through conversion of a part of their future salaries into pension entitlements (payment conversion or “Entgeltumwandlung”). This means that independently of whether the company already had any kind of corporate pension plan before – mostly held in the form of a retirement fund or pension fund and based on the defined benefit principle – since January 2002 the employer is obliged to offer his employees the salary conversion option (although he is not under any duty to finance a part of the employee’s corporate pension). 119

Specifically for low income workers, the German system provides two specific solutions: Either the non-contributory pension that is a means-tested safety net option for pensioners or the possibility to adjust the low-income worker’s pension entitlements upwards by up to 1.5 times to a maximum of 75% of the average earnings of contributors. This would then correspond to 0.75 EP points as discussed in section 3.2.3 if they have contributed for 35 years. See WEF 2004, p. 3 on Germany. With only about 1% of the population relying on the safety net option – called social assistance – that entitles to about 13% of average earnings for a single person, Germany can be considered as very effective. In the UK and Italy 40% and in France 7% of the population are receiving non-contributory means-tested pensions. See PEAPE 2004, p. 6ff and pages on Germany. 120 See OTTNAD/WAHL 2005, p. 4. 121 See KORTMANN et al. 2005, p. 66, PEAPE 2004, p. 12 and STIEFERMANN 2005, p. 8.

60

3 Fundamentals of the retirement system in Germany

Different forms of occupational pension schemes are possible: the book reserves also called direct pension promise (Direkt-/Pensionszusage), the support fund (Unterstützungskasse), the direct insurance (Direktversicherung), retirement funds (Pensionskasse), or pension funds (Pensionsfunds). 122 Voluntary occupational pension schemes that are (co-)financed by the employer are provided mostly by larger companies. These schemes can assume various forms and are predominantly offered to employees after a certain length of service with the company. Generally speaking, the larger a company is, the higher are the benefits and the greater is the proportion of employees covered by the occupational pensions scheme. However, benefits granted by occupational pension schemes vary considerably according to the type of activity. While occupational pension schemes can represent very interesting alternatives for the executive staff and thus high income workers, the advantages for semi-skilled workers are less pronounced. Besides the general occupational pensions, Germany also recognizes special occupational pensions for individuals working for the state: As mentioned above, individuals in the civil service are covered with the Civil Servant’s Pension Scheme that is designed as a standard and supplementary scheme. It aims to guarantee a gross pension amounting to about 75% of the last income prior to retirement, assuming 35 years of pensionable 122

The book reserves are an internally organized scheme, under which the employer takes upon himself to provide for the employees later on. He has the right to accumulate reserves for this purpose and encounters liquidity advantages as the taxes for the gain caught in the reserves only accrue when the pensions are paid out. The support fund is the most traditional form of corporate pension provision. It describes an independent institution that provides pension income for one or several employers. For both these vehicles there is no supervision by the state which implies free asset allocation choices. In case of insolvency of the employer the pension is secured by the mutual insurance association (Pensions Sicherungs-Verein). The direct insurance is a kind of life-insurance that the employer arranges for his employees. Retirement funds are institutions similar to life-insurances and can be borne by one or more companies. Both these vehicles are subject to the insurance supervision and thus have restricted asset allocation possibilities. The last and youngest vehicle, the pension funds are independent institutions that provide corporate pension services against payment and are subject to the insurance supervision. Contrary to the direct insurance and the retirement funds, the investments can be invested relatively freely on the capital markets (up to 100% in equity). See STIEFERMANN 2005, p. 19ff.

3.2 The German pension system

61

service. Furthermore, all wage earners and salaried employees in the public service and related fields are – in addition to the SSP – covered by the supplementary pension scheme for the public service: “In combination with the pensions paid by the statutory pension insurance, the benefits of the supplementary pension scheme for the public service are meant to guarantee an overall level of old-age income corresponding to that of civil servants”, 123 thus about 75% of their last pensionable income. Another example where occupational pension schemes play an important role for retirement provision are individuals with special professions. As mentioned above, individuals in certain professions, such as doctors, dentists, veterinary surgeons, pharmacists, lawyers, notaries, advisors on tax matters but also farmers who are self-employed or employed and organized in associations can resign from the SSP and provide for their retirement income independently. These schemes are estimated to cover around 38,000 male individuals (excluding farmers) – aged 55 and older – of which about 63% (older than 65) receive such a special pension. It is interesting to note that this scheme was intended to ensure a level of retirement income in line with former pensionable income and was, as such, not conceived as a supplementary income source. Since many of these pension funds are still in the process of maturing, the payouts have not reached the desired full level yet. However, even now the payouts reflect its purpose as a full alternative for the SSP with 26% of the individuals receiving over €2,500 per month, 40% receiving €2,000 per month and an average benefit of €1,803 per member – far above the payment received by the SSP (men with an average pension of €1,104 and women with an average pension of €493). 124 3.2.1.3 The third pillar: Voluntary personal pensions (VPP)

The voluntary personal pensions encompass only about 16% of the working population (21% of the male and 9% of the female), but in terms of value they are further developed than the occupational pension (making up 10% rather than just 5% of total pension income). But as these numbers indicate, the total volume is still limited. The complexity resulting from government regulations seems to have disadvantaged voluntary personal pensions. Germans prefer to “save in tax-favored medium-term products that allow them access to their money at any time.” 125

123

KORTMANN et al. 2005, p. 14. See KORTMANN et al. 2005, p. 22ff. 125 PEAPE 2004, p. 7. 124

62

3 Fundamentals of the retirement system in Germany

Like the occupational pensions, this form of retirement provision is also very interesting for high earners. Due to the reforms described below, personal pensions include Riester products with tax relief or direct subsidy increasing from 1% to 4% of salary (4% only in 2008). 3.2.2 Status of pension reforms Two main reforms have been enacted recently to cope with the increasing pressure on the German state pension system and to ensure long-term sustainability 126 of the financing of the pension system: the Riester Reform in 2001 and the proposals from the Rürup Commission in 2003. In 2006, further legislative changes were mandated that implemented some of the proposals of the reforms. The Riester Reform marks the start of a shift away from the PAYG system to a partially funded pension scheme. 127 It promotes a voluntary, statesupported complementary private and corporate pension provision and was introduced under the aegis of Walter Riester, the Federal minister of Labor and Social Affairs (Bundesministerium für Arbeit und Soziales). Under the assumptions of the Riester Reform the maximum state pension net replacement rate was modeled to be reduced from 70% to 67%, which was originally perceived as ensuring the long-term stability of pension levels. Riester also aimed to make the contribution rates sustainable and introduced a limit for the contribution level of 20-22% of the salary. 128 This is an essential measure since fiscal pressure needs to be reduced and increased contributions to occupational and personal pension arrangements must be permitted if the mix of the different forms of retirement income provision is to be altered. The Riester Reform also laid the legal and fiscal framework for a new range of funded personal and occupational pensions 126

BORGMANN 2005 defines sustainability as a state in which the current laws can be maintained ad infinitum without further increasing the contribution rate. BORGMANN 2005, p. 133. A sustainability factor with this aim has been introduced into the benefit calculation based on the “Gesetz zur Sicherung der nachhaltigen Finanzierungsgrundlagen der gesetzlichen Rentenversicherung” (RV-Nachhaltigkeits-Gesetz). 127 Since the risks associated with a PAYG system (mostly induced by uncertain demographic and labor market trends such as real growth rate, unemployment rate or the salary growth rate) are very different from the risks associated with a capitalized system (i.e., investment risk and rate of return risk) a combined retirement income system based on different components and different financing mechanisms enables a better balancing of risks. 128 See BÖRSCH-SUPAN/WILKE 2004, p. 29.

3.2 The German pension system

63

in order to encourage the take-up of supplementary individual pension savings. Under the original term “salary sacrifice pensions” (Lohnopfer) that was then re-branded to “payment conversion” (Entgeltumwandlung), different vehicles were provided for additional occupational pensions. 129 By supporting private and occupational pensions, “the reform introduced the possibility of government-subsidized investment amounting to a fixed percentage of the individual gross-income, annually increasing.” 130 The incentives provided by the state come either in the form of direct savings subsidies – paid into the individual savings accounts – or tax-deductible allowances, depending on which is more advantageous for the individual according to the tax authorities’ calculations. The tax deductible special expenses are usually more advantageous for workers with higher than average earnings whereas the direct subsidies during the contribution phase are very important for individuals with relatively low income or those with children. Maximum amounts for the Riester pension are €1,050 in 2005, €1,575 in 2006 and 2007 and €2,100 thereafter. 131 For both the occupational and private products the accumulated funds must be used to purchase either an annuity or an income drawdown combined with an annuity until the age of 85. They are intended as a supplement to benefits from the public pension scheme and thus planned as ongoing income stream. No tax-free lump sum is allowed. The aim is to operate these products under the EET principle. 132 Riester products also guarantee that the fund at termination is at least equivalent to the nominal value of all contributions made. 133 Until 2008, the tax advantages of occupational payment conversion pensions should exceed those of the private third pillar Riester products leading to an increasing importance of pillar II pension provisions. 134 In 2002, the Federal Ministry of Health and Social Security (Bundesministerium für Gesundheit und Soziale Sicherung) realized that the calcu129

As detailed above, this means that the individual was given a right to turn a part of his future salary into corporate pension provision and thus benefit from the respective tax advantages. 130 EHRENTRAUT et al. 2005, p. 5. 131A couple can take double the amount as “Riester Rente”. See DIA 2006b, p. 3. 132The EET (exempt, exempt, taxed) model assumes that contributions and investment growth are exempt from tax but pension payments are not. 133See PEAPE 2004, p. 25. A comprehensive review of the criteria for individual pension plans eligible for subsidies or tax relief can be found at BÖRSCHSUPAN/WILKE 2004, p. 34ff. 134 While the “salary sacrifice” products already allow a deduction of 4% of salary from taxable income or an equivalent direct subsidy in 2005, the personal pension product allows only a 1% deduction at the beginning, increasing to 4% only by 2008. See PEAPE 2004, p. 24ff.

64

3 Fundamentals of the retirement system in Germany

lations from the Riester Reform were too optimistic and that the revised version of the state pension would not be enough to dampen the effect of the demographic shift on the public budget. Therefore they set up a commission under the leadership of Professor Dr. Bert Rürup with the aim of ensuring the sustainability of the financing of the social insurance systems in Germany by stabilizing contribution rates and at the same time ensuring appropriate future pension levels. In 2003, the Rürup Commission proposed a further reduction of the replacement rate of net salary by introducing the sustainability factor into the calculation of the pension income. 135 As a key new element, this sustainability factor – effective since 2005 – reduces the pension value according to the development of the ratio of retirees to contribution payers. As the dependency ratio enters into the calculation of the individual benefit entitlements, it means that the entire demographic development (i.e., life-expectancy, birth rate, net migration rate) and also social and behavioral factors such as the contribution of women are taken into consideration. Furthermore, the sustainability factor also depends on economic developments such as the salary growth rate and the real salary level, which, however, have already been taken into consideration for the determination of the retirement income before this reform. As a consequence of the introduction of the sustainability factor, pension growth will be slower than salary growth level and the replacement rate of net income will decrease from 70% in 2005 to 52% in 2050 for the standard retiree, if the economic development of the recent past is extrapolated into the future. 136 Fig. 3.4 shows the decrease in the level of pension income measured in terms of net income (upper two lines) and gross income (lower two lines) after both the Riester reform as well as the proposals from the Rürup Commission:

135

See BOFINGER et al. 2005, p. 238 for a detailed explanation of the role the sustainability factor plays in the derivation of the pension value (cRVt). The mechanics for the calculation of the pension income based on this cRVt can be found in section 3.2.3 or DRV 2006d, p. 4. 136 Apart from the pension reforms, the Rürup Commission was also put in charge of making reform proposals for the health care and the long-term care insurance, which are not in the focus of this study.

3.2 The German pension system

65

Pension income as percent of net/gross income of the average earner 75 Share of net income in retirement before reforms

70 65 60 55 50

Share of net income in retirement after reforms

45

Share of gross income in retirement before reforms

40

Share of gross income in retirement after reforms

35 30

Year 2005

2050

Fig. 3.4

Pension income of a standard retiree before and after the reforms in 2001 and 2004

Source: Remark:

DIA 2005a, p. 1. Assuming 45 contribution years with average gross earnings, start of retirement at 65, real increase of salary of 0.65% p.a. (until 2025, Afterwards: 0.5% p.a.) and inflation rate of 1.5%.

Fig. 3.4 illustrates that the relative decrease in net income (from 70 to 52%, equal to -26%) is more pronounced than the decrease in gross income (from 46% to 38% in 2050, equal to about -17%) since taxes increase for the retirees due to the shift to deferred taxation. 137 As an additional measure, the Rürup Commission proposed raising the retirement age from 65 to 67 years. This increase corresponds to two thirds of the life-expectancy increase at the age of 65 between 1980 and 2000. According to the decision of the federal cabinet (Beschluss des Bundeskabinetts) dated November 29, 2006 this proposal has been accepted and the official retirement age will be increased gradually from 65 to 67 years between 2012 and 2029 for individuals retiring on grounds of age. If however, an individual has 45 contribution years from work, child rising or nursing care, he can still retire at the age of 65 after 2029.138 Furthermore, the Commission proposed incentives for working longer and working more intensively (i.e., by returning to work faster after having children), which should lead to an increase in the pool of contributors and thus decrease the pressure on the pension system.

137 138

Regulated through the “Alterseinkünftegesetz” introduced in 2004. See BMAS 2006b, p. 109, RASONYI 2006, p. 23 and RASONYI 2007, p. 23.

66

3 Fundamentals of the retirement system in Germany

As with the Riester Reform, the proposals from the Rürup Commission were also supported by fiscal incentives for voluntary occupational and personal saving. An example is the private base pension (Basisrente; Rürup-Rente), introduced in 2005, which also features maximum annual contributions and is taxed only on payout. An increasing share of the contributions is tax-deductible throughout the working lifespan – starting from a level of 60% and reaching 100% in 2025. 139 Therefore, from a tax point of view, the Riester pension products are more favorable in the next couple of years than the private base pension introduced by the Rürup Commission. Furthermore, since it is possible to take up to 30% of the Riester pension as a lump sum upon retirement (as opposed to the private base pension under Rürup that can only be taken as an annuity), the Riester products are also more flexible. It needs to be considered, however, that the purpose of the private base pension is to provide an additional base coverage in retirement and so compensate partially for the reduced SSP income. Correspondingly, it also shows much more restrictive payout patterns. First empirical analyses in Germany have revealed that take-up of these new products has in the first years been significantly lower than expected. Furthermore, there seems to be a lack of awareness among the German population about the imminent reduction in retirement income and the resulting retirement gap: In a survey, 70% of individuals did not intend to take out a contract for voluntary, state-supported complementary private and corporate pension provision, while about 23% of the population already had a supplementary pension scheme and only 7% were planning to have one. 140 However, it is known from the introduction of similar products that this is a long-term process, requiring a significant introduction period. Therefore, these products should not be expected to be successful from day one, as an example shows: It took 5 years for the general subsidized dedicated savings program, where savings were deducted directly from payroll (called “Vermögenswirksame Leistungen”) 141 to be used by a larger share of the population in Germany. Similarly, the IRA’s needed at

139

In 2005, 60% of the savings allowance can be deducted from the taxes. This share increases in steps of 2% per year to reach 100% tax-deductibility in 2025. 140 See DIA 2006h, p. 1. 141 “Vermögenswirksame Leistungen” is a kind of personal saving that is financed from personal or corporate sources and invested in specific vehicles (“Bausparen” and “Beteiligungen”). It is state subsidized for individuals with less than €17,900 gross income.

3.2 The German pension system

67

least as long to gain acceptance with a large share of households in the US. 142 Looking at the most recent surveys, the picture starts to look more optimistic and dynamic, specifically among the younger and the wealthier households, with the majority of Riester products being sold as private pensions (at the end of 2005, 5.6m private contracts were outstanding against around 3m contracts for corporate pension provision). 143 In 2006, the Riester contracts sold for private pension provision showed record growth rates of +43% according to the Federal Ministry of Labor and Social Affairs. 144 With a total of 2.4m new contracts issued in 2006, over 8m contracts were outstanding at the end of the year. The majority of these plans (80%) are private annuity insurances (private Rentenversicherungen). However bank savings agreements (Banksparverträge) and unit-trust contracts (Investmentfondsverträge) are also showing more momentum, with especially the latter growing at an impressive rate of 114% in 2006. 145 3.2.3 The German statutory state pension benefit formula The German statutory state benefit formula determines the gross income that an individual insured under the general pension insurance (Rentenversicherung) will receive from the statutory state pension (SSP) in retirement. The amount of retirement income depends on the income during the whole working life as well as the duration of contribution. It is detailed in this section to make transparent the different factors influencing income from the SSP, and to establish the basis for the simulation of the statutory state retirement gap from which the required saving rate for different groups of investors can be determined (sub-chapter 6.4). As shown by BORGMANN 2005, the German pension benefit formula has been subject to several revisions since its initiation: “After the expansion of the generosity of the benefit formula with the reform of 1972, the generosity has steadily been reduced in the following decades. The only exception to this trend is the introduction and expansion of benefit entitle-

142

See BÖRSCH-SUPAN/WILKE 2004, p. 38ff. See DIA 2006d, p. 1. 144 See BMAS 2007c. This growth can be compared to an initial growth rate from 2001 to 2002 of 141% that decreased thereafter to 16% (in 2003) and even further to 7% in 2004. Only in 2005, the growth started to pick up again substantially with 34% growth in total private Riester contracts. Author’s calculations based on BMAS 2007b. 145 See BMAS 2007c. 143

68

3 Fundamentals of the retirement system in Germany

ments for rearing children.” 146 Currently, the monthly pension income that an individual can expect from the statutory state pension is calculated on the basis of four factors. The first factor is exogenous and determines the income distribution between current workers and pensioners. The element of sustainability introduced by the Rürup Commission and highlighted above is included in this first factor. The other three factors represent the personal elements of the pension income and are driven by the individual working history. All parts of the formula are discussed below.

sp ti = cRVt * AFi * PTFi * EPi

(3.1)

German statutory state pension benefit formula With spt i cRVt AFi PTFi EPi Source:

Monthly gross income from the statutory state pension scheme for individual i at period t Current retirement value (Aktueller Rentenwert) – value of pension entitlement at period t (indexation) Accession factor (Zugangsfaktor) – adjustment factor for early or late retirement of individual i Pension type factor (Rentenartfaktor) – distinction of pension allowance according to different insured cases (old-age, accident, death) for individual i Earnings points (Entgeltpunkte) – number of years of coverage scaled by average earnings for individual i Analogous to DRV 2006d, p. 4

Determinants of cRVt

The cRVt represents the value of pension entitlement and corresponds to the monthly average income level of an average earner. This factor, determined by the government, is identical for all retirees at a given time t, and is an indicator for the generosity of the system. The cRVt is influenced by the sustainability factor introduced under the Rürup Commission and is adapted dynamically. 147 Through this sustainability factor, the cRVt is driven by economic conditions such as the development of the gross salary 146 147

BORGMANN 2005, p. 132. For a detailed explanation of the formula for the cRVt and the mechanics associated with the sustainability factor refer to BOFINGER et al. 2005, p. 238.

3.2 The German pension system

69

and wages of all employees subject to social insurance, charges raised on their income (i.e., contribution to social insurance, direct taxes) and the real growth rate. Furthermore, it takes into consideration the level of state expenses for pension provision and demographic developments such as the number of the insured pension recipients and the number of contributors. The less favorable the relationship between contributor and recipients of state benefits, i.e., the higher life-expectancy and the longer the average duration of receiving pensions will be, the lower the cRVt will be. The value of pension entitlement is adjusted yearly on July 1 and amounts to €26.13 since July 1, 2003. This illustrates that an adjustment does not necessarily always happen. 148 The adjustment usually directly affects the particular pension level of the individual, even if there are certain types of pensions or certain elements that do not reflect these changes to the same extent. This direct translation illustrates that the German pension system is time-oriented and not cohort-oriented. Therefore, “the burden of guaranteeing a funding of the system is also carried by the currently old.” 149 Going forward, the Deutsche Rentenversicherung Bund bases its calculations on three scenarios for the development of the cRVt: No change to the cRVt, a nominal increase of the cRVt by 1% or an increase by 2%, which seems less probable. Assuming that the cRVt growth will be around 0.7% lower than the increase of salaries and wages and that the latter would increase by around 2% until 2030, the adjustment of the cRVt would not be enough to compensate for the effect of inflation. 150 As a consequence, the real value of gross retirement income is expected to decrease from a level of €1,176 in the year 2005 to a level of €1,091 in the year 2010. Only in 2050 can the retirees expect to reach a similar real value as in the year 2005 (€1,170). 151 The scenario analyses in sub-chapter 6.4 that aim at mapping the individual financial situation in retirement will analyze the impact of different growth rates for the cRVt.

148

See DRV 2006d, p. 23. For a detailed overview of the historical adjustments of the cRVt refer to DIA 2006b, p. 1. The legal background can be found in § 68 together with § 255 e SGB VI (Sozialgesetzbuch). 149 BORGMANN/HEIDLER 2006, p. 16. 150 See DIA 2006e, p. 1. 151 Number related to the pension income of an individual in the Old Bundesländer. Assuming 45 contributory years with average gross earnings, start of retirement at the age of 65, real increase of salary of 0.65% p.a. (until 2025, afterwards: 0.5% p.a.) and an inflation rate of 1.5%. See BÖRSCH-SUPAN et al. 2004, DIA 2005a, p. 1.

70

3 Fundamentals of the retirement system in Germany

Determinants of AFi

The AFi is an adjustment factor that corrects the individual retirement pension income for early or late retirement of the individual. If an individual retires at the age of 65 in 2006, then the AFi is 1. If an individual chooses to retire later, the AFi will be above 1, if earlier, the AFi will be below 1. The reduction of the AFi amounts to 0.3% for every month of early retirement or 3.6% per year. The actuarial enhancement rate for later retirement amounts to 6% per year. 152 In light of the popularity of early retirement as well as the expected shortage of skilled labor and contributors, the timing of the transition of individuals into retirement is highly important. Therefore, it is essential that the AFi is set correctly and individuals do not receive incentives for early retirement. 153 This remains an interesting point, especially in light of the transition to the retirement age of 67. In assessing the impact of the reduction in retirement income due to early retirement, two effects have to be taken into consideration: First, the direct reduction of the AFi, and second, the fact that the individual lacks the time to earn further earnings points (EPs). BORGMANN 2005 estimates that “the effect of not earning further entitlements reduces benefits by roughly 2-2.5 percent p.a. Retiring one year early therefore reduces the monthly pension by approximately six percent in comparison to the pension that one would obtain if one had retired at age 65.” 154 Determinants of PTFi

The PTFi is an indicator for the kind of pension an individual receives. As mentioned at the beginning of this section, the aim of the statutory state pension scheme is not only the insurance of old-age income, but also of 152

See DRV 2006a, p. 4, 8. Adjustments for early or late retirement need to be applied with utmost care in order to ensure an actuarial neutrality of the system. The level of pension reduction used in the US (0.56% reduction per month of anticipated retirement) is said to lead to actuarial neutrality. Compared to this, the adjustment for early retirement in Germany seems too low and therefore leads to an effective tax rate on labor income near the end of working life that is artificially increased. See also OECD 2001, p. 87ff or BORGMANN 2005, p. 111. An indicator for the too low adjustment factor in Germany could be the historically comparatively higher proportion of individuals applying for early retirement. See WEF 2004, p. 5 on Germany. 154 BORGMANN 2005, p. 111. 153

3.2 The German pension system

71

invalidity or accidents as well as dependent survivors. Based on these different cases of insurances, the pension entitlements differ, which is reflected in the respective pension type factor (PTF). Table 3.5 provides an overview of the individual cases of insurance and their PTF. Table 3.5 Types of pension insurances under the SSP and the corresponding PTF values

Type of pension

PTF

Pension due to age (Rente wegen Alters)

1.00

Pension due to partially reduced capacity to work (Rente wegen teilweiser Erwerbsminderung)

0.50

Pension due to fully reduced capacity to work (Rente wegen voller Erwerbsminderung)

1.00

Minor survivor benefits for spouses (Kleine Witwen- und Witwerrente) - for the first three months after the month in which the spouse died (Sterbevierteljahr) - thereafter

1.00 0.25

Major survivor benefits for spouses (Grosse Witwen- und Witwerrente) - for the first three months after the month in which the spouse died (Sterbevierteljahr) - thereafter

1.00 0.55 *

Survivor benefits for children who have lost one parent (Halbwaisenrente)

0.10

Survivor benefits for children who have lost both parents (Vollwaisenrente)

0.20

* PTF amounts to 0.60 if the spouse died before 01.01.02 or - in case of a later decease - the marriage was concluded earlier than 01.01.02 or at least one spouse is born before 02.01.62

Source:

DRV 2006d, p. 6

Determinants of EPi

The earning points (EPs) determine an individual’s entitlement to benefits and are calculated yearly during the working life from the individual’s gross earnings in relationship to the average gross earnings of all employees. The individual receives one EP if his gross earnings correspond exactly to the average earnings of all employees. For the year 2006, the average gross earnings amounted to €29,304. If the gross earnings of the individual are below the average gross earnings of all employees, then the EP for that year will be lower than one. If on the other hand, the individual’s gross earnings are higher, the EP for that year will be larger than one. There is an upper limit of salary for pension contribution (Beitragsbemessungsgrenze) which amounts to €62,400 for the year 2005 and €63,000 for the year 2006. 155 Any income over this amount is not subject to compulsory insurance but at the same time does not entitle the earner to pension provision and thus an increase in the EP. The relationship between this 155

See DRV 2006d, p. 5ff.

72

3 Fundamentals of the retirement system in Germany

contribution limit and the average gross earnings determines the maximum value of EP that an individual can earn in year t. Fig. 3.5 illustrates the value of EP’s for different income levels for 2005 as well as the resulting gross replacement level looking at only the statutory state pension benefits. The forms of the graphs show clearly the digressive character of the German statutory state pension system. Value of annual EP for different income levels (contribution ceiling €62,400)

Replacement rates of gross income through state pension provision for different income levels

EPs

Replacement rate

2.5

60%

2.25 2

50%

1.75 1.5 1.25

40%

1 0.75 30%

0.5 0.25 0 22,177

35,483

50,267

65,052

79,836

Gross Income (€)

20% 22,177

35,483

50,267

65,052

79,836

Gross Income (€)

Fig. 3.5

Digressive character of the German pension system illustrated by the amount of EPs and the corresponding replacement rate as a function of different income levels

Source:

Calculations based on DRV 2006d, p. 5ff

EPs are also accumulated during periods out of the workplace spent either child rearing or on educational activities. For all individuals, these EPs are identical and are calculated based on the average income. 156 These additional EPs can only be collected if the value of the EPs is below the EPs that would have resulted if an individual had reached a salary equivalent to or higher than the contribution ceiling. With regard to educational activities, the reform has introduced a more differentiated approach. Until 2009, school education from 18 years on can contribute 3 additional EPs. As of 2009, this only applies to vocational education (preparing directly for the job). As a consequence, secondary school, A-levels or university studies no longer justify additional EPs. For individuals retiring in the year 2009 or later, an education period of maximum 8 years will still be considered for the recognition of contributory 156

For all children born before 1992, one additional EP is granted. For all children born after 31.12.1991, three additional EPs are granted, independently if parents were working during this time or not.

3.3 Summary of the fundamentals of the retirement system in Germany

73

years in the waiting period (e.g., for individuals who retire early because they already have contributed for 35 years). 157 The value of an EP can be increased by voluntary payments. These payments are limited to a maximum amount and can help an individual to reach, for example, the EP-level of the average earner. No maximum amount of pension income has been determined. But, due to changes in working curricula (e.g., through raising children, unemployment or working abroad) the cases entitled to a very high level of state pension income (e.g., €2,000 per month) are becoming scarce. Deductions from statutory state pension income

Since July 1, 1983, pensioners are required to pay contributions to the mandatory health insurance and to the care insurance for the long-term frail elderly. Like normal employees, pensioners pay half of the contributions for the health insurance, while the state covers he other half, and they pay the full contribution for the care insurance for the long-term frail elderly. 158 Due to the transition to deferred taxation (nachgelagerte Besteuerung) stipulated in the “Alterseinkünftegesetz”, the retirement income is calculated as a gross rather than a net value. This shift in taxation is specifically relevant for higher earners who will have a more important taxation burden in old-age. As a consequence, they will need to provide for more retirement income in order to compensate for the increased taxes.

3.3 Summary of the fundamentals of the retirement system in Germany This chapter illustrates the macroeconomic background against which individuals in Germany are planning for their financial situation in retirement. It gives a perspective on the demographic developments increasing the pressure on the German state retirement system and discusses the characteristics of the German retirement system. The most important findings can be summarized as follows:

157 158

See DRV 2006c, p. 10ff. While the retiree’s share of the charge for the health insurance amounts to approximately 7.3%, the contribution for the care insurance for the long-term frail elderly amounts to 1.7%. See DRV 2006b.

74

3 Fundamentals of the retirement system in Germany

• Based on estimates for the development of life-expectancy, fertility rate and net migration, the German population is expected to shrink from 82m in 2001 to 75m in 2050. At the same time, the share of people aged 65 and older increases from 17% to 30%. Correspondingly, the ratio of pension system contributors (individuals aged 20 to 65) to pension recipients (individuals aged 65 and over) is expected to halve from 3.6 contributors per receiver in 2001 to 1.8 in 2050. • The German retirement system is built on three pillars. With 85% of an average earner’s retirement income stemming from statutory state pension (SSP), the system is dominated by its first pillar that displays a strongly digressive character for high-income-earners. Corporate pensions are less important as they contribute only 5% to an average earner’s income, while personal pensions contribute 10%. Based on the Riester Reform and the proposals from the Rürup Commission, a change in the importance of these pillars can be anticipated, while the net replacement rate through the SSP for the Eckrentner is anticipated to decrease from 70 to 52% in 2050. It should be noted, however, that for the affluent segment analyzed in this research, the contribution of the private and corporate pensions tend to be substantially more important than the above-mentioned numbers indicate.

4 Retirement-specific behavioral finance and derivation of benchmark behavior for FP actions

“If we are to understand why people are saving so little and are to make helpful recommendations as to how to get people to save more, we have to incorporate more of the psychology of saving into our economic theories.” THALER 1994, p. 186 This chapter represents the normative part of the study. It aims to derive benchmark behavior for FP actions based on an enhanced understanding of typical “normal” 159 behavior. It builds on the fact that “people depart from rationality, but they do so in ways that can be predicted – and exploited.”160 To achieve this, findings related to “normal” behavior – as opposed to rational behavior – are introduced and illustrated based on three theories: the decision-making process, the behavioral life-cycle hypothesis and the behavioral portfolio theory. The first sub-chapter establishes the relevance of behavioral finance for the investigation of individual retirement-specific FPB. Then, the various elements of behavioral finance research relevant to the issue of retirementspecific FPB are detailed on the basis of the human decision-making process. Thereafter, the chapter provides an overview of the adaptation of the modern portfolio theory and the life-cycle hypothesis to “normal” human behavior. In the last part, benchmark behavior for FP actions is derived. This is based mostly on implicit indications from behavioral finance and, in selected areas, also on explicit recommendations from Markowitz’s modern portfolio theory (MPT) and practitioners’ advice stemming from the Chartered Financial Analyst (CFA) studies or the board of Certified Financial Planers (CFP) association. 159

The term “normal” goes back to STATMAN 2005 who used it to denote an understanding of the individual that is characterized by typical human tendencies identified within behavioral finance research. 160 N.N. 2006a, p. 69.

76

4 Retirement-specific behavioral finance and derivation of benchmarks

4.1 Relevance of behavioral finance to the study of individual retirement-specific FPB Underlying the shift of responsibility to the individual for providing for a secure financial situation in retirement are implicit assumptions about behavior and individual choices. These assumptions presume that individuals are well-informed and unemotional, that they process information correctly, take rational decisions and act to maximize their own welfare. Empirical evidence, however, shows that individuals often take decisions based on incomplete information, display a limited degree of rationality and – even if they have decided to act in a specific way – often do not follow through. Therefore, in order to complement the understanding of individual retirement-specific FPB, the “normal” behavior of individuals has to be highlighted and contrasted with the implicit assumptions about rationality to understand typical human limitations in individual FPB and derive recommendations for how these shortcomings can be overcome. Behavioral finance is the research stream that investigates deviations of individual behavior from the premises of rationality. 161 One of the key presumptions of behavioral finance is that individuals are not acting rationally at all times, but that their behavior is sometimes influenced by other, psychologically grounded elements. It is important to note that “the psychological evidence shows precisely that people do not deviate from rationality randomly, but rather more deviate in the same way. […] [Therefore, the behavioral tendencies described below] reflect the common judgment errors [and irrational behaviors] made by a substantial number of investors, rather than uncorrelated random mistakes.” 162 So the deviations from rationality can be considered as systematic. Some of these behavioral tendencies represent only a threat to adequate individual retirement FPB. Others represent both a threat and an opportunity as they can be leveraged to overcome human caveats. Correspondingly, “insights from behavioral finance can have a large real-world impact on the decisions people make, and ultimately on their retirement wellbeing.” 163 Therefore, they need to be understood in detail to identify possi161

Behavioral finance takes both an individual perspective as well as a market perspective. The individual perspective investigates elements like the rationality of behavior, perception biases and decision theory. The market perspective examines behavioral effects on capital markets like momentum and contrarian strategies, cycles, rebounds and overreactions. The focus of this study is on individual behavior and thus on the individual perspective from behavioral finance. 162 SHLEIFER 2000, p. 12. 163 SCOTT/STEIN 2004, p. 218.

4.1 Relevance of behavioral finance to the study of individual FPB

77

ble levers of policy-makers, financial planners and the individual that could potentially contribute to an improvement of individual FPB. 164 The analysis of “normal” behavior improves the understanding of the way individuals take decisions, the consequences of the life-cycle hypothesis as well as the application of the MPT. These three theories are discussed below as shown in Fig. 4.1. Life-cycle hypothesis

MPT

Behavioral life-cycle hypothesis

Behavioral Portfolio Theory

Standard economic theory of decision making

Behavioral Finance adapted theory of decision making Step 1: "Normal" perception of reality • Faulty probability assessment based on prominent past information – Representativeness bias – Saliency bias – Availability bias – Conservatism • Positive bias – Overconfidence – Unbounded optimism – Hindsight bias

Fig. 4.1

Step 2: "Normal" decision making • Prospect theory – Framing – Anchoring – Loss aversion • Limited cognitive abilities – Bounded rationality – Hyperbolic discounting – Money illusion – Projection bias – Lack of firm preferences • Portfolio segregation – Mental accounting – Myopia • Complexity aversion – Ambiguity aversion – Sensitivity to choice overload

Step 3: "Normal" implementation • Passivity – Procrastination – Inertia/status quo bias – Passive decision making/accepting the default options • Lack of self-control • Home bias • Regret

Grouping of behavioral finance elements relevant for individual retirement-specific FPB

With regard to the decision-making process, the presumptions from standard economic theory and the key elements of behavioral finance are illustrated in sub-chapter 4.2. Herein, the FPB relevant aspects of behavioral finance are described in the context of the three key steps in the human decision-making process; perception of reality, decision making and implementation of actions. In an analogous but more summary manner, the behavioral finance adaptations with regard to the life-cycle hypothesis and the MPT are presented in sub-chapter 4.3. 164

Here a distinction between cognitive and emotional biases is also important. Since “cognitive biases stem from faulty reasoning, better information and advice can often correct them. Conversely, because emotional biases originate from impulsive feelings or intuition – rather than conscious reasoning – they are difficult to correct.” POMPIAN/LONGO 2005, p. 59.

78

4 Retirement-specific behavioral finance and derivation of benchmarks

The last part of this chapter (4.4) aggregates the implicit findings from the behavioral finance adapted theories and the explicit postulations of the MPT as well as other practitioners’ advice to come up with six recommended benchmark behaviors for retirement-related FP actions.

4.2 The standard economic theory of decision-making and its adaptation to behavioral finance This sub-chapter is dedicated to the explanation of those insights from behavioral finance research identified as relevant to the issue of retirement FPB. 165 It is important to note that the different findings are heavily interlinked, sometimes very similar and, therefore, often hard to tell apart. To add to this complexity, several authors use different terms to describe the same phenomenon. Due to the lack of a consistent structure, the key themes along the human decision-making process and relevant to this study had to be identified first, in order to organize these insights. On this basis, the assumptions of the homo economicus inherent in the standard economic theory of decision making is introduced first, followed by one section dedicated to each step of the human decision-making process: perception of reality, decision making and implementation of actions. 4.2.1 Standard economic theory of decision-making The standard economic theory of decision making builds its assumptions on the homo economicus, a rational maximizer who takes decisions based on expected utility functions. These functions date back to VON NEUMANN/MORGENSTERN 1947 and imply that individuals always strive to maximize their utility depending on the probability of different events and the wealth expectations of the respective outcomes. The standard util165

Besides the behavioral characteristics discussed in this section, empirical analyses have revealed numerous other characteristics of human behavior such as fairness, considerations for beauty or social responsibility. FAMA/FRENCH 2004 for example acknowledge that there is pleasure in holding growth stocks or virtue in investing in socially responsible stocks. Due to their limited relevance for the study of individual retirement-specific FPB, these elements are not detailed here. On a more macro-economic perspective on retirement however, elements like e.g., the question of fairness, could be interesting for further research.

4.2 Standard economic theory and its adaptation to behavioral finance

79

ity function, shown in Fig. 4.2, is defined in terms of terminal wealth and shows a decreasing marginal utility from increasing wealth. 166

U = ln(W) Utility

Wealth

Fig. 4.2

Standard utility function

Source:

Analogous to TVERSKY 1990, p. 74f

The homo economicus has the following key characteristics: He discounts exponentially (indifference towards inter-temporal substitution), 167 he is frame-invariant (independence of decisions from design of choices), he integrates all assets with the rest of his wealth (focus on total wealth position), he assumes all money to be fungible (indifference towards the form of wealth) and finally – with regard to the risk attitude that determines the shape of the utility curve – he is risk averse. 168 166

In this model, the individual updates his probability assumptions according to new information following the Bayes’rule and thus converts à priori probabilities into à posteriori probabilities. This dates back to the mathematical theorem of Bayes. Furthermore, the utility function follows other maxims of decision theory such as e.g., steady and constant preferences. See EISENFÜHR/WEBER 2003, p. 169ff. 167 See for example ELTON 2003 or the “Theory of interest” dating back to FISCHER 1930. 168 This means that he prefers the certain prospect x to any risky prospect with expected value x. Correspondingly, when choosing in a gamble between a sure gain of $1 and a risky strategy with an expected value of $1, he prefers the sure

80

4 Retirement-specific behavioral finance and derivation of benchmarks

So much for the theory. But KAHNEMAN/RIEPE 1998 summarize that, in reality, individuals deviate from the standard economic theory of decisionmaking in various fundamental areas. As a consequence, the concept of the “normal investor”, as termed by STATMAN 2005, is introduced below. This concept strives to describe the key properties of human behavior that behavioral finance researches. It is important to know that behavioral finance does not set out to negate the assumptions about rationality and the idealistic way of decision making inherent in the standard economic theory of decision making. Rather, its aim is to understand real human behavior and thus influence sub-optimal decisions so that they become more rational. The following section describes the different elements of behavioral finance that are relevant to individual FPB. It follows the main themes identified along the three-step human decision-making process (perception of reality, decision making and their implementation). The relevance to the question of individual FPB, as described at the end of each sub-section, will be validated in the empirical analyses in Chapter 6. 4.2.2 Step 1: “Normal” perception of reality Every decision process starts with the question how an individual perceives reality and what his world views are. As mentioned above, humans are “notoriously poor statisticians” 169 and irrational in terms of judgment and perception. Therefore, they differ from the assumptions inherent in the standard economic theory “of weighing probability in highly systematic ways.” 170 On the contrary, and especially when facing difficult decisions, humans tend to use heuristics (judgmental procedures replacing the maxims of Bayesian rationality) and rules of thumb. Fig. 4.1 shows the two themes identified as relevant to the perception of reality with regard to regain. In that case, the sure $1 gain can be considered as security equivalent. The difference between the security equivalent and the expected value of the risky strategy is called the risk premium. For a risk averse individual to be independent between a sure and a risky strategy, the expected value of the risky strategy would need to be higher by a positive risk premium. If however, the individual were risk neutral, then no risk premium is required and the individual would be independent between the two options described above. Furthermore, if the individual were to show risk friendly behavior, he would choose a strategy whose expected return is lower than the security equivalent of that decision. Thus, the risk premium is negative in that case. See EISENFÜHR/WEBER 2003, p. 222ff. 169 MITCHELL/UTKUS 2006, p. 90. 170 KAHNEMAN/RIEPE 1998, p. 56.

4.2 Standard economic theory and its adaptation to behavioral finance

81

tirement-specific FPB: faulty probability assessments based on prominent past information and a positive bias. 4.2.2.1 Faulty probability assessments based on prominent past information

Individuals try to derive patterns from past events in order to extrapolate the probability of future events (representativeness bias). Thereby, they tend to overestimate the future probability of memorable past events and of events where related information is easily accessible (saliency and availability bias). As a consequence, their perception of reality is highly selective and strongly driven by their understanding of the past. Furthermore, individuals are reluctant to update their views of the world (conservatism). Representativeness bias

At the center of the representativeness bias is the human tendency to identify patterns in random data. 171 Individuals tend to impose some order or structure on past events, since “the human mind is a pattern-seeking device, and […] strongly biased to adopt the hypothesis that a causal factor is at work behind any notable sequence of events.” 172 Thus, even if, statistically speaking, historical realizations of a variable are irrelevant, they play an important role psychologically. BENARTZI 2001 and DE BONDT/THALER 1990 provides examples of the representativness bias. BENARTZI 2001 found that returns earned by a certain stock over the preceding ten years strongly influences the contribution of new money to that particular stock in 401 (k) plans. This “naïve extrapolation” represents one form of representative bias and can also be found in a rule of thumb: “Past performance is the best predictor of future performance.” 173 DE BONDT/THALER 1990 have analyzed the earnings forecasts of financial analysts and revealed that their forecasts are too extreme given the information available. They overreact in that they are much more optimistic about recent winners than they are about recent losers. The representativeness bias is highly relevant to the question of individual retirement-specific behavior. Due to the naïve extrapolation illustrated by BENARTZI 2001, individuals tend to consider the financial situation of their parents in retirement as representative. By doing so they assume that, 171

See SHLEIFER 2000, p. 113 or MITCHELL/UTKUS 2006, p. 90. KAHNEMAN/RIEPE 1998, p. 55. 173 SHEFRIN 2002, p. 4. 172

82

4 Retirement-specific behavioral finance and derivation of benchmarks

since things worked out fine for their parents, they will also work out fine for them. Such a belief reduces their motivation to undertake the necessary financial planning actions for their own retirement in a dangerous way. Saliency bias

The saliency bias relates to the tendency of individuals to attach major importance to a rare but serious event. Based on this heuristic, risks associated with rare but salient catastrophes (e.g., terror attacks, plane crashes, natural disasters and other major accidents) get overestimated. This explains why individuals buy lottery tickets (i.e., they overweight a low probability in the area of gains) or why they purchase insurance policies at the airport (i.e., they overestimate low probabilities in the area of losses). But people do not only overweight low probabilities. KAHNEMAN/RIEPE 1998 also show that “people overweight low probabilities and underweight moderate and high probabilities.” 174 For example, known risks (such as a car accident on the way to work) or consciously induced risks (e.g., cancer through smoking) are underestimated. With regard to retirement FPB, the saliency bias drives individuals to underestimate the probability of risks associated with, for example, longevity. On the other hand, it increases the awareness about the risk of further legislative retirement changes or health care costs. This can be explained by the fact that both topics have extensively been covered in the media and thus are very salient. In this context it will be interesting to see to which extent market risks are still perceived as important, given that memories from the 2000 to 2002 stock market slump have been overlaid by the recent strong market performance. Availability bias

The availability bias relates to the human tendency to rely on readily available information when faced with difficult decisions. As a consequence, from an individual’s viewpoint, things that are easily recalled are more likely. An example is mentioned by DE BONDT 1998 where the past performance of a stock is used to make assumptions about its future return. Therefore, a recent stock market crash will induce people to believe that

174

KAHNEMAN/RIEPE 1998, p. 56.

4.2 Standard economic theory and its adaptation to behavioral finance

83

the market will crash again soon. 175 This example also shows that the availability bias is closely linked to both the representativeness bias and the saliency bias. The availability bias influences retirement-specific FPB in two ways. First, personalized statements about pension eligibility (“Renteninformation”) make it easy for individuals to get transparency about their financial situation in retirement and thus improve the quality of their FP perspectives. Second, individuals see the financial situation of, e.g., their parents in retirement. In these usually favorable conditions, the availability bias induces individuals to assume a too optimistic perspective about their future. On the other hand, if parents are encountering financial difficulties for specific reasons (e.g., living in a retirement home or needing special care), the availability bias might arouse a higher awareness about the need to financially planning for retirement in the respective individuals. Conservatism

The term conservatism relates to the fact that individuals update their perception of reality only slowly to new evidence, as opposed to the Bayesian updating of mental models. Although updating does happen in the right direction, as described by EDWARDS 1968: “Opinion change is very orderly, and usually proportional to numbers calculated from the Bayes Theorem – but it is insufficient in amount. A conventional first approximation to the data would say that it takes anywhere from two to five observations to do one observation’s worth of work in inducing a subject to change his opinions.” 176 Conservatism is relevant to the research about individual retirementspecific FPB with regard to the transfer and processing of retirementspecific information and the related communication tactics: If information is to be retained and considered in the assessment of the personal situation in retirement, it needs to be transmitted in a vivid and memorable way, including lots of repetitions. 177 This effect is further accentuated if the infor175

An interesting point can be noted with regard to this tendency to estimate future performance based on past performance of a stock: Performance reports are mostly accompanied by the disclaimer “Past performance is no guarantee of future returns.” But since the size of that disclaimer is very small compared to the illustration of past performance, the availability bias limits the impact of this disclaimer. See MITCHELL/UTKUS 2004a, p. 21. 176 EDWARDS 1968, p. 359. 177 When the movie “Jaws” was shown, the number of people swimming in open waters dropped substantially, despite the fact that the probability of encounter-

84

4 Retirement-specific behavioral finance and derivation of benchmarks

mation or new evidence is objective in nature. 178 Thus, especially if individuals receive objective information about the future state of the retirement system or their personal pension eligibility, the inclusion of this information into their world view tends to happen only slowly and makes active and repetitive communication tactics necessary. 4.2.2.2 Positive bias

The second theme with regard to the perception of reality is the human tendency to project a too positive picture on one’s own abilities and knowledge. A positive bias is expressed through overconfidence, unbounded optimism and hindsight bias. Overconfidence

Overconfidence is the tendency to overestimate one’s abilities and knowledge. As an example, people overestimate the accuracy of their judgments about the future: When asked to give a confidence interval for a certain event to take place in the future, individuals tend to set overly narrow confidence bands and thus get more frequently surprised by the outcome than they anticipate. An example for the overestimation of one’s skills is the self-assessment of driving skills. 179 Overconfidence also leads to a selective perception of external information or a “selective memory”, where one only recalls those events consistent with one’s understanding of the reality. 180 At the same time information is interpreted according to personal preferences: While overconfidence-consistent information is absorbed, further reinforcing overconfidence, overconfidence-inconsistent information gets interpreted in a way that is consistent with that person’s world view. Similarly, overconfident people attribute positive results to their own abilities while they claim external factors to be responsible for bad results. With regard to gender, “psychological research has established that men are more prone to overconfidence than women, particularly so in male-

ing a shark had not changed on an objective level. Also see HARRISON 1999, who analyzes the enduring fear caused by “Jaws” and other movies and finds that exposure to “frightening media” leads people to continuously avoid the situations portrayed. 178 See SHLEIFER 2000, p. 127f. 179 KAHNEMAN/RIEPE 1998 find that 80% of individuals think that their driving skills are above the average. 180 See KAHNEMAN et al. 1982.

4.2 Standard economic theory and its adaptation to behavioral finance

85

dominated realms such as finance.” 181 This is manifested in the higher trading volumes of men, which is also documented in BARBER/ODEAN 2001. Furthermore, overconfidence is more pronounced with experts, younger and wealthier individuals as well as in the context of difficult tasks. SHEFRIN 2002 illustrates this point: “Inexperienced investors are more confident that they will beat the market than are experienced investors. Given the difficulty that many investors actually have beating the market, novice investors may be not just confident, but overconfident.” 182 YATES 1990 sees overconfidence as “an attempt to maintain a positive self-image.” 183 Its aim is to build the illusion of control, which is a central psychological need, especially in an environment characterized by insecurities and risks like planning for the individual financial situation in retirement. In this context, two more effects are of relevance: A strong sense of control increases overconfidence and overconfidence leads to the overestimation of one’s own ability to influence risks. Since most individuals are novices when it comes to their retirement planning, as retirement planning is a very difficult task and the shift of responsibility to the individual has substantially increased their sense of control, individual retirement-specific FPB is an area that is very prone to overconfidence. With regard to FPB, overconfidence prompts individuals to overestimate their own financial sophistication and, therefore, not to rely on an advisor. Furthermore, the tendency to estimate confidence intervals too narrowly carries the danger of underestimating the downside risks of adverse scenarios in the financial plan. Finally, the overestimation of their ability to influence risks might prevent individuals from mitigating the risks adequately. Unbounded optimism

Closely linked to overconfidence is unbounded optimism. This phenomenon describes the tendency to see things in a more positive light than a rational assessment would imply. When probabilities for future events have to be assessed, unbounded optimists underestimate the likelihood of bad outcomes over which they have no control. In a survey, MITCHELL/UTKUS 2004a asked college students to judge their own prospects for negative life events. The students emphasized positive outcomes for themselves

181

BARBER/ODEAN 2001, p. 289. SHEFRIN 2002, p. 48. 183 YATES 1990, p. 204. 182

86

4 Retirement-specific behavioral finance and derivation of benchmarks

whereas they were more skeptical for their roommates. 184 Unbounded optimists are also prone to illusion of control: They overestimate the degree to which they control their fate and underestimate the role of chance in human affairs. Furthermore, overly optimistic individuals tend to remember only good things and so display selective memory. Unbounded optimism is relevant to the topic of retirement-specific FPB, as overly optimistic individuals think they are less likely to experience bad outcomes than their peers. Consequently, they do not fully acknowledge the different threats that the future holds for them, such as longevity or health care risks. Therefore, unbounded optimism reduces their motivation to pursue financial planning activities and specifically the anticipation and mitigation of risks. Another manifestation of unbounded optimism is the fatalistic attitude of German women that their financial well being in retirement “will work out somehow”. 185 Hindsight bias

The tendency to believe that events that actually happened were predictable and that events that did not take place were unlikely is called hindsight bias. It is closely linked to overconfidence and relies on an imperfection of memory and perception. An example of such a perceptional mistake is when individuals believe events have happened when indeed they did not happen and the other way around. This phenomenon is equivalent to the “selective memory” described earlier. Hindsight bias “lulls us into believing that our opinions are more accurate than they really are. We thus fail to recognize the need to try to improve our judgments.” 186 According to KAHNEMAN/RIEPE 1998 “hindsight tends to promote overconfidence by fostering the illusion that the world is a more predictable place than it is.” 187 Applied to the question of individual FPB, the hindsight bias can lead individuals to remember just what they want to hear (e.g., suppressing the knowledge about a decrease in SSP or an increase in the retirement age). Furthermore, hindsight bias can induce individuals to think that they do not need to make a special effort to plan financially for retirement since in the past they seemingly succeeded in anticipating the future. They might

184

See MITCHELL/UTKUS 2004a, p. 24. See DEHM et al. 2000, p. 24f and HÖLLGER/SOBULL 2001, p. 16f. 186 YATES 1990, p. 100. 187 KAHNEMAN/RIEPE 1998, p. 55.

185

4.2 Standard economic theory and its adaptation to behavioral finance

87

also believe that their risk assessment is better than it indeed is and thus only provide for a very limited coverage of risks. 4.2.3 Step 2: “Normal” decision making Decision making relates to the question of how to frame a decision and how to process information. This section is devoted to the human limitations, complications and attitudes in the decision-making process that represent deviations from the assumptions of the homo economicus and the standard economic theory. These deviations come in four forms: Prospect theory, an integrated framework for decision making, which represents the answer of behavioral finance to the standard economic theory of decision making; limited cognitive abilities, which focuses on typical limitations in the human problem-solving approach; mental accounting, with its irrational implications on individuals’ propensity to consume; and finally, complexity aversion, describing the human preference for simplicity. 4.2.3.1 Prospect theory

Prospect theory represents a “normal” model of decision making, in contrast to the “rational” standard economic theory of decision making. It dates back to KAHNEMAN/TVERSKY 1979 and looks at the decision process as a two-step approach. First, the mental frame for the decision is constructed in the editing phase 188 and then, specific decision rules are applied in this mental frame. The prospect theory is defined by four key characteristics. The first characteristic, difficulties in probability weightings, has been discussed above in the section on faulty probability assessments. These contrast with the standard economic theory, in which the rational investor assesses risks objectively based on their probability. As a consequence, individuals in the prospect theory overweigh important events with small probabilities (e.g., lottery gains or plane crashes).

188

“The editing phase consists of a preliminary analysis of the offered prospects, which often yields a simpler representation of these prospects.” KAHNEMAN/TVERSKY 1979, p. 274. An example of this editing phase is the segregation of secure gains: In a gamble an individual either gets $30 with a probability of 30% or $70 with a probability of 70%. Typically, individuals frame these two options differently in that they consider the $30 as a sure gain and formulate the remaining cash flows as a gamble with a 30% probability of getting zero and a 70% probability of wining $40.

88

4 Retirement-specific behavioral finance and derivation of benchmarks

Framing as the second characteristic relates to the impact of frames on the outcome of a decision and emphasizes that the way in which options are presented greatly affects choices. Anchoring as the third propensity of the prospect theory describes how individuals usually evaluate options in relation to specific reference points and not to the big picture. Finally, investors are not risk averse as in the standard theory, but treat gains and losses differently; a behavior called loss aversion. Framing

The way different alternatives are presented tends to influence decisions. MADRIAN/SHEA 2001 show the impact of framing on the actual outcome of decisions. They illustrate that the participation rate in a saving plan is substantially lower when individuals must opt in, compared to the situation where automatic enrollment requires individuals to opt out of the plan if they do not want to save. The fact that rephrasing the saving question changes individuals’ preferences from not saving to saving illustrates “that many workers do not have particularly firm convictions about their desired savings behavior.” 189 Even more important is the finding that the “menu design is a more powerful influence on participant decision-making than the underlying risk and return characteristics of the investments being offered.” 190 As a key driver of individual decisions, framing is relevant to the question of individual retirement-specific FPB since it provides indications on how choice options should be framed in order to support optimal FPB. Anchoring

Anchoring relates to the fact that the outcomes of different decision alternatives are not seen from a consolidated perspective (e.g., by evaluating the change in the total wealth position) but as gains and losses relative to a mental benchmark, a reference point based on one’s own experiences. “Normal” investors tend to adapt these reference points only insufficiently to new information, an under-reaction that relates to the above-mentioned conservatism. MITCHELL/UTKUS 2006 describe their analysis of how much individuals invest in equity when they enter a saving plan at different moments of the market cycle. They find that individuals who enrolled near the 189

MITCHELL/UTKUS 2006, p. 85. This point is further detailed below in the section on the lack of firm preferences. 190 MITCHELL/UTKUS 2004a, p. 16.

4.2 Standard economic theory and its adaptation to behavioral finance

89

top of the bull market in 1999 still allocated about 70% of their new contributions to equities in June of 2003, despite the huge market drop in the preceding three years. Participants who joined the plan during the first six months of 2003 on the other hand allocated less than 50% to equities. While the 2004 enrollees were making their choices based on then-current information, the 1999 enrollees did not react so dramatically to market news. 191 This example illustrates on one hand the sensitivity of allocation decisions to the market conditions at the time of enrollment and on the other hand how much the absolute value of a first decision, the reference point, influences later decisions, no matter how arbitrarily the reference point has been chosen. The insufficient adaptation of reference points can also be seen as a form of inertia, which is described below. Anchoring is relevant to the investigation of retirement FPB because it impacts investment behavior and saving decisions. As an example, it will be very hard to change the average share of equity in retirement saving portfolios due to anchoring effects. In Germany for example, where the average share of equity holdings has historically been lower than the US average, 192 anchoring will make it hard to increase this equity level. Along the same line of reasoning, large required increases in the saving rate will always be difficult to achieve because of anchoring in the actual saving rate. 193 Also, anchoring induces people to assess their future retirement income based on their parents’ retirement income. Thus, they do not consider legislated reductions in pension income sufficiently. Loss aversion

Loss aversion acknowledges that the presumed reversibility of indifference curves supposed by the standard economic theory does not accurately reflect preferences. 194 On the contrary, depending on the direction of pro191

See MITCHELL/UTKUS 2006, p. 87. According to the DAI 2006, German households owned between 9-10% of their financial assets in direct stock holdings or equity mutual funds. In the US, for example, the average household had already in 1996 19% of their assets in stock holdings and a further 10% in mutual funds. 193 “Once households get used to a particular level of disposable income, they tend to view reductions in that level as a loss. Thus households may be reluctant to increase their contributions to the savings plan because they do not want to experience this cut in take-home pay.” THALER/BENARTZI 2004, p. 169. 194 The standard economic theory supposes that the rate of commodity substitution at a point on an indifference curve is the same for movements in either direction, meaning that the trade-off between A for B and B for A is identical over the same interval. However, empirical findings have shown that people make 192

90

4 Retirement-specific behavioral finance and derivation of benchmarks

posed trades and the starting point, the “minimum compensation people demand to give up a good has been found to be several times larger than the maximum amount they are willing to pay for a commensurate entitlement.” 195 This confirms that there is more pain parting with an object than there is joy in obtaining it. 196 As shown by KAHNEMAN/TVERSKY 1979 losses are felt about 2.5 times as painfully as gains of the same amount are felt to cause pleasure. BENARTZI/THALER 1995 show that the equity risk premium of 6% 197 corresponds to the risk premium investors require if they evaluate their portfolio once per year. Since they value possible losses 2.5 times more heavily than possible gains and since the probability for losses is higher with stocks, the factor of 2.5 on the weight of the negative outcome requires the full compensation of the higher return in equity to match the attractiveness of a safer asset like a treasury bill. Therefore, at the horizon of one year, investor will find stocks and bonds equally attractive under the assumption of the historical risk premium of 6%. Correspondingly for shorter time horizons, fixed income seems more attractive even in light of this high risk premium. Similarly, while individuals are usually risk friendly in the area of losses, they are risk averse in the area of gains – except for very small probabilities (like a lottery) where the pattern is reversed. 198 According to SHEFRIN 2002 emotionality, fear and the emphasis of security dominate risk aversion, whereas hope and the emphasis of potential influence risk friendliness. So risk is not one-dimensional but rather depends on several factors, one being recent experience (i.e., if someone has just gone through a stock market crash, he will no longer invest that freely into equity).199 These properties of evaluation are reflected in the s-shaped value function of Fig. 4.3.

choices that differ depending on the direction of the proposed trade. See KNETSCH 1989, p. 1277. 195 KNETSCH 1989, p. 1277. 196 See LOEWENSTEIN et al. 2003, p. 1214. 197 While the average stock return from 1926 to 1995 was 7%, the return on treasury bonds amounted to less than one percent. See BENARTZI/THALER 1995, p. 73. 198 See TVERSKY 1990, p. 74. 199 SHIV et al. 2005 examine the effect of emotions on decision making and find that individuals with emotions (compared to those who were unemotional due to accident or sickness) showed sub-optimal behavior. They were too optimistic after a winning experience and too pessimistic in case of losing.

4.2 Standard economic theory and its adaptation to behavioral finance

91

Value

Losses

Gains

Fig. 4.3

Value function from Kahneman’s and Tversky’s Prospect Theory

Source:

KAHNEMAN/TVERSKY 1979, p. 279

A manifestation of loss aversion is the notorious reluctance of investors to sell losing stocks. SHEFRIN/STATMAN 1985 and ODEAN 1998 find that investors have a preference for selling winning strategies or stocks too soon and postpone selling losing strategies or stocks. If individuals are faced with the realization of a loss (e.g., if the stock they own has fallen below their reference point), many people seek additional risk in an effort to recoup their investment. This is contrary to the conventional economic notion of “sunk costs”, according to which rational investors should ignore past losses. Loss aversion is relevant to the investigation of retirement-specific FPB because it highlights the importance of determining the reference point against which individuals are evaluating gains or losses at the outset of deciding on a financial planning strategy. Overall, the prospect theory illustrates that people are more loss averse than risk averse. As a consequence, retirement planning could be made more relevant to people if the topic were framed more as a “loss question” than as a question of secure lifestyle in retirement.

92

4 Retirement-specific behavioral finance and derivation of benchmarks

4.2.3.2 Limited cognitive abilities

Limited cognitive abilities summarize a number of typical human shortcomings in terms of problem solving and planning, which prevent individuals from acting in a rational way. The five elements of limited cognitive abilities detailed below are key concepts that help to understand which problems individuals are facing with regard to the inter-temporal financial optimization problem illustrated in sub-chapter 2.1. Bounded rationality

SIMON 1955 suggested the term “bounded rationality” to portray a concept of human problem-solving capabilities that does not rely on rationality and the perfect procession of information but describes a human limitation in rationality. 200 It reflects the limited cognitive and intellectual abilities that constrain human problem-solving capabilities. The consequence of bounded rationality is that certain types of decisions are too complex for individuals to master on their own. Bounded rationality is relevant to the investigation of individual FPB, as households are expected to solve the complex multi-period dynamic optimization problem described in sub-chapter 2.1. Not only are the different income and expense streams difficult to estimate, but substantial insecurity is also associated with the different probabilities and various risks that influence an individual’s financial situation in retirement. Therefore, “determining the appropriate savings rate is difficult, even for someone with economics training.” 201 Furthermore, since individual micro-level behavior also depends on the understanding of the broader macro-economic context, it is relevant that limited cognitive and intellectual abilities can also be perceived in the understanding of the mechanics of the retirement system: A recent survey conducted in Germany has revealed that only a minority of 41% of interviewees understand how the PAYG system works and that all of their contributions are used to finance current pensioners, with nothing going towards their own retirement. Furthermore it could be shown that less than 42% of those that dare to make an estimate about the costs of the SSP system know that the contribution rate amounts to 19.5% of the salary, while an even higher share of individuals underestimates these

200 201

See SIMON 1955, p. 99ff. THALER/BENARTZI 2004, p. 167.

4.2 Standard economic theory and its adaptation to behavioral finance

93

costs. 202 It is important to note that bounded rationality is also present with regard to financial mechanisms: REILLY/BROWN 2000 state that “fewer than 40 percent of employees who participate in their firm’s retirement savings plan have a good understanding of the value of diversification, the harmful effect of inflation on one’s savings, or the relationship between risk and return.” 203 Overall, the task of financially planning for retirement is “daunting and discouraging. And for some people, the problem may be so complex that they are forced to rely on decision heuristics that simplify decision-making, but may not necessarily produce appropriate outcomes.” 204 Ways to cope with bounded rationality are the use of historical experience, rules of thumb or learning. 205 Due to the current reforms underway, historical experience is not a good approximation of what the future financial situation in retirement will look like in Germany. Rules of thumb are rarely available for the question of individual retirement financial planning due to the specifics of the individual situation. 206 Financial education as a third lever can reduce bounded rationality and most authors also attest it a high effectiveness. 207 However, others like CHOI et al. 2002 for example, caution that “while financial education does improve savings outcomes, its effects are modest at best.” 208 Therefore, education needs to be complemented with other measures. Another point is remarkable with regard to an individual’s preparedness to overcome bounded rationality: As LUSARDI 2004 puts it, relatively few people feel that they are able to plan effectively for retirement due to reasons such as bounded rationality. Therefore accepting bounded rationality as an explanation for their own typical human

202

Only 80% of all interviewees dared to make an estimate and of these, 45% thought the contribution rate was lower than 19.5% and 13% expected it to be higher. See BOERI et al. 2001, p. 23. 203 REILLY/BROWN 2000, p. 53. 204 MITCHELL/UTKUS 2004a, p. 35. 205 See THALER 1994, p. 187. 206 Practitioners for example have developed the rule of thumb to save 10% of the disposable income. See KOBLINER 2000, p. 42. However, as the simulation of the required saving rate for the different groups of investors will show in subchapter 6.4, the ideal saving rates deviate substantially from this rule of thumb indication and are strongly influenced by the individual situation and preferences. Indeed, organizations specialized on individual financial advice such as UBS, Credit Suisse or Wegelin emphasize that it is impossible to set up generally applicable rules. See FISCHER 2006, GAST 2005 and ORGLAND 2006. 207 See for example LUSARDI 2004, CLARK et al. 2004 and the OECD 2005. 208 CHOI et al. 2002, p. 70.

94

4 Retirement-specific behavioral finance and derivation of benchmarks

limitations in problem solving offers a fertile ground for improving individuals’ FPB and could be leveraged as a motivator. Hyperbolic discounting

In the standard theory of decision making all agents are assumed to discount exponentially. This means that they use a discount rate that is constant over time and thus their utility function is constantly decreasing. Thus, they are “equally patient at long and short horizons.” 209 But empirical research also found deviations from the standard theory in this field. Half a century ago, STROTZ 1956 suggested that people are more impatient when they make short-run trade-offs than when they make longrun trade-offs. Since then, many formal experiments have shown that decision makers show more impatience in the short than in the long run. Evidence has shown “that people display time-inconsistent behavior, specifically, weighing current and near-term consumption especially heavily”210 and thus displaying “present biased” preferences as termed by O'DONOGHUE/RABIN 1999a. Practically, this means that “when two rewards are both far away in time, decision makers act relatively patiently. For example, a worker prefers a 20-minute break in 101 days, rather than a 15-minute break in 100 days. But when both rewards are brought forward in time, preferences exhibit a reversal, reflecting more impatience; the same person prefers a 15-minute break right now, than a 20-minute break tomorrow.” 211 This observation can be explained by the fact that consumers have a short-run preference for instantaneous gratification but a longrun preference to act patiently. This combination of time preferences is called “hyperbolic discounting”. Fig. 4.4 depicts the shapes of the exponential and the hyperbolic discount function for the value of a “util” that is delayed in time as well as the application of these discounting functions to the value of one dollar of saving in the future.

209

MULLAINATHAN/THALER 2000, p. 9. THALER/BENARTZI 2004, p. 167. 211 ANGELETOS et al. 2001, p. 48.

210

4.2 Standard economic theory and its adaptation to behavioral finance Value of util delayed by τ years

Value $

1.2

6.0

1.0

5.0

0.8

4.0

0.6

95

Exponential discounter: $5.74 in 30 years

Hyperbolic discounter: $3.32 in 30 years

3.0 Hyperbolic

0.4

2.0

0.2

0% Time value of money

1.0

Exponential

0.0

0.0 0

5 10 15 20 25 30 35 40 45 50 Delay (years)

0

5

10

15

20

25

30 Years

Fig. 4.4

Development of the value of a “util” and the value of one dollar of today’s saving over time

Source:

ANGELETOS et al. 2001, p. 51 and MITCHELL/UTKUS 2004a, p. 7

Hyperbolic discounting can be applied to the question of retirement financial planning in two dimensions: With regard to the development of the value of today’s consumption going forward (displayed as the value of one “util” in the left graph), the hyperbolic individual will overestimate the loss in value of consumption tomorrow relative to consumption today and correspondingly overestimate the value of consumption today relative to future consumption. Thus he will consume too much today. Even if in the long run the hyperbolic-discounting individual considers the decrease in the value of an util (e.g., consumption) as less pronounced than an exponentially-discounting individual, this long-term perspective does not substantially influence actual behavior, since individuals tend to focus on the present (an effect termed myopia and described below). With regard to the evolution of the value of one actual dollar of saving, the right graph shows that a hyperbolic agent substantially undervalues the future value of today’s saving in the long run. As a consequence, individuals will overvalue today’s consumption and undervalue the future value of today’s savings. Both these effects tend to have an adverse impact on the adequacy of individual provision for retirement as they substantially reduce the motivation for saving.

96

4 Retirement-specific behavioral finance and derivation of benchmarks

If individuals realize that they have hyperbolic consumption functions that represent a self-control problem, 212 they are called “sophisticated selves”. They “correctly predict that later selves will not honor the preferences of early selves. Thus, the early selves take actions that seek to constrain their future selves.” 213 Therefore, “sophisticates may complete an unpleasant task before they would if they had no self-control problem,” 214 because their awareness of potential future misbehavior increases the cost of current misbehavior and thus encourages the sophisticated selves to behave correctly in the present. “Naïve” individuals on the contrary make current choices “under the false belief that later selves will act in the interests of the current self. Such “naïfs” have optimistic forecasts in the sense that they believe that future selves will carry out the wishes of the current self. Under this belief, the current self constructs the sequence of actions that maximizes the preferences of the current self. The current self then implements the first action in that sequence, expecting future selves to implement the remaining actions. Of course, those future selves conduct their own optimization and therefore implement actions that potentially do not maximize earlier selves’ preferences.” 215 In terms of deriving suggestions for a better FPB, the distinction between “sophisticated” and “naïve selves” shows that education and increasing the awareness about typical human limitations leading to “sophisticated selves” can contribute to an improvement of individual provision for retirement because it increases the preparedness for self-regulation actions and commitment. An impressive real world example of hyperbolic discounting can be found at WARNER/PLEETER 2001. They analyze the military drawdown program of the Department of Defense (DoD) of the early 1990 in order to estimate personal discount rates. In this program, 11,000 officers and 55,000 enlisted personnel had the choice of an annuity for twice the years of service or a lump sum payment. The internal rate of return of the annuity 216 ranged between 17.5% for those with 7 years of service and 19.8% 212

The self-control problem describes an irrationality in terms of action detailed below. Namely, it is the fact that individuals have problems implementing their decisions due to bounded willpower. 213 ANGELETOS et al. 2001, p. 52. 214 O’DONOGHUE/RABIN 1999a, p. 118. 215 ANGELETOS et al. 2001, p. 52. 216 Break even discount rates where the value of the annuities equals the value of the lump-sum, without taking into consideration the probably higher tax burden on lump-sum payments.

4.2 Standard economic theory and its adaptation to behavioral finance

97

for those with 15 years of service, compared to a money market return at that time of 7%. Building on rational considerations, the majority of the employees was expected to choose the annuity. But the results of the study give a completely different picture: 51% of the officers and 92% of the enlisted personnel took the lump sum, with higher acceptance rates for individuals with a shorter time of service. In order to shed light on these results, WARNER/PLEETER 2001 used a loglinear model to derive the discount rates individuals used to equal the value of future annuity payments to the value of the lump sum. These discount rates are depicted in Fig. 4.5. Breakeven discount rates Percent Officers

Enlisted personnel

71.4

29.1

Years of service

7

23.2

9

18.0

13.2

9.9

11

13

15

60.7

52.7

45.9

53.6 38.9

18.7

All

7

9

11

13

15

All

Fig. 4.5

Breakeven discount rates applied by army personnel of different ranks

Source:

Analogue to WARNER/PLEETER 2001, p. 48

These discount rates reveal three characteristics. First, comparing the results of the officers with the enlisted personnel, it becomes obvious that the higher the amounts in question (as is the case for the payments to the officers), the lower the discount rates become. This means that a lower income leads to a higher personal discount rate. Similarly, richer individuals have lower discount rates. Second, comparing the discount rates for individuals with a longer time horizon (i.e., individuals receiving the annuities for a longer period due to a higher number of years of service) the typical hyperbolic propensities become visible: Namely the fact that individuals are more patient in the long run and thus decrease their discount rate as the time horizon increases for which an annuity is to be received. Third, comparing the applied discount rates with the relevant rates of a risk free investment shows how irrationally high they were. The consequence of hyperbolic discounting for retirement-specific FPB is that “consumers will report a gap between their long-run goals [a high level of retirement income] and their short-run behavior [renouncing pre-

98

4 Retirement-specific behavioral finance and derivation of benchmarks

sent consumption through saving]. They will not achieve their desired level of ‘target savings’, since short-run preferences for instantaneous gratification undermine the consumers’ efforts to implement patient longrun plans.” 217 This might lead to a sub-optimal saving rate over the entire life-time as individuals consume too much early on and, at a later time, decide “to consume more – and save less – than originally planned.” 218 Furthermore, the hyperbolic discounting function delays the start of retirement-specific FP actions since individuals tend to postpone unpleasant tasks. For example, an individual might intend to start an aggressive savings plan next year. However, when next year actually rolls around, the preferences of the individual might have shifted and he will postpone the start of the program for another year. 219 Another problem highlighted in the analysis of WARNER/PLEETER 2001 is the low acceptance rate for annuities. People in general seem to dislike annuities and accord them a higher discount rate than is rational. One explanation for this observation is the tendency of individuals to underestimate their life-expectancy. As a consequence, they also underestimate the duration of annuity payments and thus further increase the discount in the value that they attribute to annuity payments. In addition, especially those individuals with lower incomes tend to have even higher personal discount rates and thus run an even greater risk of not accepting a favorable annuity solution. Given that they tend to have the lowest amount of additional savings and would need the security stemming from annuitization most urgently, this behavior is particularly dangerous. A solution to the problems associated with the hyperbolic discounting functions is to impose control on the self. This can be achieved through signing up to a commitment such as a savings plan or through building on the human tendency for mental accounting described below. Apart from these strategies, pre-commitment measures would be reasonable where the individual makes a commitment now for something in the future (such as the approach used by the SMarT program from THALER/BENARTZI 2004 220 where individuals are asked today to commit future salary increases to additional savings). Furthermore, as the difference between sophisticated and naïve selves has shown, education can help to raise awareness of hyperbolic discounting and thus the preparedness to accept commitment measures. On the other hand, the example of the US military drawdown shows that despite the fact that the DoD went to great lengths to inform the per217

ANGELETOS et al. 2001, p. 48. LOEWENSTEIN et al. 2003, p. 1209. 219 See LAIBSON 1997, p. 446. 220 For a detailed description of the SMarT plan refer to Footnote 20.

218

4.2 Standard economic theory and its adaptation to behavioral finance

99

sonnel about the programs (e.g., through pamphlets with comparisons of the DCF of the annuity to the lump-sum amount, articles in the newspaper and even individual counseling), the results have shown that apparently the information has not been sufficiently incorporated into the decisionmaking process. 221 Money illusion

Money illusion describes the human limitation with regard to grasping the full effects of inflation. It is caused by several reasons. To start with, the average worker seems to be poorly informed about inflation rates. 222 Furthermore, “gains and losses appear to be experienced in nominal dollars” 223 rather than in real terms which can lead to a wrong assessment of the true impact of a decision. Additionally, even if individuals can figure out how to adjust for inflation, it is not a natural way for them to think. “The natural way to think is in terms of nominal values. Therefore, people’s emotional reaction is driven by the nominal values.” 224 The problem with money illusion is further accentuated by the saliency bias, which makes people more receptive to inflation when it affects their expense side rather than when it affects their income side. Money illusion is relevant to the investigation of retirement FPB as the long-time horizon up to retirement and the duration of retirement, expected to be about 24 years for women, 225 are time frames in which inflation plays a very important role and thus needs to be taken into consideration. Furthermore, the fact that people’s actions are driven by nominal values means that if values like the retirement income are presented in nominal terms, people will feel content about almost any increase even if they might grasp that in real terms it represents a decrease in value. Therefore, in order to increase the awareness about the true value of retirement in221

See WARNER/PLEETER 2001, p. 34f. See BODIE et al. 2002. 223 THALER/BENARTZI 2004, p. 169. 224 SHEFRIN 2002, p. 32. As an example the financial situation of two individuals who graduated from the same university one year apart and upon graduation took similar jobs is highlighted. While individual A encounters no inflation in the first year and gets a salary increase of 2% at the end of the year, individual B lives in an environment with 4% inflation and gets a salary increase of 5%. Correspondingly, individual A is better off in real terms. However, in most people’s mind, individual B tends to be happier while individual A will probably start to look for another job. 225 See BÖRSCH-SUPAN et al. 2005, p. 13ff. 222

100

4 Retirement-specific behavioral finance and derivation of benchmarks

come and to be consistent with SHARPE 1990, the simulation calculations in this study are performed in real terms. Furthermore, with regard to the derivation of levers for policy-makers, financial planners or the individual, it is important to note that money illusion can also be used positively in the design of retirement plans. If, for example, individuals tend to think in terms of nominal take-home pay, a saving increase could be implemented to coincide with salary increases. Thus in nominal terms the take-home pay would remain constant even if in real terms this might represent a real reduction of income. Projection bias

According to LOEWENSTEIN/O'DONOGHUE/RABIN 2003, individuals exhibit a general bias in the prediction of future tastes and preferences: They seem to understand the directions in which their tastes will change, but systematically underestimate the magnitudes of these changes. Specifically, people underestimate the effect of long-term changes in tastes, such as the demand for a better lifestyle, resulting from the adaptation to an increasing standard of living. Projection bias is relevant to FPB as the question about the individual financial situation in retirement has to do with a “life-cycle consumption model with habit formation. When consumption is habit forming, a person should rationally pursue an increasing consumption profile, so that she is always consuming more than she is accustomed to. Projection bias leads a person to under-appreciate the impact of current consumption on future utility, and hence to consume too much early in life.” 226 If an individual is confronted with a situation where the consumption preferences are higher than anticipated, income might be valued more highly at that given time in the future and thus the individual might decide to continue to work or retire later than originally planned. Correspondingly, in the analysis of the FP perspectives, projection bias is relevant as it tends to reduce the estimated sum of financial needs in retirement. Lack of firm preferences

Contrary to the presumptions of the standard economic theory that individuals have clearly defined and steady preferences, “normal” individuals 226

LOEWENSTEIN et al. 2003, p. 1211.

4.2 Standard economic theory and its adaptation to behavioral finance

101

display varying characteristics with regard to the strength of their preferences. The lack of firm preferences demonstrates that individual preferences tend to be largely situational. Consequently, they emerge at the time a decision is taken, based on the circumstances surrounding the decision. Compared to earlier preferences, the situational adaptation of preferences can lead to preference reversal. The lack of firm preferences confirms the effect of framing and can be perceived in two ways. First, individuals show a strong tendency to avoid the extremes, even if it means that they have to deviate from their original set of preferences. BENARTZI/THALER 2002 conducted a test where individuals were given the chance to choose their future asset allocation according to their own historical asset allocation, the median portfolio or the average portfolio. About eight out of ten individuals preferred the median portfolio to their own portfolio. Consequently, participants seemed to be happier with portfolios constructed as the statistical average of their peers than their own portfolio. Thus, given the new information, many of them showed preference reversal. Another application is naïve diversification heuristics. BENARTZI/THALER 2001 show that, when deciding about the asset allocation within DC pension plans, individuals are substantially influenced by the different menu options in the plan. If, for example, the menu of a plan offers 10 equity options and 5 non-equity options, individuals tend to put 2/3 of their money into equity. By offering different combinations of menu options, BENARTZI/THALER 2001 find that individuals lack a consistent set of well-ordered risk preferences. Instead they seem to apply the “avoid extremes, pick the middle option” heuristic. 227 Overall, both examples confirm that individuals do not have a firm set of personal preferences. Second, the weakness of the personal set of preferences can also be perceived in the effect of peer influence on individual behavior. DUFLO/SAEZ 2004 document an interesting spill-over effect with regard to the attendance of retirement seminars, program enrollment rates and contribution choices for employees working in the same department. They find that social network effects still prompt some people to take steps, which ulti227

Sometimes, this tendency to the mean can also have rational reasons. SCHARFSTEIN/STEIN 1990 have found that institutional portfolio managers sometimes ignore substantive private information and mimic the investment behavior of other asset managers. Even if this behavior looks inefficient, it can be rational from a social standpoint if the managers are concerned about their reputation in the market. This is due to the fact that a bad decision is not as bad for the reputation when others make the same mistake. In that sense herding and the acceptance of the mean strategy is even a rational attempt of managers to enhance their reputation. See SCHARFSTEIN/STEIN 1990, p. 465ff.

102

4 Retirement-specific behavioral finance and derivation of benchmarks

mately lead them to positively change their 410(k) plan participation decisions. In addition, they illustrate the fact that if individuals see the attendance at a session as compulsory (e.g., they are paid for attending) they pay less attention than if they attend because of social pressure. The lack of firm preferences is relevant to retirement-specific FPB because it shows to which extent individual behavior can be influenced by design choices and the formulation of average preferences. Furthermore, the meaning of social networks can be leveraged to promote responsibility for individual financial planning and induce people to undertake the right steps together. 4.2.3.3 Portfolio segregation

The portfolio segregation concept represents an answer to the standard economic assumption of fungibility of assets or the presumption that behavior should not depend on the label associated with any pot of money. It describes different perspectives an individual takes to consider the elements of a portfolio. These perspectives can relate to a varying propensity to consume different asset pots (mental accounting) and the framing of decisions (myopia). Mental accounting

“Mental accounting is the set of (implicit or explicit) cognitive activities that individuals and households engage in to serve the same function that regular accounting serves in an organization.” 228 It can be shown that “wealth coming in the form of current income is almost entirely consumed, but wealth coming in the form of an increase in home equity or pension assets has little or no effects on consumption.” 229 Alternatively put, there are mental accounts such as cash at hand or dividend income that are more “tempting” to consume than, for example, money in a savings account, which in turn is more tempting than money in a pension plan or home equity. 230 The latter are so-called “capital accounts” that are protected from consumption by the rule of thumb “Don’t dip into capital”. 231 Other rules are “don’t kill the goose that lays the golden eggs” or “pay yourself first”, the direct deduction of contributions from a worker’s pay in order to avoid 228

THALER et al. 1997, p. 648. THALER 1994, p. 188. 230 See THALER 1995, p. 10ff. 231 SHEFRIN/STATMAN 1993, p. 131.

229

4.2 Standard economic theory and its adaptation to behavioral finance

103

that the money is spent. Since people find it easier to save from inheritances or lump sum payments (e.g., bonuses) than regular income, 232 it might make sense to incorporate special saving incentives for inheritances or bonus money in a saving plan and for an employer to proactively pay bonuses as lump sums rather than to spread them evenly over the year. As a consequence, varying propensities to consume different wealth pots are highly relevant to the question of retirement-specific FPB as they offer a way of imposing control on the self. Myopia

Myopia is a sub-set of mental accounting and concerns the framing of decisions. The question of framing relates on the one hand to the degree of integration of different asset positions in one portfolio and on the other hand to the timing of evaluation cycles. The degree of integration of different asset positions in one portfolio is relevant as it drives individual investment behavior. If a portfolio were fully integrated, the individual would only look at the total wealth position rather than at relative gains and losses. Furthermore, the entire portfolio would only be analyzed under one common measure of risk aversion and in the world of Markowitz, the correlation of different securities would be taken into consideration. But “normal” individuals tend to apply a layered approach as illustrated in the behavioral portfolio theory (BPT) below. Also, they tend to keep separate mental accounts for unrealized and realized gains and losses. Therefore, selling a loser stock and thus closing an account at a realized loss is especially painful. 233 If an individual is “framing a decision narrowly”, he thinks about investments one at a time rather than aggregating them into a portfolio, neglects the effect of correlation and diversification and thus favors short-term choices rather than longterm policies. The timing of evaluation cycles is another key element of myopia. In this context, narrow framing drives individuals to evaluate gains and losses frequently and thus has consequences for the tolerance for equity holdings. Since the probability of observing a loss is higher when the frequency of 232 233

See SHEFRIN 2002, p. 144. On this basis, SHEFRIN 2002 proposes to motivate such a transaction by thinking of it as a reallocation of assets from one mental account to an other account (“Transfer your assets!”) rather than closing one account at a realized loss. SHEFRIN 2002, p. 27. The effect of why selling a loser is so painful has already been illustrated in the context of the prospect theory and the loss aversion highlighted above.

104

4 Retirement-specific behavioral finance and derivation of benchmarks

evaluation is high and, furthermore, losses cause more mental anguish than equivalent gains cause pleasure (due to the loss aversion discussed above), investors who are framing shortly will derive less utility from owning stocks. As a consequence, an investor who is prepared to wait a long time before evaluating the outcome of the investment, will find a risky asset more attractive than another investor (equally loss averse, but more myopic) who evaluates the outcome more frequently. 234 BENARTZI/THALER 1999 and THALER et al. 1997 reveal two interesting findings in this regard. First, they show that if individuals are provided with short-term performance reports, their investments in equity are reduced. Second, they state that aggregating one-year returns into 30-year equivalents increases the attractiveness of stocks and thus leads to a higher share of equity investments. 235 Myopic behavior is mainly relevant to the investigation of retirementspecific FPB in that it influences the allocation choices of individuals. On the one hand, myopia drives the segregation of the total portfolio into different layers, which can be seen in the BPT. On the other hand, it influences the share of equity: As long as the investment is not evaluated frequently, “the attractiveness of the risky asset will depend on the time horizon of the investor. The longer the investor intends to hold the asset, the more attractive the risky asset will appear.” 236 If however, individuals tend to evaluate their outcomes frequently, they might risk under-investing in equity. Given the long time frames that are relevant to FPB, such an equity under-investment may represent a substantial amount of foregone retirement income. 237 Nevertheless, myopia can be overcome by compelling individuals to commit themselves to the same asset allocation for several periods (e.g., by restricting their reallocation opportunities), by providing them with performance information at relatively infrequent intervals and by showing them long-term performance expectations for their investment options.

234

See THALER et al. 1997, p. 648f or KAHNEMAN/RIEPE 1998, p. 62. They conduct a test between two groups of employees covered by a DB plan. One group is shown the annual rates of return for two asset types; the other group is shown a distribution of simulated 30-year rates of return. They find that the latter group invests substantially more of their retirement funds in stocks than the first group (90% versus 40%). See THALER et al. 1997, p. 659. 236 BENARTZI/THALER 1995, p. 75. 237 As a point of caution however, it is important to note that this effect of myopia can be compensated by the above described phenomenon of overconfidence in the sense that people overestimate their ability to select the future winners and thus invest too much in a few specific titles.

235

4.2 Standard economic theory and its adaptation to behavioral finance

105

4.2.3.4 Complexity aversion

The forth key theme of human decision making is the preference for simple decisions and choices. It is expressed by an aversion towards the unknown and unfamiliar (ambiguity aversion) as well as a kind of paralysis resulting from choice overload. Ambiguity aversion

Not knowing a probability is usually perceived as a risk factor, while the level of credibility of a probability often gets subjectively underestimated. 238 This phenomenon dates back to ELLSBERG 1961 and therefore is termed “Ellsberg paradox”. Ambiguity aversion leads to fear and risk aversion, which could be documented in games where the chances for gains and losses are unknown. 239 Retirement is characterized by ambiguous risks and probabilities. Therefore, ambiguity aversion is important for the analysis of FPB for two reasons. On a more negative note, as planning for one’s retirement is mostly perceived as an unfamiliar situation, it can be assumed that the predominant emotion in the context of FPB is fear. On a more positive note, individuals with a financial plan enjoy more security and oversight about their financial situation in retirement and perceive a higher utility due to a reduction of the unknown and their level of ambiguity. As a consequence, the positive effect of having more transparency and less ambiguity could be used as a motivation for individuals to engage in their financial planning for retirement. Sensitivity to choice overload

“Choice overload” relates to the fact that individuals who are exposed to too many options get overwhelmed and end up with sub-optimal decisions. Intuitively, the wider the choices for individuals, the higher the perceived utility, as the possibilities of different options tend to increase an individual’s sense of personal control and thus his feelings of intrinsic motivation. As such, a wider set of choices seems more desirable. But an extensive ar238 239

See EISENFÜHR/WEBER 2003, p. 361ff. For example, in a drawing game of 90 red, black and yellow balls where 30 are red and 60 are black or yellow, people tend to prefer the game where they win if a red ball is drawn over the game where a black ball means victory. See EISENFÜHR/WEBER 2003, p. 361.

106

4 Retirement-specific behavioral finance and derivation of benchmarks

ray of choices can also reduce the subsequent motivation to choose and to commit to a decision. Research has shown that the more options a 401(k) plan offers, the lower the participation rates are. SETHI-JYENGAR/HUBERMAN/JIANG 2004 find that individuals who are faced with complex choice-making processes may experience frustration. In addition, they state that dissatisfaction resulting from the perceived greater responsibility for the choices these individuals have to make might reduce their willingness to commit to a specific choice. This phenomenon of “choice overload” is further exacerbated if the costs of making the wrong choice are prominent and if “substantial time and effort would be required to make truly informed comparisons among alternatives. The more individuals perceive their choice-making task to necessitate expert information, the more they are inclined not to choose. In such cases, they may even surrender the choice to someone else – whom they presumably see as more expert.” 240 Conversely, recent psychological research “suggests that a limited number of choices may in fact lead to greater happiness.” 241 Since the characteristics of the problem described in this quote fit quite well to the characteristics of the individual inter-temporal financial optimization problem, it illustrates why “choice overload” is relevant to individual FPB. To prevent “choice overload”, the options provided by e.g., financial planners or policy-makers should be limited accordingly. This has, for example, been realized by the TIAA-CREF pension fund that offers only 10 basic investment options. This induces its participants not to focus on the question of which funds to own but which asset classes to invest in. 242 Two studies offer substantial insights with regard to recommendations for adaptations of decision options to avoid choice overload: SCOTT/STEIN 2004 have analyzed the design of advice and the different probabilities that advice gets followed and incorporated. Their study reveals that not showing all the different options but just the status quo and the best possible alternative provides the best results with regard to the incorporation of advice into the actual decision process. Offering only two options focuses the participant’s attention on the binary decision of staying where he is or switching to a single alternative. A wider range of choices is still available, but the participant has to actively request it. Thus, fewer and more direct choices are more likely to generate actions. Similarly, MACFARLAND/MARCONI/UTKUS 2004 recommend to tier the available options according to the level of sophistication of the different groups of 240

SETHI-JYENGAR et al. 2004, p. 86. BENARTZI/THALER 2002, p. 1594. 242 See ZWEIG 1998, p. 114f. 241

4.2 Standard economic theory and its adaptation to behavioral finance

107

addressees. As a consequence, they propose offering only a limited set of options to less sophisticated individuals. Apart from the above design recommendations, it needs to be considered that individuals tend to analyze only the first five pieces of information they receive, assuming that important information is presented first.243 This again favors few options and simplified communication to support the individual in his financial planning activities. 4.2.4 Step 3: “Normal” implementation of actions The third step within the human decision-making process is concerned with the transfer of the decision into action. This section focuses on the specific actions or the lack of actions that result from typical human behavior. In this context, four themes have been identified as relevant. The most pronounced is the theme around passivity. Passivity stands for everything related to not moving forward, avoiding change or just taking the path of least resistance. The second action theme with a specifically high relevance for the question of retirement financial planning is the lack of self-control, the bounded willingness to commit to the actions one has decided. The third theme is called home bias and has to do with a concentration of investments in securities of one’s own company or country. Lastly, regret stands for the feeling of disappointment at not having done the right thing. 4.2.4.1 Passivity

Passivity is composed of three elements: Procrastination, the tendency to postpone unpleasant tasks and thus delay change; inertia or sticking with the status quo; and lastly the tendency to accept the default options of a choice that also means taking the path of least resistance, which is equivalent to passive decision making. Procrastination

Procrastination describes the “familiar tendency to postpone unpleasant tasks” 244 and is a form of time-inconsistent behavior. Thinking about retirement and eventually one’s own death to determine an expected dissaving period as well as renouncing consumption today in order to save for 243 244

See YATES 1990, p. 198. THALER/BENARTZI 2004, p. 167.

108

4 Retirement-specific behavioral finance and derivation of benchmarks

the future are “unpleasant tasks”. Therefore, to postpone either planning for retirement or starting with a savings plan are typical examples of procrastination. Two main effects are responsible for procrastination. First, “hyperbolic agents procrastinate because they (wrongly) think that whatever they will be doing later will not be as important as what they are doing now. The more naive agents are, the more pronounced the tendency to procrastinate.” 245 Second, procrastination can also be the result of a very complicated decision where individuals procrastinate because they are overwhelmed by the complexity of the task. The determination of the adequate saving rate in the context of the inter-temporal financial optimization problem is one such decision. Procrastination can lead to two major outcomes. On the one hand, it increases inertia and, on the other hand, it induces individuals not to take an active choice but just accept default options as described below. According to MADRIAN/SHEA 2001, procrastination can be reduced by making decisions less complicated, for example, by offering a limited menu of the most popular investment choices within a 401(k) plan. Furthermore, since sophisticated selves tend to undertake measures in order to cope better with the danger of hyperbolic discounting, increasing the sophistication level through e.g., education also represents a measure against procrastination. Inertia/Status quo bias

SAMUELSON/ZECKHAUSER 1988 state that to do nothing is within the power of men. They have termed this observation as “inertia” or “status quo bias”. 246 To document inertia, SAMUELSON/ZECKHAUSER 1988 studied the individual changes of asset allocation in a pension fund. They found that the median number of changes in the asset allocation over the life-time was zero, meaning that more than half of the participants reached retirement with the same asset allocation they chose the day they became eligible for the plan. As a consequence, they were constantly buying the same percentage of equity with their incremental savings. Given the high growth rates of equity and the constant flow of new money into equity despite an increasing age, the plans ended up with a substantial overweight in equity at the moment of retirement. This behavior is relevant for the investigation of individual retirementspecific FPB with regard to two dimensions. On the one hand, the share of 245 246

THALER/BENARTZI 2004, p. 168. SAMUELSON/ZECKHAUSER 1988, p. 7.

4.2 Standard economic theory and its adaptation to behavioral finance

109

new money paid into equity should decrease as one approaches retirement, in order to reflect the shorter time horizon of the investor and thus his lower risk capability. On the other hand, the entire portfolio should be rebalanced regularly to account for the different appreciation rates of the different investment classes. Inertia can be caused by procrastination or by avoiding transaction costs. 247 The latter effect is confirmed by O'DONOGHUE/RABIN 1999b who point to transaction costs as one explanation for why a person does not “immediately transfer retirement savings from a current account to some alternative that yields higher interest.” 248 Applied to the changes of the default asset allocation within a pension fund, transaction costs would be the indirect costs of learning about the alternatives and evaluating the different options and the “direct costs of implementing a desired change.” 249 On a more positive note, inertia can be leveraged to enhance individual FPB: Once an individual has established a financial plan for retirement, inertia will reduce his willingness to give it up again. This is why it is essential to induce individuals to get started with financial planning for retirement early. Since inertia describes the fact of sticking to the status quo, it is closely linked to the concept of accepting default options, a form of passive decision making that is highlighted in the next section. Passive decision making/Accepting the default options

The second effect of procrastination, which mostly occurs in the context of complex decisions, is a passive form of decision making: the acceptance of default options. It describes the fact that “employees are likely to do whatever requires the least current effort: employees often follow the path of least resistance.” 250 Applied to the question of decision making, the easiest thing to do is to just accept default options. MADRIAN/SHEA 2001 have shown that procrastination leads to just accepting the default saving rate and the default asset allocation within a 401(k) plan. 251 Another reason for accepting the default rates might be the fact that individuals have only very weak preferences and, thus, rather than making an active choice, individuals prefer to accept the choice of others. 247

See SAMUELSON/ZECKHAUSER 1988, p. 33. O’DONOGHUE/RABIN 1999b, p. 131. 249 MADRIAN/SHEA 2001, p. 1177. 250 CHOI et al. 2002, p. 70. 251 See MADRIAN/SHEA 2001, p. 1184. 248

110

4 Retirement-specific behavioral finance and derivation of benchmarks

As a consequence for retirement FPB, the design of a pension plan with its default options is a key means of influencing the savings and investment choices of individuals building on the path of least resistance. 252 Therefore, financial planners and policy-makers in particular need to be careful about how they design default options within retirement provision programs. 4.2.4.2 Lack of self-control

The standard economic theory assumes that a homo economicus – once having solved the decision problem for the optimal solution – follows through on his decisions. However, “real humans, even when they know what is best, sometimes fail to choose it for self-control reasons.” 253 Too often they struggle to take action and when they do act their behaviors are often half-hearted and ineffective and it seems as if they have “bounded willpower” or limited capacity and desires to execute their intentions. 254 The lack of self-control is relevant to the topic of individual retirementspecific FPB for various reasons. First, it explains that there is a substantial difference between the actions people think they should undertake and the actions they indeed undertake. This is most striking with regard to the saving rate: “Many households report that they would like to save more but lack the willpower.” 255 An illustrative example is provided by CHOI et al. 2002. They conducted a survey of 10,000 employees at a single firm and found that 68% of the individuals indicated that they were not saving enough for retirement: Surveyed individuals reported they should save on average 14% but were only saving about 6%. The fact that awareness alone does not lead to action is also confirmed by DEHM/KILBERTH/PSYCHONOMICS 2000 who studied female old-age pension provision in Germany. They found that a majority of women acknowledge that state pension provision will probably not be enough to cover expenses during retirement, however, only a minority also acts on this knowledge. 256 Second, the lack of self-control is visible with regard to the change of behavior since there is a large difference between actions individuals plan to undertake and the actions they indeed undertake. For example, “almost none of the employees who report that they intend to raise their saving rate 252

See CHOI et al. 2002, p. 68. MULLAINATHAN/THALER 2000, p. 4. 254 See MITCHELL/UTKUS 2004a, p. 6. 255 THALER/BENARTZI 2004, p. 167. 256 See DEHM et al. 2000, p. 1.

253

4.2 Standard economic theory and its adaptation to behavioral finance

111

in the next two months actually do so”. 257 This has implications for managing interventions to improve individual FPB, since studies have revealed that either the changes individuals want to make are conducted almost immediately after an intervention such as e.g., a seminar, or not at all. 258 Correspondingly, it would be best to approach the individuals with product ideas and concrete decisions immediately after the seminar when the information is still fresh. Third, as SHEFRIN/THALER 1988 mention in their behavioral life-cycle hypothesis illustrated below, “willpower becomes increasingly difficult to exercise when income (and therefore consumption) diminishes.” 259 Therefore, exercising willpower with regard to saving is most difficult for that group for whom retirement-specific FPB is most critical because they have fewer assets to cover a possible pension gap. Even if the awareness about the retirement problem alone is not enough to ensure a good financial situation in retirement, there are measures such as commitment, pre-commitment or even enforcement that can translate the awareness into actions and thus overcome the problem associated with the lack of self-control. An interesting example is the survey conducted by BOERI/BOERSCH-SUPAN/TABELLINI 2002. They found that if Germans were to get the option to opt out of the SSP, they would want another mandatory savings plan instead. 260 This illustrates that when individuals are aware of their self-control problem (i.e., they can be considered as “sophisticated selves”), they are prepared to limit their freedom in order to overcome their human shortcomings. The readiness to invest in illiquid investment vehicles such as a pension plan with clear financial disincentives to consume the assets (e.g., through early withdrawal penalties) also reflects this point. Here, individuals leverage psychological hurdles in the form of mental accounts in order to overcome their self-control problem. Furthermore, the cultivation of habits, e.g., regular saving, is a good commitment device for self control. An ideal example for habit formation is dollar cost averaging, the investment of a constant amount into a mutual funds savings account, or paying back a mortgage installment on the first of every month. 261 257

CHOI et al. 2002, p. 70. See CHOI et al. 2002, p. 103. 259 SHEFRIN/THALER 1988, p. 622. 260 See BOERI et al. 2002, p. 397. 261 See SHEFRIN 2002, p. 150ff. In light of the above discussed inertia, dollar cost averaging does seem recommendable in connection with so-called life-cycle funds or target funds that automatically adjust the asset allocation to reduce the level of equity over time. See for example Fidelity’s target 2010 Euro fund

258

112

4 Retirement-specific behavioral finance and derivation of benchmarks

As a conclusion, “a key obstacle to saving more is not necessarily the lack of awareness, but rather the ability to take action on the knowledge.” 262 Therefore, (pre)commitment devices, enforcements, mental accounting and habit formation need to be leveraged to overcome the lack of self-control. However, these measures need to be selected carefully and in accordance with different priorities. In the words of SHEFRIN 2002, individuals “should not place themselves in situations where they make the thin voice of retirement saving compete for a portion of take-home pay with the shouts for food, entertainment, and vacation travel. The voice for retirement saving will be drowned out. […] Retirement saving is more likely to get accomplished through a regimented routine rather than through discretion.” 263 4.2.4.3 Home bias

The home bias captures two limitations of individual asset allocation in the context of pension plans. They are related to an overweighting of certain investment products and lead to an inefficient set-up of portfolios relative to MPT due to an insufficient diversification and thus a concentration of risk. The first source of inefficiency is the fact that individuals tend to overinvest in their own company stock. In the US, for example, 11 million participants of DC plans have allocated over 20% of their account balance to company stock. More extremely, five million have allocations above 60%. 264 This is on the one hand driven by logical explanations such as incentive programs (promotion of employees’ productivity and staff retention through stock ownership). On the other hand, it can be explained by an irrational risk assessment of one’s own company stock, judging it safer than a diversified fund. This is also an expression of overconfidence and unbounded optimism. Furthermore, due to a phenomenon called endorsement effect, employees tend to interpret the allocation of an employer’s contributions (which usually get invested in one’s own company fund) as implicit investment advice. 265 The second source of inefficiency relative to the MPT is that individuals tend to have a nationally focused portfolio. Here, possible explanations are (FIDELITY 2006a) that will have only cash holdings in 2010 or the Swisscanto Life-cycle fund 2020 (SWISSCANTO 2006) with a similar investment strategy focusing on the year 2020 as payback time. 262 MITCHELL/UTKUS 2004a, p. 8. 263 SHEFRIN 2002, p. 142. 264 See MITCHELL/UTKUS 2006, p. 88. 265 See BENARTZI 2001, p. 1748ff.

4.2 Standard economic theory and its adaptation to behavioral finance

113

derived from availability heuristics, ambiguity aversion and overconfidence with regard to national investments. This is confirmed by FRENCH/POTERBA 1991 who found that US citizens invest mainly in US securities, Japanese investors strongly prefer Japanese titles and also the UK individuals are heavily overexposed to UK stocks. Another indication for this phenomenon is the fact that “Japanese investors […] expect returns from Japanese stocks which are more than 300 basis points greater than the returns U.S. investors expect.” 266 However, FRENCH/POTERBA 1991 expect this international diversification puzzle to recede over time. The insufficient leverage of the diversification potential offered through international security selection or investments in different sectors illustrates that the knowledge of individuals with regard to diversification is limited. It is thus essential to discuss this irrational home bias with investors and define ways to overcome it in order to improve individual FPB. 4.2.4.4 Regret

Regret stands for the emotion of feeling disappointment at not having made the right decision. “Regret is more than the pain of loss. It is the pain associated with feeling responsible for the loss.” 267 The regret of omission (e.g., not having changed anything or having been stuck with the habit) is less pronounced than the regret of commission (having done something differently like e.g., changing a habit which later proved to be wrong) due to differences in opportunity costs and perceived losses. 268 The fact that all individuals aim for regret minimization can be leveraged for retirement financial planning. One approach is to use an imaginative picture. If, for example, someone sees his neighbor in a financially secured retirement set-up, he will envy him for having provided for retirement during his youth and thus feel regret not to have done the same for himself. Another approach is to use regret as an investment guideline according to Markowitz. He claimed to have chosen a 50%:50% allocation between equity and fixed income in his retirement TIAA-CREF account. His intention was to minimize future regret if on the one hand the stock market went up and he was not in or on the other hand if it went down and he was fully exposed to it. 269 Furthermore, since regret omissions are less heavily perceived than regret commissions, it can be expected that once individuals have started a financial plan and initiated a savings habit, they 266

FRENCH/POTERBA 1991, p. 223. SHEFRIN 2002, p. 30. 268 See KAHNEMAN/RIEPE 1998, p. 63. 269 See ZWEIG 1998, p. 118. 267

114

4 Retirement-specific behavioral finance and derivation of benchmarks

will be reluctant to change their habits. 270 This is another illustration of how important it is to overcome the first hurdle associated with retirement FPB.

4.3 Behavioral finance adaptations of additional FPB relevant theories Similarly to the standard theory of decision making, the original form of the life-cycle hypothesis described in sub-chapter 2.1, as well as the MPT, are also based on the homo economicus. And as with the development of a behavioral model of decision making, human characteristics, limitations and shortfalls require behavioral adaptations of the original life-cycle hypothesis and the MPT. Therefore, as shown in Fig. 4.1, they have been expanded to the behavioral life-cycle theory and the behavioral portfolio theory to reflect the typical human tendencies in perceptions, decision making and actions. 4.3.1 Behavioral finance adaptation of the life-cycle hypothesis By describing actual rather than rational behavior, SHEFRIN/THALER 1988 adapted the standard life-cycle hypothesis introduced in sub-chapter 2.1 to a behavioral life-cycle hypothesis. They proposed behavioral enrichments of the original model by incorporating the lack of self-control, mental accounting and framing into the model. Furthermore they departed from the concept of fungibility of assets by differentiating between current income, current assets and future assets as three mental accounts with different propensities to be consumed. The behavioral life-cycle hypothesis is relevant to the analysis of individual retirement-specific FPB as it allows a comparison between its five key predictions and actual empirical findings about individual retirementspecific FPB.

270

See SHEFRIN 2002, p. 130ff.

4.3 Behavioral finance adaptations of additional FPB relevant theories

115

First, the behavioral life-cycle hypothesis predicts that “the change in discretionary saving with respect to a change in [mandatory] pension saving increases (in absolute value) with income or wealth.” 271 This means that it gets increasingly difficult to exercise the willpower for discretionary saving as income and wealth diminish – a fact that has been pointed out in the section on the lack of self-control. As a consequence, richer households should have higher discretionary savings than households with a lower income. Second, the original life-cycle hypothesis is based on the idea of a smooth consumption profile, implying that post-retirement consumption is similar to pre-retirement consumption. Opposed to this assumption, the behavioral life-cycle hypothesis states that – in the absence of sufficiently large income sources – the post-retirement consumption is lower than the pre-retirement consumption. This situation is depicted in the consumption streams in Fig. 2.1. SHEFRIN/THALER 1988 offer different explanations for this observation. On the one hand, saving has not been as high as the standard life-cycle model would have requested and thus does not allow for the same consumption level in retirement as during work life. On the other hand, since life-expectancy increases with age, the time for which financing will be required increases as individuals get older. Therefore they need to split up their funds over more periods in retirement than initially anticipated. Third, the original life-cycle hypothesis indicates that the saving rate increases with permanent income. SHEFRIN/THALER 1988 reject this proportionality principle that implies that individuals with different incomes save the same proportion of their disposable income. Fourth, the behavioral theory states that with constant wealth, the income level drives consumption. The fifth prediction relates to the amount of dissaving of retirees. According to the standard life-cycle hypothesis, retirees are assumed to dissave an annuity consisting of their retirement income and the corresponding value of their wealth level. But SHEFRIN/THALER 1988 postulate that households will draw down their assets slower than the standard life-cycle hypothesis predicts. The fact that reverse mortgages have very little consumer response and that typical retired households do not even have mortgages anymore confirms this tendency especially with regard to real estate. From this, SHEFRIN/THALER 1988 follow that “the elderly appear reluctant to consume out of their ‘home equity’ account, even during retirement.[…] The elderly appear to spend money from their income account more readily than they draw down their assets, specially their housing wealth. Again this appears to represent voluntary behavior rather than capital market imperfections.” 272 271 272

SHEFRIN/THALER 1988, p. 621. SHEFRIN/THALER 1988, p. 633.

116

4 Retirement-specific behavioral finance and derivation of benchmarks

Also, SHEFRIN/THALER 1988 observed that the marginal propensity to consume bonus income is lower than the marginal propensity to consume regular income. This is another illustration of the framing effect and mental accounting since the bonus income stream gets mentally separated from the normal income stream. If, on the other hand, an individual can enjoy a windfall profit, then the propensity to consume it lies between the propensity to consume income and the propensity to consume a bonus. This effect has also been analyzed among others by BRAUN et al. 2002. They confirm that individuals in Germany have a lower tendency to consume an inheritance compared to consuming regular income. 4.3.2 Behavioral finance adaptation of the modern portfolio theory The behavioral portfolio theory was developed by SHEFRIN/STATMAN 2000. One of their key deviations from the MPT developed by MARKOWITZ 1952 is that investors do not choose their portfolios based on mean and variance. On the contrary, their investors are assumed to choose portfolios depending on the expected wealth, the desire for security and potential, different aspiration levels and the probabilities of achieving them. Additionally, they distinguish two scenarios with regard to the level of integration of the portfolio. First, they defined one portfolio where investors integrate their positions into one mental account, taking covariance into consideration (called BPT-SA, single account). Second, they introduce a portfolio where investors segregate their positions into mental accounts and overlook covariance among them (termed BPT-MA, multiple accounts). In the latter portfolio, the low aspiration level is designed for safety to avoid poverty (e.g., emergency savings or buying of insurance) while the high aspiration level is designed for potential (“intended for a shot at getting rich” 273). The behavioral portfolio theory is relevant to the analysis of retirementspecific FPB as it offers a mental investment framework that is consistent with the human tendency for mental accounting. The BPT-MA portfolio reflects that most individuals look at their assets as if they consisted of different layers, corresponding to different goals and risk attitudes, 274 and construct them through pyramiding investment choices. An example of such a pyramid portfolio, used by financial planners to advice clients about 273 274

SHEFRIN 2002, p. 122. For example, consider also the distinction between lunch money and smart money brought forward by SPREMANN 1999, p. 22.

4.4 Postulated benchmark behavior for individual FP actions

117

building sub-portfolios, is illustrated in SHEFRIN 2002. This approach is in contrast to the Markowitz model, which is based on one consistent attitude towards risk for all elements of wealth and one integrated perspective. For example, investors in Markowitz’s model would never buy lottery tickets since they are always risk averse and never risk seeking. However, as shown above in the description of the prospect theory, this behavior is observable for a “normal” investor.

4.4 Postulated benchmark behavior for individual FP actions The general decision-making theory, the life-cycle hypothesis as well as the MPT represent key foundations of individual behavior with regard to retirement-specific FPB. The previous sub-chapters have shed light on these theories by incorporating the findings from behavioral finance research and allowing for a more “normal” understanding of human behavior. The aim of this sub-chapter now is to derive a set of generally applicable principles for benchmark behavior with regard to individual FP actions. These principles for benchmark behavior will represent the base, against which the empirically observed FP behavior can be compared in subchapter 6.3 in order to identify existing gaps and ultimately derive suggestions for how policy-makers, financial planners or the individual can enhance individual retirement-specific FPB. Behavioral finance based academic research with regard to individual retirement-specific FPB almost exclusively focuses on the description of empirically observable behavior. Based on these observations, it induces design recommendations for plan sponsors (specifically 401(k) plans). Unfortunately, generally applicable and explicit recommendations for individual retirement-specific FP actions are hard to find. However, some elements of explicit advice can be found in the MPT: The principles of diversification as well as the adaptation of the share of equity to the individual investment horizon or risk capability can be seen as such explicit recommendations. Also practitioners such as bank advisors, insurance brokers, or publications from practitioners (e.g., the Institute of Chartered Financial Analysts or the Certified Financial Planners Board of Standard) limit their recommendations mostly to the above mentioned implications of the MPT. When it comes to more explicit rules for retirement-specific FP actions, they tend to argue that every recommendation needs to be tailored to the individual

118

4 Retirement-specific behavioral finance and derivation of benchmarks

circumstances and needs. Therefore they claim that it is impossible to set up generally applicable rules. 275 Against this background, this sub-chapter derives a set of generally applicable principles for benchmark behavior that represent the normative base for retirement-specific FP actions. They are derived from explicit MPT recommendations, supported by the arguments of practitioners (i.e., the CFA), and complemented by implicit recommendations from findings of behavioral finance. With this approach, these principles for retirementspecific FP actions link academic research with the practical aspects of financial planning for retirement. The following list gives an overview of the six derived, generally applicable principles for FP actions against which the empirical FP actions are evaluated in sub-chapter 6.3. The rational for each is detailed below. 276 1. Start to plan your financial situation in retirement the very day you enter work life 2. Understand the issues and solutions related to your financial situation in retirement by both leveraging the advice of experts and by educating yourself through various information sources 3. Complement your retirement savings with investments in dedicated pension savings products 4. Diversify your retirement assets not only across industries and geographies but also across asset classes and different retirement savings vehicles 5. Dare to choose a higher risk-return profile for your retirement assets as long as you are young but continuously reduce this risk level as you approach retirement 6. Mitigate non-market-performance-related risks selectively, by attributing the highest priority to the inflation and longevity risks

275

The interviews with ORGLAND 2006, GAST 2005 and BENENNI 2006 confirmed these findings and point out the high level of individuality of each situation that makes it necessary to tailor the recommendations to the individual. 276 While it is possible to differentiate some behavioral benchmarks for individuals with a lower or a higher capability for risk, most statements, in particular the ones derived from behavioral finance, are of a general nature and can be applied to all investor groups. Noteworthy however is the fact that these propositions are intended for the group of the affluent individuals that stands in the focus of this study. These individuals operate in a given context that will not be analyzed and in which no changes are assumed. Correspondingly, the recommendations would need to be adapted for changes in the environment or if different segments of the population (e.g., the retail or the HNWI segment) are examined.

4.4 Postulated benchmark behavior for individual FP actions

119

Apart from these behavioral benchmarks that cover the first six elements of the FP actions, a simulation analysis will derive a normative basis for the seventh element, the required saving rate. This analysis replicates the personal financial situation in retirement according to the individual characteristics, life plans and financial objectives in order to determine if the individual is faced with a retirement gap and derive the required amount of savings accordingly. As it is based on the population of the inter-temporal financial optimization model with the effective individual parameters, it is presented in the empirical part in sub-chapter 6.4. 4.4.1 Benchmark behavior: Start of financial planning activities “You think it is crazy to worry now about retirement then? It is crazy not to.” KOBLINER 2000, p. 150 One of the key elements of retirement-specific financial planning activities investigated empirically in this study is the age at which individuals start to think about their financial situation in retirement. 277 SCOTT/STEIN 2004 have shown that once individuals have started to think about retirement financial planning (e.g., by studying information material, searching the Internet or contacting an advisor), they have made one of the most important steps in the entire process. Once this first hurdle is overcome, it is much easier to (externally) steer individual FPB. However since “the costs of taking action are immediate and concrete, and the benefits are distant and abstract”, 278 pure cost-benefit considerations will not induce people to engage in regular financial planning activities. The recommended benchmark behavior with regard to the start of financial planning activities is as follows: Start to plan your financial situation in retirement the very day you enter work life The arguments for this recommendation are threefold:

277

As the term “thinking” already indicates, this point refers to the mental activity of looking into the individual financial situation in retirement. Since “thinking” can only be the start of the process, concrete actions need to follow. 278 WEBER 2004, p. 64.

120

4 Retirement-specific behavioral finance and derivation of benchmarks

First, due to the effect of compound interest, assets should be invested in the capital market as long as possible. This helps to avoid missing out on early investment opportunities and increases the ability to “sit out” any potential unfavorable developments of the financial markets. Second, thinking about the different sources for retirement income helps to get an understanding of the criteria determining the eligibility for different pension options (e.g., pension plan offered by the employer or state pension income). An early understanding of these criteria helps to leverage the saving incentives offered by the system (e.g., if the employer provides a match within the company sponsored 401(k) plan). 279 Furthermore, the knowledge about the systems and the qualification criteria increases the awareness about potential gap years that potentially reduce the eligibility for the state pension plan later on. Finally, behavioral finance research shows that “normal” individuals display human tendencies that inhibit an early enough start of financial planning for retirement: Procrastination leads people to postpone unpleasant tasks such as consumption deferral (i.e., saving) or thinking about one’s own death. But thinking about one’s own death is necessary to estimate the time for which funding is required in retirement. Hyperbolic discounting induces naïve individuals to assume that they will start providing for their financial situation in retirement in the next period, (e.g., start with an aggressive savings plan in the next year) and thus leads them to start retirement saving too late. This focus on the present is further accentuated by myopia. Overconfidence and unbounded optimism on the other hand will induce individuals to wrongly believe that they are well off in the future that they do not have a retirement gap and thus do not need to worry about planning financially for retirement. Especially remembering the good old times of the retirees in the mid 80s and 90, 280 this perception might also be influenced by the representativeness bias and conservatism. A projection bias further reinforces this dangerous reality assessment through an underestimation of future preferences and needs. In addition, inertia leads individuals to stick to the status quo and thus prevents them to engage in fi279

See for example THALER/BENARTZI 2004: “The costs of actively joining the plan (typically filling out a short form) are trivial compared with the potential benefits of the tax-free accumulation of wealth, and in some cases a ‘match’ [that] is provided by the employer, in which the employer typically contributes 50 cents to the plan for every dollar the employee contributes, up to some maximum.” THALER/BENARTZI 2004, p. 169. 280 See OECD 2001, p. 27 for a table illustrating that the people living e.g., in the US, Canada, Germany, Japan or Sweden and aged 65 to 70 had between 80100% of the income of individuals aged 18 and over.

4.4 Postulated benchmark behavior for individual FP actions

121

nancial planning for retirement. Finally, it is a sign of a lack of selfcontrol, if the start of financial planning for retirement represents a large internal hurdle. 4.4.2 Benchmark behavior: Overall understanding of the individual financial situation in retirement The inter-temporal financial optimization problem laid out in sub-chapter 2.1 has illustrated the complexity an individual faces with regard to providing for his financial situation in retirement and that it is difficult to grasp all aspects of this problem. On the other hand, human deviations from rational behavior (e.g., biases in perception, problem solving limitations and implementation shortcomings) and the responsibility shift to the individual make a sound understanding of one’s own financial situation in retirement inevitable. Such an understanding is based ideally on two pillars. First, expert advisors should provide holistic information leading to the development of a professional and integrated financial plan. Second, the individual himself should consult different kinds of information sources to obtain the necessary level of knowledge to enable him to develop an independent and critical view on any proposed retirement-specific FP actions. The recommended benchmark behavior with regard to the overall understanding of the individual financial situation in retirement is as follows: Understand the issues and solutions related to your financial situation in retirement by both leveraging the advice of experts and by educating yourself through various information sources The arguments for this are as follows: The nature of the inter-temporal financial optimization problem (e.g., the fact that it expands over several periods, encompasses different regulatory elements like taxes or questions of inheritance and contains many variables that require assumptions) make financial planning for retirement a highly complex issue. In addition, behavioral finance highlights different limitations in human behavior that further complicate the problem: Bounded rationality describes the limited problem solving capability of individuals. As described by the money illusion, individuals are mostly thinking in nominal terms. This is especially relevant to retirement plan-

122

4 Retirement-specific behavioral finance and derivation of benchmarks

ning, where financial forecasts over periods of up to 40 years 281 are heavily influenced by differences between real and nominal scenarios. As a consequence, the confusion of real and nominal values can substantially jeopardize the security of one’s financial situation in retirement. 282 Furthermore, hyperbolic discounting and myopia lead to the fact that the problems are framed too narrowly and that the present is overweighed. Additionally, the errors in the perception of reality described above (e.g., availability bias, saliency bias, representative bias and conservatism), the overestimation of one’s own capabilities due to overconfidence and hindsight bias as well as the wrong estimation of future preferences (i.e., prediction bias) further accentuate the problem. Besides these findings it is a sign of realism if LUSARDI 2004 finds that relatively few people feel that they are able to plan effectively for retirement. Therefore, an independent advisor assessing the different financial flows and risks objectively and at the same time having the analytic skills to solve the inter-temporal financial optimization problem is a necessity with regard to ensuring a sound understanding of one’s own financial situation in retirement. The solution of the financial optimization problem is only one argument why an individual should rely on advisors. Another argument is that – once the problem is solved – advisors can help to take decisions with regard to retirement financial planning and support the implementation of these decisions. Here again, behavioral finance offers several reasons why the support of an advisor is recommended: Sensitivity to choice overload leads to the fact that individuals tend not to take any decision when faced with too many options. As SCOTT/STEIN 2004 proposed, a good advisor could support the decision process in stripping down the different options to showing only the status quo as well as the best alternative. Furthermore – since individual behavior follows the path of least resistance (passive decision making) – an advisor should design the financial plan in such a way that the path of least resistance represents the best solution for the individual. 281

From the age of 20, the ideal start of financial planning, to 60, the actual average retirement age. 282 According to KLÖCKNER 1995 building-up a wealth position without taking inflation into consideration and without investment in inflation protected assets is more destruction of wealth and wealth illusion than creation of wealth. See KLÖCKNER 1995, p. 49. According to BODIE et al. 2002 individuals are rather poorly informed about volatility in asset returns and inflation rates. This finding is based on historical circumstances. The nearly two decade-long equity bull markets that started in 1982 coincided with a period of tame inflation. Consequently the average retiree mistakenly assumed that equities provide an effective inflation hedge, leading to poorly constructed portfolios. See BODIE et al. 2002, p. 7.

4.4 Postulated benchmark behavior for individual FP actions

123

Moreover, to overcome the problem associated with the fact that not knowing probabilities is perceived as risk, the advisor could perform sensitivity analyses highlighting possible outcomes under different scenarios. With regard to the implementation of the financial plan, individuals display difficulties with sticking to the actions they committed to due to lack of self-control and procrastination. Furthermore, inertia induces individuals to not monitor and review their financial plan regularly as required in an ideal financial planning process. As an example, equity-heavy and therefore riskier portfolios can result from this form of passivity in combination with a strong equity growth over time. An independent advisor could overcome these problems by conducting regular review cycles of the financial plan and re-weighting the assets accordingly (i.e., he could create a habit of review cycles with the client or implement commitment measures such as automatic rebalancing or dollar cost averaging). Lastly, and on a more emotional note, PANIS 2004 found that individuals with an advisor are more satisfied than these without. As a conclusion, an analogy supports the recommendation to use an advisor when financially planning for retirement: The realization of a workout or a rehabilitation program for a patient requires an expert developing a plan based on detailed personal information and specialist know-how. But it also calls for a coach that enforces its implementation. The same applies to financial planning for retirement. Despite the fact that the use of a financial advisor is highly recommended for adequate retirement financial planning, a note of caution should be sounded. In an ideal world, an advisor is independent and provides best product advice. In the real world however, any advisor is subjected to specific incentives that influence his behavior. Retrocessions from product providers (e.g., life-insurance saving plans, mutual funds) are one example of these incentives. A “real world” advisor will always be tempted to leverage an information asymmetry that might exist between him and his client and propose products that are favorable to his own financial situation. Due to these inherent shortcomings in the advisor concept, it is essential that the individual has a basic understanding of retirement financial planning. Besides a clear understanding of one’s own financial situation, individuals should also have a grasp of the current and planned future regulatory environment, the relevant key saving and retirement products as well as the associated incentives of involved stakeholders (including the advisor). In this regard, it is highly recommended that individuals keep themselves informed on relevant topics. Useful sources of information include generalized information from investment magazines or the money pages of newspapers, TV and radio, the Internet, but also more immediate and per-

124

4 Retirement-specific behavioral finance and derivation of benchmarks

sonalized information sources such as friends and family or the above discussed advisors. With regard to the processing of information, behavioral finance identifies two human tendencies of relevance: First, an availability, saliency and representativeness bias induces individuals not to perceive information objectively. Therefore, to avoid faulty probability assessments, individuals should regularly consult different information sources with a strong focus on balanced content and objective information while being alert to their typical human tendencies. This content focus also specifically encourages attending retirement planning seminars or reading relevant books. Second, myopic behavior induces individuals to evaluate their positions too frequently. As a consequence, they are induced to engage in suboptimal investment decisions by taking less risk than an objective evaluation would consider as appropriate (e.g., not enough equity for long-term investments or too frequent re-weightings). To counteract this effect, an individual should avoid consulting information sources (e.g., daily stock news or the performance report of his retirement portfolio) too frequently or at least to bear this human tendency in mind and act accordingly. As a consequence and to counteract the two human tendencies described above, the use of information should focus on content that enhances an individual’s understanding of the relevant retirement-specific mechanisms rather than on a pure reporting of the personal portfolio’s performance development. 4.4.3 Benchmark behavior: Holding of classical pension savings products The need for adequate financial planning for retirement inevitably leads to the question of whether or not to use classical pension savings products. Typically, these products are designed for saving activities over a longterm horizon and with a specific goal (i.e., receiving a lump sum or pension upon retirement). They often are regulated by the legislator and so benefit from tax advantages but come at the price of asset allocation and capital withdrawal restrictions. Examples of these classical pension products are private pension plans or annuities (“Private Rentenversicherung”) or unit-linked life-insurances (“Fondsgebundene Rentenversicherung”). Also employer-based contributory pension schemes can be considered as such a classical vehicle to save for retirement. The recommended benchmark behavior with regard to the holding of classical pension savings products is as follows:

4.4 Postulated benchmark behavior for individual FP actions

125

Complement your retirement savings with investments in dedicated pension savings products The most obvious advantage of classical pension products, which also gets regularly cited by advisors selling them, is their tax benefit. However, this argument always should be scrutinized in light of the total cost of these products (e.g., embedded distribution costs, management fees of underlying asset management products). Whatever such an analysis might reveal about the financial attractiveness of these products, behavioral finance offers various arguments that support their use. These arguments differentiate between general findings applicable to all classical pension savings products on the one hand and specific findings for annuity products on the other hand. Generally, the human tendency for mental accounting leads to a low propensity to consume classical pension savings products and thus makes them a good vehicle for retirement saving. Additionally, cultivating a habit through saving in such vehicles represents a commitment measure to overcome the problem of self-control as well as procrastination. Furthermore, due to loss aversion it can be expected that people will actually derive value from owning such a product and be very reluctant to sell it for a reduced value. Finally, the heightened financial security in retirement associated with such a product could also somewhat reduce the ambiguity of old age and thus have beneficial effects on the well being of the individual. Apart from these general findings applicable to all classical pension savings products, important research has been conducted with regard to annuities. Besides the advantages mentioned above, annuities are recommended for retirement saving for several reasons. In the first place, annuities offer protection against longevity risk, since they pay benefits as long as the retiree lives. This aspect is specifically important as individuals tend to underestimate their life-expectancy. 283 Also, annuities are positively linked to the overall satisfaction level of retirees. PANIS 2004, for example, has found that individuals “with greater annuitization were more satisfied in retirement, and [that] they maintained their satisfaction throughout retirement. […] The guaranteed income benefits may reduce anxiety about the risks of outliving one’s savings and ending up in poverty,” 284 thus resulting in a higher level of peace of mind. 285 Despite these obvious advantages, annuities are not enjoying a high level of popularity for various reasons. There exist certain logical argu283

See BÖRSCH-SUPAN et al. 2005, p. 16ff. PANIS 2004, p. 270. 285 See PANIS 2004, p. 267. 284

126

4 Retirement-specific behavioral finance and derivation of benchmarks

ments against annuitization. MITCHELL/UTKUS 2006 mentions the fact that the annuity insurance is perceived as too expensive due to an “adverse selection process” (people think that individuals who annuitize tend to live longer than average). However, recent research by HURD/PANIS 2006 has shown that “individuals who remain in the pool of (future) annuitants expect to enjoy average lifespans.” 286 Other reasons are that people are afraid of outliving their insurance company, they are anxious about taking an irreversible decision as it “locks in” the then-current yields, and they worry about large expenses (e.g., medical care) for which they need funding during retirement. 287 Besides these logical arguments, there also exist human tendencies that restrain an individual from annuitization: Individuals tend to focus more on the risk of dying too early rather than the probability of outliving their assets. Also, they have a strong desire to maintain liquid assets to bequeath to their children – an effect reinforced by loss aversion, leading to an over-valuation of a potential wealth loss to their heirs in the event of the annuity holder’s early death. Additionally, hyperbolic discounting leads individuals to heavily discount benefits from future coverage and a prediction bias makes them underestimate their needs and preferences in the future. Another behavioral reason why people prefer lump sum payments over annuities is the fact that in most pension plans lump sum payments are currently offered as the default solution. And due to the tendency for passive decision, individuals stick with these default solutions. Furthermore, due to framing, the large cash amount associated with lump-sum payments seems more attractive than the monthly pension of the annuity contract. From a different perspective, people’s overestimation of their own ability to manage their assets drives their preference for lump sum payments. Another serious problem associated with the preference for lump sum payments is self-control: As documented by MOORE/MULLER 2002, individuals roll over only some of their lump-sup payments into IRA (Individual Retirement Accounts) but spend substantial shares of the money to pay back debt and cover current expenses. Furthermore, around 2% use their lump-sum for “big-ticket” items such as cars and boats. A similar finding is illustrated by CHOI et al. 2002. They show that terminated employees with retirement balances below $5,000, who receive cash distributions from these accounts, regularly undercut retirement wealth accumulation by consuming the proceeds of these payments. 288 Recent research by HURD/PANIS 2006 takes a broader approach and comes up with a more op286

HURD/PANIS 2006, p. 2226. See MITCHELL/UTKUS 2006, p. 91 and PANIS 2004, p. 270f. 288 See CHOI et al. 2002, p. 82ff.

287

4.4 Postulated benchmark behavior for individual FP actions

127

timistic picture as it identifies cash-out rates that are far below those reported in previous research. They find that most of the cash was invested into savings with only about 6% of all plans or 2% of the dollar amount going into current consumption or being used to pay back debt. Despite the fact that the use of these dedicated pension savings products is highly recommended for adequate retirement financial planning, a note of caution should be sounded about using these products. In an ideal world, these products would be priced in a fair manner and offer transparency about the individual cost items. In the real world however, most of these products are burdened with very intransparent and for the client very unfavorable pricing arrangements (e.g., “Zillmerung” allows for the accrual of marketing and sales costs in the first few years of a product, negatively influencing its overall expected return). While these inherent shortcomings substantially reduce the arguments for having these kinds of products, a change in regulations could bring a lot of relief. 4.4.4 Benchmark behavior: Diversification In addition to the implicit recommendations about adequate FP actions derived from behavioral finance, MARKOWITZ 1952’s and SHARPE 1964‘s modern portfolio theory (MPT) 289 provides explicit advice for individual

289

In MPT, MARKOWITZ 1952 characterizes capital markets by distinguishing between risky assets such as securities and a risk free asset such as a AAA treasury bond. He defines them both in terms of their expected mean return and their volatility and thus derives the term mean-variance portfolio. The MPT calculates the efficient frontier, which explicitly takes into consideration the covariance between individual titles and represents combinations of securities that offer the highest return for a given level of risk. With regard to the individual investors, MPT makes two important assumptions: First, it follows standard economic theory in assuming that individuals are always risk averse and thus demand a higher compensation for accepting a higher level of risk. Second, MPT states that rational individuals choose a combination of securities that optimize their risk-return profile based on their utility function represented by their indifference curve. Flat indifference curves indicate that an investor has a high tolerance for risk and thus a less pronounced risk aversion, while very steep indifference curves are typical for highly risk-averse investors. The expected utility that an investor can expect from a portfolio is the risk-adjusted expected return, because the return is reduced by a risk penalty, consisting of the standard deviation of the portfolio, divided by the risk tolerance of the investor. This risk penalty increases, the higher the volatility of the investment and the smaller an investor’s risk tolerance is. For investors who are extremely risk averse, the risk

128

4 Retirement-specific behavioral finance and derivation of benchmarks

FP actions too. These explicit recommendations mainly concern suggestions about diversification, the share of equity and the leverage of real estate. This section focuses on the recommendations related to diversification whereas the latter two will be treated in section 4.4.5. According to the MPT, the most obvious application of investment diversification is on the basis of sector, geography or asset class (i.e., stocks, bonds, cash, real estate, etc.). In the context of financial planning for retirement, there exists a wealth of products that are typically linked to specific regulatory conditions and so display novel risk-return characteristics. Therefore, for the analysis of retirement-specific FP actions, the concept of diversification also has to be extended to the dimension of different pension savings vehicles (e.g., personal pension insurance or annuity, savings linked to life-insurance and corporate pensions). The recommended benchmark behavior with regard to diversification is as follows: Diversify your retirement assets not only across industries and geographies but also across asset classes and different retirement savings vehicles The first argument for this principle stems from finance research: SHARPE 1990 stated that “the asset allocation decision is by far the most important [decision] […] made by an investor” 290 and the most important part of the investment decision process. MPT offers insights on how diversification of securities enhances the risk-return profile of an investment portfolio: Since markets only compensate aggregated market and not titlespecific risks, the theory stipulates a diversification of holdings to eliminate firm-specific risks. In a broader context, diversification can be applied to different asset categories with specific risk-return characteristics and correlations such as equities, fixed income, real estate and commodities. Indeed, a study by BRINSON/HOOD/BEEBOWER 1986 has proven empirically that the importance of allocation decisions across different asset categories for the volatility of the outcome is higher than the impact of security selection. They compared the actual quarterly performance of 91 actively managed large pension funds with the performance of an artificially assembled passive tracking portfolio for each fund (i.e., no security selection or intra-quarter shifts but asset class allocations according to the weighting of cash equivalents, bonds and stocks of the respective pension tolerance is small and the risk penalty thus very large, leading to a low utility value. See SHARPE 1990, p. 7 - 9ff and REILLY/BROWN 2000, p. 279. 290 SHARPE 1990, p. 7 - 3.

4.4 Postulated benchmark behavior for individual FP actions

129

fund). They found that the allocation to these three asset classes accounted for over 90% of the variance (volatility) in quarterly returns for a typical large pension fund. 291 However, asset allocation choices explained only around 40% of the performance differences of the individual active pension funds versus the tracking portfolio. 292 The second argument for the diversification principle stems from behavioral finance. Due to mental accounting and myopia (i.e., the problem of narrow framing), individuals look at portfolio positions in an isolated way and do not consider the covariance between different asset types and the potential improvement for returns that it offers. Thus, the resulting portfolios risk ending up below the efficient frontier. The above described behavioral portfolio theory also documents this human tendency. Furthermore, overconfidence will induce individuals to overestimate their ability to select “winners” and thus leads to a concentration of holdings. The home bias, induced by the illusion of familiarity and control, further reinforces the resulting lack of diversification. On the other hand, and as described earlier, individuals tend to apply naïve diversification strategies where they invest their holdings according to the menu design of the investment options offered by their pension plan. This lack of “investor tailored” diversification, mainly caused by framing and particularly dangerous if the menu of the plan is not well balanced, illustrates that individuals usually apply the concept of diversification in an insufficient way – an observation that is also confirmed by other empirical research. 293 Finally, also within the domain of classical pension savings products, a diversification should be aimed at. Such a strategy hedges the risks inherent in potential changes of pension saving related legislation (e.g., tax advantages for private pension plans) and thus reduces the overall risk profile of the portfolio. 291

BRINSON et al. 1986 and BRINSON et al. 1991 conducted several studies where they examined the performance of pension plans and analyzed the extent to which the variation in return could be explained by the investment policy and the long-term asset allocation. In their 1991 study they conclude that 91.5% of the variance of actual returns of 82 pension plans could be explained by the returns of the tracking portfolio. See BRINSON et al. 1991, p. 45. 292 As mentioned in GRÜNBICHLER 2004a, p. 67. 293 POLKOVNICHENKO 2005 studied the holding of stocks among US households and found that the median family owns only two different titles whereas even the most affluent households only hold a median of 15 different stocks. With regard to diversification over international holdings, the evidence is also daunting: FRENCH/POTERBA 1991 describe the domestic ownership of corporate equity and find that it amounts to 92% in the US, 96% in Japan and 92% in the UK. See FRENCH/POTERBA 1991, p. 222.

130

4 Retirement-specific behavioral finance and derivation of benchmarks

4.4.5 Benchmark behavior: Risk-return profile of the personal asset portfolio Typically, the risk-return profile of the personal asset portfolio can be measured on two dimensions – its share of equity and its real-estate leverage. A higher share of equity increases the riskiness and at the same time the expected return of a portfolio, whereas leveraged real estate holdings grow the total volume of a portfolio. 294 This additional investment volume can lead to more returns but comes at the cost of a higher overall risk exposure. The recommended benchmark behavior with regard to the risk-return portfolio is as follows: Dare to choose a higher risk-return profile for your retirement assets as long as you are young but continuously reduce this risk level as you approach retirement Regarding the share of equity of a retirement portfolio, the principle is based on several arguments. Due to mean reversion of stock market returns, a long-term perspective makes investments in equity less risky and thus allows a long-term investor to invest a larger fraction of this portfolio in stocks. Publications of the CFA such as KAISER 1990 or REILLY/BROWN 2000 also emphasize that – in line with the MPT – the riskiness of a portfolio should be adapted to the life-stage of the individual: Young investors early in their careers can tolerate a high level of risk as they have more opportunities to recover from market downturns than older investors, and thus their portfolio should reflect more aggressive growth characteristics. 295 Investors in mid-careers still have a rather long investment horizon but their portfolios should become less aggressive. In that period, KAISER 1990 recommends balancing high capital gain investments with some lower-risk assets. This also avoids having “to put their current nest egg into jeopardy.” 296 Investors just before retirement may soon not be able to rely on a steady income flow to offset any negative portfolio effects. Therefore, investors in this later stage of life should assume the least 294

This includes on the one hand, property as investment vehicle and relates on the other hand to the amount of leverage on the property position that might be reinvested into capital markets. 295 Typically, these investors can be considered as being in their accumulation phase where the net worth is typically small relative to the liabilities (e.g., house mortgage). Assets in this phase tend to be non-diversified, with home equity representing the largest share. See KAISER 1990, p. 3-18. 296 REILLY/BROWN 2000, p. 38.

4.4 Postulated benchmark behavior for individual FP actions

131

risk. However, as the investment horizon for them can still be well over 10 or 20 years, “some investments in the portfolio should continue to have growth and inflation-hedge potential.” 297 Consequently, as investors progress through the different stages in the life-cycle, they should start with “growth investments”, then switch to “yield investments” and lastly hold “income portfolios”. This idea of behavioral life-cycle investing is the basis for another series of arguments for a decreasing share of equity as individuals approach retirement. In this concept, individuals use their human capital to rebalance the performance of their financial investments. One of the key propositions of behavioral life-cycle investing is that “an individual will tend to exhibit more conservative investment behavior as he nears retirement” 298 since his human capital and labor supply flexibility are reduced over time. BODIE/MERTON/SAMUELSON 1992 thus consider the reduction in risk, i.e., the share of equity, as a rational act. Several approaches exist to adapt the share of equity of a retirement portfolio to an individual’s position in the life cycle. SPREMANN 1995 describes the idea of inter-temporal diversification where an individual invests about the same absolute amount in equity over various periods. Since an individual’s wealth typically grows over time, a constant absolute amount devoted to the equity market year after year is equivalent to investing a decreasing share of total assets in equity. 299 The popular investment principle, according to which the percentage of “100 minus the actual age” should be invested in equity, comes to a similar conclusion. 300 Life-cycle funds, also called target funds, offer an automated process for implementing this kind of investment strategy. However, a point of caution needs to be raised here: The recommended share of equity has to reflect an individual’s situation and circumstances, his preferences and his risk profile. For example, if an individual shows a high sensitivity to interim portfolio declines, which corresponds to a low “risk appetite”, this attitude will dictate a lower overall risk exposure – even if the individual has a long investment horizon. On the other hand, if an individual has a short investment horizon (i.e., is standing shortly before retirement) but very low income needs or a significant amount of safe earnings, he might be able to assume more risk than what would be ex-

297

KAISER 1990, p. 3-19. BODIE et al. 1992, p. 446. 299 See SPREMANN 1995, p. 123ff. 300 See WAGGLE/ENGLIS 2000, p. 81 or MITCHELL/UTKUS 2006, p. 86. 298

132

4 Retirement-specific behavioral finance and derivation of benchmarks

pected from his position in the life-cycle. 301 Finally, if there is a conflict between risk and caution, publications such as KAISER 1990 recommend erring on the side of caution. Also according to SHIM/SIEGEL 1991 “conservatism in financial planning is recommended, so there is an aversion to high risk.” 302 Applied to the real estate leverage, the arguments for the principle above are three-fold. First, reducing leverage as one approaches retirement means reducing volatility and thus the risk exposure of a portfolio, both on the side of the expenses (i.e., mortgage rates) as well as on the side of income (i.e., if the mortgage capital is invested on the capital markets). Second, reducing the leverage means decreasing expenses (i.e., interest payment), a reasonable tactic given the reduced income streams in retirement. 303 Third, a mortgage free property increases financial flexibility during retirement since it can be sold or used for a reverse mortgage in an emergency situation. Also practitioners confirm this principle: NIEHUES 1997, for example, suggests that individuals should have paid back their mortgage by the age of 55 in order to live without having to pay mortgages in retirement. Finally, a low real estate leverage or even no mortgages as one approaches retirement is also consistent with the behavioral life-cycle hypothesis described by SHEFRIN/THALER 1988. 4.4.6 Benchmark behavior: Risk mitigation As illustrated in the description of the individual financial optimization problem in sub-chapter 2.1, three types of risks are relevant to an individual’s financial situation in retirement: regulatory, capital market and personal risks. Risk mitigation is concerned with whether individuals hedge specific risks they face. It encompasses two elements – the overall awareness about a specific risk and whether this awareness gets translated into concrete risk mitigation actions. The awareness about specific regulatory, financial and personal risks related to the financial situation in retirement will be analyzed in section 6.2.4, in the context of FP perspectives. The 301

However, with regard to the time horizon, one note of caution needs to be made here: It is not only the individual investment horizon but quite often the investment horizon of other people that needs to be taken into consideration (e.g., parents passing away, children going on to higher education or their need for seed money to build a house or start their own business). 302 SHIM/SIEGEL 1991, p. 238. 303 It needs to be kept in mind that even if a property is mortgage-free, there are still investments required to maintain it (e.g., renovation fund). Therefore, living expenses can never be reduced to zero.

4.4 Postulated benchmark behavior for individual FP actions

133

second element, the level of actual mitigation of specific risks, is analyzed in section 6.3.6 in the context of FP actions. The recommended benchmark behavior with regard to risk mitigation is as follows: Mitigate non-market-performance-related risks selectively, by attributing the highest priority to the inflation and longevity risks This principle proposes a tiered approach towards risk mitigation. There are two reasons for the proposed tiered approach: In the first place, risk mitigation is always costly and therefore the decision to mitigate a risk needs to stand a cost-benefit consideration, in the second, mitigation is not always possible. With regard to the prioritization of risks to mitigate, the following arguments apply: For normal capital market risks, such as negative performance or specific overexposure, the principle for diversification introduced above already contributes to risk mitigation. It can be further supported by the choice of the respective products (e.g., capital protected products or guaranteed funds). With regard to inflation, a capital market risk with substantial impact on retirement finances, a high priority needs to be assigned to the mitigation of this risk. This focused risk mitigation is recommended due to the long time horizon associated with retirement-specific financial planning. Because especially the longer the horizon, the more concerned the investor should be with inflation and real returns. In practice, mitigating the inflation risk can be achieved through e.g., inflation protected bonds or commodity investments such as gold. R. Shiller and G. Mankiw, for example, both use inflation-protected bonds in their own TIAA-CREF pension fund allocations. 304 SHIM/SIEGEL 1991 consider investments in tangibles such as real estate as an inflation hedge to mitigate this risk. With regard to personal risks, the most important and at the same time most underestimated risk is the danger of outliving one’s own assets, i.e., the longevity risk. The best way to mitigate this longevity risk is the use of annuity products. Annuitizing part of the wealth helps to overcome the danger of “having no guaranteed level of income” during old age while ensuring that not all the money is tied up when needed and also that a bequest is still possible. Apart from buying annuities to mitigate the longev304

R. Shiller for example prefers inflation-indexed bonds because they “correspond to the ‘risk less asset’ in finance theory better than anything we have ever had, so people should use them to adjust the risk level of their portfolios.” ZWEIG 1998, p. 118.

134

4 Retirement-specific behavioral finance and derivation of benchmarks

ity risk, individuals can also delay their transition into retirement to reduce the risk of outliving their assets or they can purchase a life-insurance. Another practical approach is to reduce living expenses during retirement. With regard to regulatory risks, the above proposed use of different classical retirement saving products already contributes to the mitigation of changes in retirement legislation (i.e., taxation schemes for specific products). Having alternative pension income sources could also, at least partially, help to compensate the risks associated with a decrease of statutory state pension or a development of SSP income that does not keep pace with the development of the cost of living. With regard to an increase in general taxes, mitigation does not seem to be possible at reasonable costs and is therefore not recommended. Finally, the individual always has the potential to influence these developments in the democratic process.

4.5 Summary of retirement-specific behavioral finance and the derivation of benchmark behavior for FP actions This chapter represents the normative part of the study’s conceptual approach and sets the standard against which actual FP actions and perspectives can be evaluated. It highlights different human tendencies and limitations in decision making and enhances these findings with recommendations from the MPT and practitioners’ advice. As a result, the following six behavioral benchmarks for FP actions are derived: 1. Start to plan your financial situation in retirement the very day you enter work life 2. Understand the issues and solutions related to your financial situation in retirement by both leveraging the advice of experts and by educating yourself through various information sources 3. Complement your retirement savings with investments in dedicated pension savings products 4. Diversify your retirement assets not only across industries and geographies but also across asset classes and different retirement savings vehicles

4.5 Summary of behavioral finance based benchmarks for individual FPB

135

5. Dare to choose a higher risk-return profile for your retirement assets as long as you are young but continuously reduce this risk level as you approach retirement 6. Mitigate non-market-performance-related risks selectively, by attributing the highest priority to the inflation and longevity risks

5 Investor retirement survey and outlook on empirical analyses about individual retirementspecific FPB

“Representative financial literacy surveys […] indicate that many consumers do not have an adequate financial background or understanding and that they often overestimate their knowledge of financial issues.” OECD 2005, p. 15 While Chapter 4 focused on the normative part, Chapters 5 to 7 deal with the empirical dimension of this study: Chapter 5 illustrates the operationalization (i.e., measurement specifications) of the research questions and introduces the target group and the survey that tested individual retirement-specific FPB among German affluent investors. It also previews the subsequent empirical analyses of Chapters 6 and 7 by highlighting the different investor groups used as vehicles for analysis and by giving an overview of the structure of the following analyses. Chapter 6 covers the empirical analyses of the characteristics of and differences between various investor types as well as the comparison of actual and recommended FPB. Chapter 7 then recapitulates the general findings from the empirical analyses, summarizes the FPB profile by investor type and sets out the suggestions for different stakeholders. Since this study is set in the area of real sciences, 305 all knowledge gathered is based on real circumstances and can only be tested through the examination of reality. 306 This examination of reality calls for an operationalization of the research questions formulated in sub-chapter 1.3. It also 305

TROMMSDORFF 1998 illustrates the breakdown of sciences into formal sciences and real sciences. Within real sciences he then further distinguishes between natural sciences and social sciences. Economic science is defined as part of social sciences. See TROMMSDORFF 1998, p. 16. 306 “Examination”, in this sense, can be understood broadly as controlled, direct or indirect perception of reality through human senses and observation tools (such as a survey) that have been constructed for this end. See KROMREY 1995, p. 28.

138

5 Investor retirement survey and outlook on empirical analyses

requires the choice and realization of the observation instrument as well as a plan for the empirical analyses. Therefore, as an operationalization of individual retirement-specific FPB, the first sub-chapter of this chapter defines the study-specific measurement of the two components of individual FPB, FP perspectives and FP actions. In the second sub-chapter, the target group is introduced together with the standardized personal interview that has been chosen as the observation instrument. The third and fourth subchapter then focus on the choice of investor groups as vehicle of analyses as well as the plan for the empirical analyses. This plan is the empirical replication of the conceptual approach presented in sub-chapter 2.3.

5.1 Operationalization of research-specific FP perspectives and FP actions The operationalization of the research questions is the first prerequisite for the examination of reality. Sub-chapter 2.2 illustrated the study-specific understanding of individual retirement-specific FPB with its two components FP perspectives and FP actions. In order to empirically analyze these elements at the individual’s level, their study-specific definitions need to be translated into constructs to be investigated with interview questions. As the conceptual approach in sub-chapter 2.3 has highlighted, individuals’ socio-demographic and socio-economic circumstances influence their behavior. Therefore the required analyses of FP actions and FP perspectives must be conducted for different investor groups. So, the first section of this sub-chapter describes the operationalization of sociodemographic and socio-economic attributes. The next section highlights the operationalization of the FP perspectives, while the last section illustrates how FP actions will be measured. 5.1.1 Operationalization and measurement specifications of socio-demographic and socio-economic attributes The empirical analyses are conducted for different groups of investors that have comparable individual characteristics and thus similar situations and challenges with regard to their financial position in retirement. The logic of defining investor groups with specific characteristics (presented in subchapter 5.3) has been limited to nine socio-demographic and socioeconomic variables. This limitation of variables was necessary to increase the comprehensiveness of the investor groups and to limit complexity. But to get a better understanding of the full characteristics of the different in-

5.1 Operationalization of research-specific FP perspectives and FP actions

139

vestor groups, it is essential to grasp their entire set of socio-demographic and socio-economic attributes. The empirical realizations of these attributes are described in sub-chapter 6.1 and serve as the base for determining the pooling potential between different investor groups. Table 5.1 gives an overview of the socio-demographic attributes captured for the different interviewees. They describe the key characteristics of the individual and his family ties. In order to establish a link to the questionnaire, each measurement specification (i.e., operationalization of a topic) has a reference to the different answer options (i.e., differentiator), categories of analysis and question labels. 307 Table 5.1

Measurement specifications for the socio-demographic attributes

Identifier Topic Socio-demographics

Differentiator

Categories of analysis

SD_1 SD_2

Gender Age

Exact age in years

SD_3

Marital status

-

SD_4

Children

Number of children

Male; female 45 - 49; 50 - 54; 55 - 59; 60 - 64; 65 - 70 – Weighted average of exact age Married/co-habiting; single (including divorced, widowed) Has children; has no children – Average number of children

Question label

A. 6 H. 12 A. 8 A. 12

The socio-economic attributes have both qualitative and quantitative elements. Table 5.2 shows the qualitative elements related to education and job situation. Furthermore, as highlighted in sub-chapter 2.1, the individual financial optimization problem is influenced by personal risks associated with health issues. Therefore the health level is investigated under the qualitative socio-economic attributes too.

307

The label of a question consists of a letter to describe the section within the macrostructure of the questionnaire and a number to indicate the order of the question.

140

5 Investor retirement survey and outlook on empirical analyses

Table 5.2

Measurement specifications for the qualitative socio-economic attributes

Identifier Topic Socio-economics SE_1

Differentiator

Education level

Categories of analysis

Question label

Highest education level attained Secondary school with/without certificate; A-levels; A. 11 university degree

SE_2

Labor intensity

-

Full-time; part-time; not employed

A. 2

SE_3

Job type

Current or most recent occupation

Professional/freelance occupations (e.g., doctors, lawyers) or owner of medium/large companies; senior management (e.g., board member, director, professor, head physician); owner of small-scale businesses; middle management (e.g., product manager); lower management (e.g., administrator, clerical assistant); skilled trades occupations; unskilled trades occupations; agriculture, farming, fishing; unemployed; homemaker

A. 7

SE_4

Employment status Health status

-

Self-employed; employed

A. 3

SE_5

SE_6

Poor/fair; good; very good/excellent Self-assessed overall health status: poor; fair; good; very good; excellent Retirement status Self-assessed retirement status, Retired; pre-retired independent of current work situation

H. 11

A. 4

The quantitative side of the socio-economic attributes, shown in Table 5.3, looks at the income level as well as the different components of wealth, such as financial assets, property value and net property value (property value net of mortgages). With regard to the ownership of real estate, the different kinds of property ownership are investigated (e.g., residential property for personal needs or property for investment purposes). Table 5.3

Measurement specifications for the quantitative socio-economic attributes

Identifier Topic Socio-economics

Differentiator

Categories of analysis

Current level of net household income

€ <45k; 45 - <75k; 75 - <110k; 110 - <140k; >=140k – Weighted average

Question label

SE_7

Household income

SE_8

Financial wealth Total financial investments per € 100 - 150k; 150 - 400k; 400 - 700k; 700 - 1,400k household (excl. state/ employer – Weighted average pension and property)

H. 4

SE_9

Housing situation

H. 1

Nature of real estate situation

Own the house I live in; rent the house I live in; own a rental property; own a vacation property or second home

H. 9

5.1 Operationalization of research-specific FP perspectives and FP actions Table 5.3

141

Measurement specifications for the quantitative socio-economic attributes (continued)

Identifier Topic Differentiator Categories of analysis Socio-economics Weighted average of the following ranges: € 0; SE_10 Property wealth Absolute value of real estate <150k; 150 - 250k; 250 - 400k; 400 - 700k; >700k investments – original value ranges of the questionnaire: € 0; <100k; 100 - 150k; 150 - 200k; 200 - 250k; 250 - 400k; 400 550k; 550 - 700k; 700 - 1,050k; 1,050 - 1,400k; >1,400k

Question label H. 2

SE_11 Mortgage value

Absolute value of mortgages – Weighted average of the following ranges: € 0; <150k; 150 - 250k; 250 - 400k; 400 - 700k; >700k original value ranges of the questionnaire: € 0; <100k; 100 150k; 150 - 200k; 200 - 250k; 250 - 400k; 400 - 550k; 550 700k; 700 - 1,050k; 1,050 1,400k; >1,400k

H. 3

SE_12 Share of average mortgages value relative to average property value

Share of weighted average mortgages value (SE_11) relative to weighted average property value (SE_10)

Weighted average of SE_11 / weighted average of SE_10; in percent

Calculated from H. 2; H. 3

SE_13 Net real estate value

Net amount of wealth invested Weighted average of SE_10 - weighted average of in real estate – calculated as SE_11 difference between property value (SE_10) and value of the mortgages (SE_11)

Calculated from H. 2; H. 3

SE_14 Total wealth

Sum of financial wealth (excl. Weighted average of the following ranges: € 100 - Calculated state/employer pension and 150k; 150 - 400k; 400 - 700k; 700 - 1,400k; >1,400k from H. 2; property) (SE_8) and property H. 3; H. 4 value (SE_10) minus mortgage value (SE_11); all in their original ranges summed up for each individual

5.1.2 Operationalization and measurement specifications of FP perspectives As illustrated in Fig. 2.3 (overview of FPB), the analysis of FP perspectives relies on four elements: the planned life in retirement, the financial view on life in retirement, transaction preferences and the risk profile. The planned life in retirement, as shown in Table 5.4, depends on qualitative expectations and world views individuals have about their retirement. This aspect covers sociological developments such as changes in lifestyle and performed activities as well as shifts in the importance of social ties. Questions about lifestyle investigate when individuals plan to retire and what they intend to do in their retirement, including whether or not they plan to continue working. It also sheds light on the importance of social ties by investigating whether individuals intend to spend more time

142

5 Investor retirement survey and outlook on empirical analyses

with their family, perform child care and engage in charitable work. Furthermore, “coping strategies” get analyzed. They include steps individuals are ready to take in order to cope with a reduced income. The last element investigates the financial aims in retirement that correspond to the financial objectives at the outset of a financial planning process (as mentioned in section 2.2.1). Table 5.4

Measurement specifications for the planned life in retirement (1st element of FP perspectives)

Identifier Topic Differentiator Planned life in retirement

Categories of analysis

Question label

PL_1

Retirement age

Age at which individuals intend < 60 (early retirement); 60 - 65 (normal retirement); A. 19; A. to retire or did retire > 65 (late retirement) – Weighted average of exact 17; H. 12 planned or actual retirement age

PL_2

Retirement life plans

Intended or actually performed activities in retirement

Planning to undertake one or several of the following: C. 1 spend a lot of time with the family; provide childcare for family; perform voluntary/charitable activities; travel extensively; spend extended time periods abroad; move abroad; pursue indoor hobbies (e.g., reading); pursue outdoor hobbies (e.g., hiking); study; continue to work (part-time)

PL_3

Coping strategies Planned steps to cope with a potential gap between required and anticipated retirement income

C. 9 Being somewhat or extremely willing to engage in one or several of the following steps: moving to a less expensive area/smaller property; moving in with family; restricting life-style; continuing to work (parttime or full-time); releasing investments (e.g., mutual funds); selling a second property (e.g., vacation home); selling an investment property; releasing some home equity (e.g., taking out a mortgage, transferring it for an annuity)

PL_4

Financial objectives in retirement

Intended use of assets in retirement

Agreeing or agreeing strongly to one or several of the C. 2 following: able to spend all assets as there is no absolute necessity to leave an inheritance; keep some assets to leave an inheritance; keep a reserve of funds to cover uncertain future events; continue to accumulate savings; provide for large items of discretionary spending

The financial view described in Table 5.5 analyses the quantitative dimension of the planned life in retirement. It gives an indication of how financially savvy individuals are (i.e., their ability to make realistic assumptions about their financial flows in retirement and thus their insights into the inter-temporal financial optimization problem highlighted in subchapter 2.1). Specifically, this element investigates how much preretirement income individuals expect to have and how much of that income they judge necessary to live comfortably in retirement. These two variables, together with the financial aims mentioned above, define the total expense side of the budget constraint.

5.1 Operationalization of research-specific FP perspectives and FP actions

143

The analysis of the financial view on life in retirement also encompasses the analysis of the income side. This includes the investigation of different income sources as well as the quantification of their contribution. The selfdefined quantification of the income and expense streams allows the identification of a possible retirement gap. This allows a contrast to be made between the findings about a quantitative income gap and the subjective feeling of financial preparedness for retirement. Table 5.5

Measurement specifications for the financial view on life in retirement (2nd element of FP perspectives)

Identifier Topic Differentiator Financial view on life in retirement

Categories of analysis

Question label

FV_1

Expected annual Expected net annual household Weighted average of the following ranges: € <45k; C. 4 household income prior to retirement 45 - 75k; 75 - 110k; 110 - 140k; >140k income prior to retirement

FV_2

Percentage of last preretirement income needed in retirement

Expected relative income needs <50%; 50 - < 60%; 60 - < 70%; 70 - < 80%; 80 - < in retirement (as % of last 90%; 90 - < 100%; 100% – Weighted average household income prior to retirement)

C. 5; also set in relationship to C. 4

FV_3

Income needed to life comfortably in retirement

(Expected) absolute income needs in retirement (expenses)

€ <45k; 45 - 75k; 75 - 110k; 110 - 140k; >140k – Weighted average

H. 5; also set in relationship to C. 4

FV_4

Primary source of retirement income

(Expected) nature of main source of retirement income

One of the following: pension income from state pension; private pension; employer-based contributory pension; employer-based defined benefit pension; inheritance; income from savings and investments; income from second property; income from continued forms of work

A. 14

FV_5

Complementary (Expected) nature of sources of complementary retirement retirement income sources income

FV_6

Complexity of pension arrangements

Weighted average number of complementary Number of pension income income sources (Maximum: 8) sources individuals list as complementary income sources

FV_7

Percentage of last preretirement income expected to receive in retirement

Expected retirement income from statutory state pension, employer based pension and private pension (as percentage of household income immediately prior to retirement)

One or more of the following: pension income from A. 14 state pension; private pension; employer-based contributory pension; employer-based defined benefit pension; inheritance; income from savings and investments; income from second property; income from continued forms of work Calculated from A. 14

For state pension income: < 25%; 25 - < 45%; 45 - C. 6; C. 6a; < 65%; > 65% – Weighted average; for private C. 6b pension income: weighted average from the following ranges: 0 - 15%; 15 - 25%; 25 - 35%; 35 45%; > 45%; for corporate pension income: weighted average from the following ranges: 0 15%; 15 - 25%; 25 - 35%; > 35%; for all income sources together: weighted average from the following ranges: > 50%; 50 - 60%; 60 - 70%; 70 80%; 80 - 90%; 90 - 100%; 100%; > 100%

144

5 Investor retirement survey and outlook on empirical analyses

Table 5.5

Measurement specifications for the financial view on life in retirement (2nd element of FP perspectives) (continued)

Identifier Topic Differentiator Financial view on life in retirement

Categories of analysis

Question label

FV_8

Retirement income

(Expected) absolute retirement € <45k; 45 - 75k; 75 - 110k; 110 - 140k; > 140k – income Weighted average

FV_9

Retirement gap

Difference between (expected) retirement income and income needed to live comfortably in retirement (expenses) (FV_8 FV_3)

Income greater than expenses by more than € 15k; Calculated income greater than expenses by up to € 15k from H. 5; (positive retirement gaps); income equals expenses H. 6 (no gap); expenses greater than income by up to € 15k; expenses greater than income by more than € 15k (negative retirement gaps)

Distinction of individuals according to whether they feel/felt very/fairly well prepared for retirement, if they feel/felt neither prepared nor unprepared or if they feel/felt very or fairly unprepared; for retirees, the feeling of how well prepared they felt is contrasted with the feeling of how well prepared they actually were

Individual feels well prepared for retirement; feels C. 18a; C. neither prepared nor unprepared; feels unprepared; 18b level of preparedness felt before retirement compared to actual level of preparedness (for Retirees only)

FV_10 Feeling of financial preparedness

H. 6

The third element of FP perspectives sheds light on individuals’ transaction preferences and is set out in Table 5.6. It examines how individuals collect information and take decisions. Family relations and social roles but also personal factors such as personality and self-concept (i.e., how an individual sees himself) influence this element. Specifically, it investigates the level of delegation of information search and decision-making to external advisors as well as the level of inter-family consultation that individuals feel confident with in their retirement planning.

5.1 Operationalization of research-specific FP perspectives and FP actions Table 5.6

145

Measurement specifications for transaction preferences (3rd element of FP perspectives)

Identifier Topic Differentiator Transaction preferences TP_1

Decision making Analysis of the way financial information is collected and decisions are made

TP_2

Decision preferences in the family context

Categories of analysis

Information collected from various sources but decision taken alone (self-directed); information collected from multiple financial professionals but decision taken alone (validator); information collected from one financial advisor but decision taken alone (advice seeker); relationship with one financial advisor who also takes decisions (delegator)

Analysis whether interviewee is Individual takes decisions together with partner; the sole decision-taker or if individual takes decisions on his own financial decisions are taken jointly with the partner

Question label

D. 1

A. 10

Table 5.7 details the individual risk profile as the fourth element that impacts FP perspectives. As illustrated in section 2.2.3 an individual’s risk profile is composed of three elements: risk capability, risk appetite and risk sophistication. The risk capability depends on an individual’s socio-economic and socio-demographic attributes. These attributes capture the objective dimension of risk and were presented in detail in section 5.1.1. The subjective risk appetite is measured through the self-assessed willingness of an individual to accept a certain chance of (interim) loss in exchange for enhancing the expected overall return. The subjective risk sophistication is based on the self-assessed financial sophistication, the awareness of different risks and finally the interest individuals express for a product that protect them against specific risks. As the description of the inter-temporal financial optimization problem has shown, three types of risk influence the individual financial situation in retirement: financial, regulatory and personal risks. Therefore, these three risk types are investigated in the context of the analysis of the risk sophistication.

146

5 Investor retirement survey and outlook on empirical analyses

Table 5.7

Measurement specifications for the subjective dimensions of the risk profile (4th element of FP perspectives)

Identifier Topic Risk profile

Differentiator

Categories of analysis

Question label

RP_1

Self-assessed risk appetite

Attitude towards temporary losses in order to enhance the overall return expectations of an investment

Only investments in cash or equivalents (completely B. 3 risk averse); ready to accept a minimum 0% return if on average 5 - 7% p.a. return can be expected (risk averse); prepared to risk up to 5% p.a. but expecting to make up to 10 - 12% p.a. (somewhat comfortable with risk); prepared to risk up to 10% if a return of 20% or more can be expected (comfortable with risk)

RP_2

Self-assessed financial sophistication

Assignment of own financial knowledge when planning for retirement compared to individuals of similar age and background

B. 2 Worse than average level of financial sophistication; average level of financial sophistication; better than average level of financial sophistication

RP_3

0 - 1; 2 - 5; 6 - 9; 10 - 13 (total: 13 risks) – Risk awareness – Number of risks that are Worry indicator recognized as extremely, very or Weighted average number of risks acknowledged somewhat important

RP_4

Risk awareness – Kind of risks considered as important

Extent to which an individual is aware of a specific risk and finds the particular risk important for his financial situation in retirement

Considering one or several of the following risks to C. 11 be somewhat, very or extremely important: - capital market risks: inflation will erode buying power of retirement savings; savings will be reduced due to unfavorable market developments; income from savings will be lower than expected; surplus/profit participation of pension or life insurance will be lower than anticipated - personal risks: outliving the assets; poor health and medical bills will run down the retirement assets; having to pay to live in a retirement or nursing home for an extended period; the money will be tied up and unavailable when needed for specific expenses; unable to leave as valuable an estate behind as intended - regulatory risks: not receiving the state pension that is currently expected; erosion of the buying power of the retirement savings through an increase in tax rates; value of the state pension not increasing in line with living expenses; lack of a source of guaranteed retirement income

RP_5

Risk hedging

Extent to which individuals are interested in buying products that protect them from specific risks

C. 14; C. 15 Being somewhat, very or extremely interested in buying one or several of the following products to protect against - capital market risks: inflation will erode buying power of retirement savings; savings will be reduced due to unfavorable market developments; income from savings will be lower than expected; surplus/profit participation of pension or life insurance will be lower than anticipated - personal risks: outliving the assets (before and after confrontation with longer life-expectancy); poor health and medical bills not covered by health insurance will run down retirement assets (before and after confrontation with longer life-expectancy) - regulatory risks: regulatory retirement gap, i.e., risk that pension income will be reduced due to legislative changes (before and after confrontation with longer life-expectancy)

C. 11

5.1 Operationalization of research-specific FP perspectives and FP actions

147

5.1.3 Operationalization and measurement specifications of FP actions To measure FP actions as the second component of retirement-specific FPB, seven constructs are analyzed as pointed out in Fig. 2.3: While the first two relate to the process of financial planning with the question of timing of financial planning and the use of support in the decision process, the following five describe the choice of investment vehicles and thus correspond to the implementation of the chosen program. Table 5.8 describes the operationalization of the first two elements: The question of timing investigates at what age individuals start to think about planning for their financial situation in retirement. The question related to the use of support sheds light on the sources that individuals consult to get information during the process. To start with, individuals are asked if they have a primary financial advisor with whom they can discuss the financial aspects of their retirement. Furthermore, their interest for holistic advice leading to an integrated financial plan is tested. With regard to the use of information sources, the kind and the frequency of usage for printed information sources such as investment magazines or money pages of newspapers, the Internet and finally face to face information sources are investigated. The latter can be friends or family, a bank-employed relationship manager or financial advisor, an insurance-employed advisor (working for only one or for several firms), or an IFA. These points are relevant as they offer insights into the strength of the relationship individuals have with their advisors and into how they can best be targeted and influenced. Table 5.8

Measurement specifications for process-related aspects of FP actions

Identifier Topic Differentiator Start of financial planning activities ST_1

Start of financial Age at which individual begins/began to think about his planning financial needs in retirement activities and thus to think about financial planning and saving activities

Categories of analysis

Question label

Started before 40; between 40 and 50; between 50 and 60; after 60 – Weighted average of actually indicated age at which individuals begins/began financial planning activities

Calculated from A. 17; A. 18; A. 20; H.12

148

5 Investor retirement survey and outlook on empirical analyses

Table 5.8

Measurement specifications for process-related aspects of FP actions (continued)

Identifier Topic Decision support

Differentiator

Categories of analysis

DS_1

Use of financial Analysis whether an individual Individual has a primary financial advisor; advisor has a primary financial advisor individual has no primary financial advisor with whom he can discuss financial aspects of his retirement

DS_2

Interest in an integrated financial plan

Extent to which individual finds Very/fairly unimportant; neither important nor unimportant; fairly/very important holistic advice leading to an integrated financial plan important

DS_3

Use of information sources

Kind and frequency of use of information sources to obtain general financial information, to support a specific decision or to stay up to date

Question label

D. 5

D. 2

Weekly, monthly, less than monthly or no use of B. 1 printed information sources: investment magazines; money pages of daily newspapers; the Internet; and face to face information sources: friends/family members; bank advisor; insurance advisor working for one firm; insurance advisor working for several firms; IFA

Apart from these process related elements, various aspects of the portfolio choice are investigated (Table 5.9). To start with, the probability that these individuals hold classical pension savings products such as annuities, savings linked to life-insurances or an employer-based contributory pension provision is analyzed. Then, the level of diversification is analyzed, building on a self-assessed level of diversification and comparing this to an objective assessment of diversification (i.e., the distribution of total wealth into different asset categories and classical retirement saving products). In order to test the riskiness of the portfolio, the share of equity 308 is investigated. Also, the leverage of the portfolio is analyzed in this respect, building on the relationship between outstanding mortgages and real estate value. Finally, the level of mitigation of the different risk types is considered. This element allows comparison of the awareness of risks with the actual action level to mitigate them and can be seen as an indicator of the level of commitment and action-orientation of the individuals. 308

The share of equity relates to the direct stock holding as well as the indirect holding of equity through mutual funds. For the indirect stock holdings a for Germany typical share of equity holdings in mutual funds is taken into consideration. According to the BVI, the German “Bundesverband Investment und Asset Management”, the share of pure equity funds amounts to 31% of total fund shareholdings and the share of balanced funds amounts to 5%. As a consequence, about a third of the volume invested in mutual funds can be assumed to be equity investments in 2004. See SCHARDT/VON BARBY 2005, p. 86.

5.1 Operationalization of research-specific FP perspectives and FP actions

149

With regard to saving as the mechanism of shifting consumption between periods, the amount individuals are prepared to save is captured in attribute PC_7. It is investigated in more detail in the context of the retirement gap simulation shown in sub-chapter 6.4. Table 5.9

Measurement specifications for portfolio choices within FP actions

Identifier Topic Portfolio choices

Differentiator

Categories of analysis

Question label

PC_1

Individual holds at least one of Holding of classical pension the following typical pension saving vehicles products: life insurance; personal pension plan; employer based contributory pension provision

PC_2

Subjective assessment of portfolio diversification

Individual who says they have diversified according C. 13 Self-assessed asset diversification level with regard to these criteria; individual who says they have not diversified according to these criteria to product types (e.g., diversification of savings through holding of life insurances, real estate, stock holdings)

PC_3

Objective assessment portfolio diversification

Objective level of portfolio diversification measured through the constitution of the total wealth portfolio

PC_4

Equity exposure Share of equity in the portfolio 0%; 0 - 10%; 10 - 25%; 25 - 50%; 50 - 75%; 75% - Calculated from H. 7 (equity from direct holdings of 100% – Average share of equity holding by age stocks and 1/3 of mutual fund group holdings)

PC_5

Real estate leverage

Individual holds at least one of these typical pension A. 15 saving products; Individual does not hold any of these three products – Differentiation of average share of individuals that hold the respective product

Individual whose portfolio is objectively Calculated from H. 7 diversified: contains at least fixed income and mutual funds or equity and mutual funds and either property or life insurance; individual whose portfolio is objectively undiversified according to these criteria

Amount of mortgages relative to 0%; 0 - 20%; 20 - 40%; 40 - 60%; 40 - 80%; 80 100% – Average share of real estate leverage by age the property value, calculated group from original values (value brackets offered: € 0; < 100k; 100 - 150k; 150 - 200k; 200 250k; 250 - 400k; 400 - 550k; 550 - 700k; 700 - 1,050k; 1,050 1,400k; > 1,400k)

Calculated from detailed indications of H. 2 and H. 3

150

5 Investor retirement survey and outlook on empirical analyses

Table 5.9

Measurement specifications for portfolio choices within FP actions (continued)

Identifier Topic Portfolio choices PC_6

Risk mitigation

Differentiator

Categories of analysis

Analysis whether awareness about a risk (seeing it as important) has lead to its mitigation

Individual who has assessed a specific risk as somewhat, very or extremely important and at the same time mitigated it; individual who has also assessed a specific risk as somewhat, very or extremely important but has not done anything to mitigate it

Question label

C. 11; C. 12

Risks include: - capital market risks: inflation will erode buying power of retirement savings; savings will be reduced due to unfavorable market developments; income from savings will be lower than expected; surplus/profit participation of pension or life insurance will be lower than anticipated - personal risks: outliving the assets; poor health and medical bills will run down the retirement assets; having to pay to live in a retirement or nursing home for an extended period; the money will be tied up and unavailable when needed for specific expenses; unable to leave as valuable an estate behind as intended - regulatory risks: not receiving the state pension that is currently expected; erosion of the buying power of the retirement savings through an increase in tax rates; value of the state pension not increasing in line with living expenses; lack of a source of guaranteed retirement income PC_7

0 - 10%; 10 - 30%; 30 - 50%; >= 50% Readiness to save Proportion of income that individuals are prepared to invest until retirement in order to ensure financial security in retirement (including any savings/investments already made)

C. 8

5.2 Investor retirement survey as chosen observation instrument The following sub-chapter introduces the target group of this study as well as the observation instrument used for the empirical investigation. The first section presents the target group and highlights the different criteria that were relevant for the selection of this segment of the German population. In the second section, the chosen observation instrument, an investor retirement survey consisting of standardized personal interviews, is intro-

5.2 Investor retirement survey as chosen observation instrument

151

duced. Then the questionnaire structure and content are discussed. This sub-chapter closes with the description of how the survey was realized. 5.2.1 Choice of the target group As the SOR model described by MEFFERT 2000, KOTLER/BLIEMEL 1995 and KOTLER 1999 shows, different macro-economic variables, as well as micro-economic attributes such as culture, sub-culture or social class, have a strong influence on buying behavior. Similarly, belonging to a specific social class can be assumed to have a strong influence on an individual’s retirement-specific FPB. Therefore, in order to avoid diluting results by mixing different social classes and to get a more concise picture of the relevant attitudes and behaviors of one class, the focus of this study is on a sub-group of the population: the affluent segment in Germany. This subgroup, called the target group, is defined by three criteria: a specific age range, a wealth bracket, and the exclusion of specific professions. The first criterion for inclusion in the target group is age. Only individuals aged between 45 and 70 – the birth-intensive generation born between 1935 to 1960 that partially coincides with the “Baby Boomers” – are considered. 309 Due to their high importance in the share of the population (in the year 2000 they made up over a third of the total population), their contribution to the total wealth pot 310 and their impact in driving changes in customer behavior, 311 this age-segment is of high interest. Furthermore, their life-cycle is nearing retirement, which highlights that the question of securing their dissaving period financially should be very important for them. Also, given this imminent change, it would be particularly telling if not even these individuals were providing adequately for their old age. The second criterion for the definition of the target group is the wealth range. It has been set at between €100k and €1.4m for the total financial wealth of the household (excluding pensions and real estate). This wealth 309

In FRICK 2005 the term “Baby Boomers” refers to individuals born 1946 to 1964. The focus in this study has been expanded to include slightly older individuals to capture also the behavior of already retired individuals and thus to allow for inter-generational comparisons. 310 According to BRAUN et al. 2002 the current generation of retirees disposes of substantial wealth that they will pass on to the next generation in a major “money-in-motion” act. See BRAUN et al. 2002, p. 3f. Also the EVS, conducted by the STBA, has revealed that individuals aged 45 to 70 own around 57% of the total pot of financial wealth that they cover with their survey. See STBA 2003b. 311 See for example DYCHTWALD 1999 or FRICK 2005.

152

5 Investor retirement survey and outlook on empirical analyses

group is interesting because of their important contribution to total personal savings. Additionally, since this group owns the majority of stocks, bonds and mutual funds held by households, “their investment decisions have potentially important implications for the behavior of financial markets. […][Furthermore] one would expect high-income, wealthy people to have experience with saving and financial planning, so it would be particularly telling to find poorly conceived saving decisions in a group like this.” 312 As a third criterion, individuals with certain industry-specific or functional know-how were excluded from the target group in order to avoid a distortion of the results due to information asymmetry. Thus, individuals working in life-insurance, pensions associations, investment or asset management, brokerage, as well as individuals working in marketing, public relations, advertising or journalism, were excluded. Building on the total German population, the first and the second criteria were applied to get a better understanding of the characteristics of the target group of this study. Among the German population the share of individuals aged 45-70 years makes up 32%, consisting of 13.2m men and 13.4m women. 313 Together, these individuals own 58% of the total financial assets held by private households in Germany in 2003 (according to the Einkommens- und Verbrauchsstichprobe (EVS) this amounted to around €875 billion). 314

312

KENNICKELL et al. 1997, p. 2. Population statistics are based on the distribution of the German population as of 2004. See STBA 2005a. 314 The EVS is conducted every five years by the German Statistical Federal Office and gives insights into the economic situation of households in Germany. Contrary to the statistics of the German Federal Bank, the EVS looks only at private households with less than €~18,000 monthly income. The EVS excludes the very wealthy individuals (i.e., the HNWI) and private organizations without pecuniary purpose such as churches and unions. The EVS components include savings accounts, building savings agreements, other savings at banks or savings banks, securities, life-insurance and money lent to private persons. Cash holdings and checking accounts are excluded. See STBA 2003b. This explains why the total financial wealth covered in the EVS is below the estimate of the German federal bank (in 1993, they had a total of €1.95bn while the EVS came up to €1bn). See STBA 1997. In 2004, the total volume of the German Federal Bank amounted to €2.5bn. See DIA 2005d. Since however these other groups are not in the focus of this study and since the EVS is more appropriate from an academic perspective (see e.g., BÖRSCH-SUPAN et al. 1999), this study is relying on the data of the EVS to characterize the target group. 313

5.2 Investor retirement survey as chosen observation instrument

153

In order to reflect that the focus of this study is on the affluent segment of this age group, having between €100k to €1,4m financial assets, an omnibus survey 315 was conducted to identify the respective proportion within the entire German population aged 45 to 70. The omnibus survey revealed that only 33% of all individuals aged 45-70 (some 8.8m people) fall in this wealth bracket. Based on the rough indications of the omnibus participants about the average value of their financial assets, an approximation of their share of the total wealth pot is possible. As a result, these individuals are estimated to own about two thirds of the wealth pot or about €550 billion in financial assets. Correspondingly, the target group of this study includes almost 9m individuals with total assets of over half a trillion Euro. This corresponds to slightly over 10% of the total German population. Based on the distribution of the retirement status in the omnibus sample, the share of pre-retired individuals in this share of the population amounts to 55%. Building on these considerations, a sampling survey was conducted with about 550 individuals who fulfilled the three criteria for the target group described above. A detailed explanation for how these individuals were chosen can be found in the section describing the realization of the investor survey (5.2.4). Important to note is that the weight of each individual interviewee has then been adjusted to reflect the distribution of the key socio-demographic and socio-economic parameters in a representative sample of the population of the target group, the above described omnibus survey. 316 315

The omnibus survey is a multipurpose survey that is conducted regularly. It was developed to allow different topics from various interest groups to be tested simultaneously and very quickly on a large sample of individuals and thus reaching a high level of representativeness. Its participants are chosen as a random probability sample stratified by region. New respondents are chosen for every round to ensure that the data is free from panel effects. The omnibus survey was conducted with 1,000 individuals as computer assisted personal interviews in the week of April 18, 2005 by a separate market research agency who is specialized on this kind of survey. (Details can be found in Appendix 4). The questions asked for this survey referred to demographics (gender, age, financial wealth level, retirement status) and retirement behavioral aspects like the question of which financial products individuals hold. The weight of each of the 528 individual interviews is based on the gender, age, retirement status and financial wealth distribution of all participants to the omnibus survey that fell in the age and wealth bracket that defines the target group of this study (i.e., being 45 to 70 year old and having between €100k and €1,400k investable assets). 316 A pre-condition of applying the principles of sampling theory is a valid representation of the target group’s key characteristics within the sample being analyzed. The more homogenous the population, the smaller the required size of the

154

5 Investor retirement survey and outlook on empirical analyses

It has to be taken into consideration that the choice of interviewees and interviewers is always subject to some kind of selection bias. There is the interviewer bias as well as the selection bias of people who are interested in surveys and willing to give answers. For example, it could be shown that voluntary participants in surveys mostly have a higher educational level, a higher self-assessed social status, higher intelligence, a higher need for social approval and that they are more social and less authoritative. Additionally, the type of research question can have implications on the propensity to participate. If people are interested in a specific topic, if the research is considered significant or if it is officially supported by authorities, individuals’ willingness to contribute increases. The same also applies if the participants are offered some kind of compensation or if they know the researcher personally. 317 With regard to the generalization of results, it is important to note that these biases are only relevant if the behavior of those that did not participate deviates significantly from the behavior of those examined. 318 In the current study, the possibility to express their opinions on an intensely debated issue seems to have been a good motivator for potential interviewees. However, due to the fact that the questionnaire included very personal and delicate financial details such as the volume of assets or the income level, the interviews were subject to the risk that individuals would not answer these questions or give wrong indications. 319 To avoid any answer distortions and ensure a good quality of the data, a more personal approach was chosen as described in 5.2.4 to increase the level confidence of the interviewees and guarantee security of the data. As there is no evidence that the interviewees selected behave differently than the target group and since it is impossible to test the entire population or draw a random sample in the strict sense give these circumstances, the results can be considered as a valid representation of the target group. Moreover, aspects that could lead to a potential bias, such as education level, have been explicitly addressed in the questionnaire and are made transparent in the description of the different investor groups. sample. Sampling exercises in social sciences relate to specific real populations that exist in a limited time frame. Therefore, the generalizability of the knowledge is limited and results can only be applied to populations living in the same context (i.e., time, country). In the current research, the population to which its results can be applied is living in Germany in the year 2005 and is described by the parameters age group, wealth level and profession. 317 See BORTZ/DÖRING 2002, p. 75ff. 318 See BROSIUS 2004, p. 479. 319 The same difficulty is also discussed by BÖRSCH-SUPAN et al. 1999, p. 8ff.

5.2 Investor retirement survey as chosen observation instrument

155

The focus on the affluent segment is at the same time a conscious decision against both the retail segment as well as the high net worth (HNW) segment. This explicit choice has been taken based on anticipated differences in circumstances and behavior that would dilute the findings of the behavior of a more concisely defined group of the population. As the details about the life-cycle hypothesis have shown in sub-chapter 2.1, saving can be assumed to follow income and thus also wealth. As a consequence, it can be supposed that the HNW segment tends to provide amply for its retirement and will most probably also be closely covered by a (private) bank-employed advisor who, together with pension specialists, ensures a good preparation for the financial situation in retirement with tailored products and solutions. The retail segment is at the other end of the spectrum, where saving seems to be difficult and the statutory state pension is expected to be the main income source in retirement. These individuals are faced with the choice of saving a small amount and then be able to keep their – mostly modest – lifestyle. Alternatively they can decide explicitly not to save for retirement, maximize their consumption in the present and then rely on state subsidies but with the danger of having to reduce their retirement lifestyle substantially. The latter strategy of this herein termed “state-reliant free rider” is a phenomenon expressing a fatalistic attitude and does inevitably lead to a very modest lifestyle in retirement. Considering that lifestyle is habit forming, it can be supposed that only individuals who are used to a very modest lifestyle would choose this fatalistic strategy, even if the projection bias induces individuals to underestimate the extent to which their preferences will change. Therefore, it can be assumed that the group of individuals standing at the center of this research does not assume such as strategy. 5.2.2 Introduction of the observation instrument In order to empirically analyze and validate the individual retirementspecific FPB of the target group, the necessary data had to be collected. The choice for an adequate observation instrument fell on an investor retirement survey consisting of a set of standardized personal interviews. The rationale for using standardized personal interviews is that they are the most appropriate instrument to examine individual retirement-specific FPB for a wide group of individuals, such as the one defined in the previous section. The standardized questions allow comparing different elements across the interviewees and thus are effective in answering the research questions. Furthermore, a big enough number of interviews can be obtained in order to represent the population properly. Also their popular-

156

5 Investor retirement survey and outlook on empirical analyses

ity as the most commonly used observation instrument for collecting information about reality represents an argument. Further advantages are highlighted by FRIEDRICHS 1990, STIER 1996 or MEFFERT 2000. 320 However, there are also limitations and biases associated with standardized questionnaires that need to be addressed in the research set-up. 321 According to FRIEDRICHS 1990, three things must be taken into consideration with standardized personal interviews. First, interviews are a form of asymmetrical communication, where the interviewer asks questions, but does not show his answers. It is therefore a form of investigation rather than communication. In this context, the quality of the interviews depends significantly on good verbal capabilities, a common use of language, and an understanding of the subject being investigated by both the interviewer and the interviewee. These considerations are particularly important for the current research since the topic examined, even if it is a widely discussed issue, uses quite specialized terms and expressions. Second, since in most cases an external interviewer and not the researcher conducts the interviews, he becomes the contact person of the interviewee. In such a role, the external interviewer is not just an agent of the researcher, but a central methodological element in the collection of data. This is why the choice of interviewers is critical for the quality of the data. Third, significant care needs to be applied to the survey itself, which represents the translation of the researcher’s questions and hypotheses. Since it is used by the interviewer in different interview situations and its macro- and micro-structure significantly influences the attentiveness and interest of both the interviewer and the interviewee, the design of the questionnaire should be well structured and neutral. 322 BORTZ/DÖRING 2002 provide a questionnaire quality checklist that was used in the design of the questionnaire for this study. 323 To ensure comprehension and ease of use, the questionnaire has also been validated before the interviewing process through pre-testing and focus groups.

320

See FRIEDRICHS 1990, p. 207ff and STIER 1996, p. 173ff or MEFFERT 2000, p. 156. 321 For further details refer to BORTZ/DÖRING 2002, p. 238ff, KROMREY 1995, p. 394ff or MEFFERT 2000, p. 156. 322 See FRIEDRICHS 1990, p. 207. 323 See BORTZ/DÖRING 2002, p. 244ff.

5.2 Investor retirement survey as chosen observation instrument

157

5.2.3 Structure, content and formal characteristics of the questionnaire Addressing the third limitation mentioned by FRIEDRICHS 1990 substantial care was applied to the development of the standardized questionnaire used for the investor survey, described below. With regard to the structure of the questionnaire, macro- and microlevel aspects have to be taken into consideration. The macro-structure determines the overall logic of the interview. The micro-planning on the other hand specifies the contents of the different parts of the survey, the level of standardization for individual questions and thus their formal characteristics. The macro-planning is displayed in Fig. 5.1.324 It is important to note that the relevant data for this study have been collected in the context of a wider survey, which investigates the relationship between financial service providers and retirement solutions. 325 Since the focus of this study lies on the individual and his behavior, only the FPB relevant part of the original survey is illustrated. Section

Content

Introduction

Information about the interviewing agency, the interviewer and some key indications about the interview

A B C D

Qualification and demographic profile Individual financial sophistication Life in retirement and specific risks Advice preferences

H

Supplementary information (for self-completion)

Fig. 5.1

Macro-structure of the standardized interview questionnaire

Remark:

Since only the study-specific part of the questionnaire is illustrated, the questions relating to the buying process (section E), the views and choices of products (section F) and the assessment of the financial services providers (section G) are not shown here.

324 325

The questionnaire used for the interviews can be found in the Appendix 3. The “Retirement Initiative” survey was conducted by McKinsey & Company, Inc. on a global basis. Its focus on the provision of retirement-related services by financial institutions makes it unique among other industry surveys. It investigates the interactions individuals have with financial services firms, how products are bought and who initiates the buying process. Furthermore it examines how the quality of different institutions is perceived. The author of the present thesis worked on this “Retirement Initiative” in Germany and the UK, specifically in the data collection and analysis phase. McKinsey & Company, Inc. explicitly agreed to the use of selected raw data for this study.

158

5 Investor retirement survey and outlook on empirical analyses

The interview is initiated by an introduction of the interviewing agency and the interviewer, to give the general context of the survey and to establish the relationship with the interviewee. The key personal data about the interviewee are collected to ensure that he can be contacted at a later time, in case questions with regard to the interview should arise. 326 According to MEFFERT 2000, these introductory and contact questions are intended to eliminate potential biases an interviewee might have and increase his responsiveness towards the key questions. The questionnaire then starts with inquiring socio-demographic and socio-economic data in section A. The key objective is to ensure that interviewees correspond to the target group. When individuals do not meet the selection criteria the interview is stopped and their answers are discarded. In sections B to D, the questionnaire explores the different aspects of individual retirement-specific FPB. Section B investigates the overall financial sophistication of the individual. This encompasses the use of information sources, the risk appetite, as well as the self-assessed level of financial sophistication. The latter two are determinants of an individual’s risk profile. Section C investigates the life individuals plan to have in retirement, both from a qualitative and a quantitative perspective. Specifically, life plans, financial aims and coping strategies are analyzed. Furthermore, the awareness about specific risks with regard to life in retirement and the interest in risk protection is tested and complemented with the analysis of actions individuals are planning to take to mitigate these risks. Section D then looks at the transaction preferences and use of an advisor. This structure ensures that the questions become more and more focused in the process of the interview, which also corresponds to the above mentioned survey design recommendations. The last part of the questionnaire, section H, contains personal and confidential information such as the exact age, different aggregates of income and wealth positions as well as an indication about the current health status. It is separated from the other questions and filled out by the interviewee himself. This approach also corresponds to survey design best practice, which states that the willingness of an interviewee to share personal information is greater if he can fill in the data personally. Furthermore, since this section contains questions that have already been asked earlier in a more general way (e.g., age ranges and total amount of finan-

326

In order to respect the guidelines for data security, this information is only kept at the interviewing agency.

5.2 Investor retirement survey as chosen observation instrument

159

cial wealth), this part also serves to check the consistency and plausibility of the answers. 327 The formal characteristics of the questionnaire can be summarized as follows: Answer options contain different scales of variables (e.g., nominal, ordinal, ratio scales). 328 Nominally scaled variables are, for example, the (naturally) dichotomous elements of gender (A. 6) or the artificially created polytomous elements of the age-range groupings (A. 5). 329 Additionally, the questionnaire contains many ratio-scaled questions that are both bipolar (two opposite attitudes, such as the assessment of how important certain risks are (C. 11)) or unipolar (i.e., there may be a natural zero value, such as the number of children (A. 12)). According to BORTZ/DÖRING 2002 the important condition for ratio scales is that the distance between the individual elements is perceived to be identical, which is ensured through adequate wording. An example is the formulation “Disagree strongly – Disagree – Neither agree nor disagree – Agree – Agree strongly” used for many questions, which shows that the scales are mostly built on five answer levels (e.g., D. 13). According to BORTZ/DÖRING 2002, the most prominent disadvantages associated with rating scales is the tendency to the mean. This occurs mostly when the interviewee is not familiar with the item being rated or if the differentiation between the two ends of the scale is not sufficiently large. 330 To avoid this tendency to the mean, e.g., in case of undecidedness or insecurity of the individual, the interviewee is also offered the choice of not making an explicit choice or of stating that the question is not applicable (e.g., C. 1 or C. 18a). Open questions were avoided in order to increase the comparability of answers and the probability of answering. However, certain questions allowed for additional, open answers (e.g., B 1).

327

For further details about controlling and plausibility questions, refer to MEFFERT 2000, p. 157. 328 Nominally and ordinally scaled variables are non-metrical scales, whereas interval and ratio scale variables are metrical scales and allow significantly more statistical operations. See BACKHAUS et al. 2003, p. 6. 329 The requirements for this kind of data to be collected and evaluated correctly are described by BORTZ/DÖRING 2002 as accuracy, exclusiveness and exhaustion. See BORTZ/DÖRING 2002, p. 139f. 330 See BORTZ/DÖRING 2002, p. 183.

160

5 Investor retirement survey and outlook on empirical analyses

5.2.4 Realization of the investor retirement survey As noted above, the content of the survey was perceived to be so sensitive in Germany that had a completely random approach been chosen for the selection of interviewees, a high share of non-respondents, missing information (with regard to the wealth level) or even wrong information would have resulted. Therefore, it was decided to rely on an interviewing agency with a strong local coverage to conduct the survey. The use of such an agency gives access to a wide set of interviewers, ensures a local spread of the sample and thus an adequate coverage of the population. At the same time, this procedure contributes to respecting the guidelines for data security and provides the interviewees with the level of confidentiality required for such a delicate topic. 331 Furthermore, a careful selection and detailed briefing of this interviewing agency addressed the first two concerns raised by FRIEDRICHS 1990 with regard to using a standardized questionnaire, namely the issues associated with the communication asymmetry and the importance of understanding of the topic. Building on the strong network of this market research agency, the selection of the individual interviewees was then conducted based on a multiplier effect called “snowball sampling”: The marketing agency contacted its 1,500 interviewers with the description of the target group. These interviewers were then asked to put together a list of potential interview partners. Based on an initial round of feedback from the 1,500 interviewers, 125 interviewers were chosen across the country to conduct the interviews, thereby ensuring the representation of different regions. 332 A total of 528 valid interviews were conducted within the German affluent segment. The interviews started on March 7, 2005 and lasted until April 25 of the same year. All interviews were conducted in person as paper-and-pencil interviews. Answered questionnaires that contained too many “non-response items” and so did not correspond to the content requirements were excluded. But thanks to a detailed briefing of the interviewers, fewer than a dozen questionnaires had to be eliminated. To ensure a comprehensive understanding of the pre-retired individuals, a split of 70% pre-retirees to 30% retirees was chosen for the interviews, 331 332

Details for the conducting agencies can be found in the Appendix 4. As a consequence, it needs to be acknowledged that the data sample used for this study is not random in a strict statistical sense because that would have required first an identification of all individuals within the entire German population that fulfill these criteria and then among those a random drawing of individuals with whom interviews were to be conducted. Therefore, the explanatory power of the statistical tests within this study represents only an approximation of the statistical tests conducted with a purely random sample.

5.3 Investor groups with a particular capability for risk

161

which corresponds to a considerable overweighting of the share of preretirees relative to their share in the target group (amounting to 55%). Furthermore, to ensure adequate representation of the female population’s perspectives, a minimum ratio of 20% female interviewees was enforced. As noted above, each interview also received a weighting in order to increase the validity of the sample for representing the target group, the German affluent segment of the specified age. The weight attribution was based on the omnibus survey that tested the distribution of gender and retirement status in the corresponding age and wealth group of the population (i.e., people aged 45 to 70 and having between €100k and €1.4m investable financial assets). This weighted base of interviews ensures a valid representation of the investigated population with regard to age, wealth, gender and retirement status. Therefore, it represents a quota sample, as described by BORTZ/DÖRING 2002, that was used for further analyses.

5.3 Identification of different investor groups with a particular capability for risk The conceptual model presented in sub-chapter 2.3 introduced the idea of deriving “groups of individuals” based on their objective risk capability and using them as research vehicles. This sub-chapter describes the prescriptions for attributing a person to one of these groups of individuals. The logic upon which the distinction for different “groups of individuals” is built bases on the idea of differing levels of objective risk capability. The objective ability of an individual to bear risk depends on his actual financial and wealth position, the outlook on his financial situation as well as the family ties and responsibilities. Therefore, an individual’s social and economic circumstances, captured in the socio-demographic and socioeconomic characteristics, are the factors that drive an individual’s risk capability. 333 This approach to identify individuals with a higher or lower than average risk capability builds on the idea of life-cycle investing that dates back to BODIE/MERTON/SAMUELSON 1992 and has been further illustrated by BOSCALJON 2005 and SPREMANN 1995. The model defines an individual’s 333

This is similar to the definition of risk capability in the context of life-cycle investing described by SPREMANN 1995. There the individual risk capability – which he terms “risk aversion” – is derived from the sum of human capital (i.e., the discounted value of all future work-related income) and the sum of financial capital (i.e., the discounted value of total investments, inheritances less donations, pensions) minus the liabilities for financing retirement.

162

5 Investor retirement survey and outlook on empirical analyses

total human wealth as the sum of saving (i.e., financial wealth) and human capital. Human capital represents the present value of future earnings. Therewith the model does not only look at the already accumulated level of financial wealth but also examines the value of human capital to give a perspective on the financial future. 334 The idea behind human capital considerations is that the further away from retirement individuals are, the more they have the chance to increase their expected future wages by gaining experience and education. On the other hand, human capital is gradually depleting as an individual approaches retirement. Correspondingly, a young person with a higher education or someone with very relevant work experience can assume more risk because he can expect a substantial improvement of his financial outlook if he sets his human capital into action. In other words, the “labor supply flexibility creates a kind of insurance against adverse investment outcomes.” 335 This means that a young individual with greater flexibility has a higher risk capability because if markets crash, he will be induced to increase his labor supply, thus earning additional income. Apart from highlighting the importance of earning power based on education or job experience, the model also illustrates the different personal risk factors that might lead to a cut in human capital (e.g., if an individual loses his job or experiences health problems). All these factors enter the reasoning about individuals with a higher or lower risk capability described below. As highlighted in the conceptual model, this study distinguishes individuals whose socio-demographic or socio-economic circumstances represent an advantage from those whose socio-demographic or socio-economic situation represent a threat or insecurity for their financial position in retirement. 336 The investor groups defined thus have either a higher or lower 334

Building on these thoughts, the model takes into consideration the trade-off between saving, consumption and additionally, leisure time. “Specifically, the model does not assume that individuals solely maximize wealth and reduce their allocation in equities based primary on their age. Instead, it assumes that individuals make decisions to maximize leisure time in addition to wealth.” BOSCALJON 2005, p. 46. Therefore, the model induces the individual to adapt his investment decisions and work supply (e.g., how much to work and when to retire) accordingly. 335 BODIE et al. 1992, p. 428. 336 An advantage or disadvantage can stem from personal and social uncertainties captured in an individual’s socio-demographic attributes or economic risks that are inherent in an individual’s socio-economic attributes. Potential insecurities for their financial situation in retirement that individuals need to take into consideration even as pre-retirees are e.g., whether individuals should anticipate a reduction in income or just an expected limit in future wealth growth. Further-

5.3 Investor groups with a particular capability for risk

163

capability for risk than the average individual in the age and wealth bracket analyzed. General considerations underlying the assignment of an individual to one of these groups are described. Furthermore, very specific definitions of borders for the respective socio-demographic and socio-economic attributes are given. The latter is needed to apply these group definitions to the individuals surveyed and attribute these interviewees to the different investor groups based on their socio-demographic and socio-economic characteristics. As mentioned, this classification is based only on the individual’s objective ability to bear risks. In order to reduce the influence of subjective perception biases, it does not take into consideration risk appetite or risk sophistication. Furthermore, to enhance the clarity of the classification, the choice of indicators to attribute an individual to one of the groups has been limited to the following nine socio-demographic and socio-economic attributes: age, gender, marital status, having children, education, status of employment, retirement status, health status and total investable assets (excluding pension or property assets). 337 Each investor group is defined by a specific sub-set of these attributes. Five investor groups with a lower than average and three investor groups with a higher than average capability for risk have been identified. They are introduced in Fig. 5.2 and will be characterized below.

more, social responsibilities associated with caring for a family, personal health problems or the riskiness of a job can lead to financial threats. On the other hand, a higher risk capability can stem from an already achieved financial cushion or a very good outlook on future earnings inherent in a higher education. 337 Since these nine variables give only an indication of the position of an individual with regard to his financial situation in retirement, the assignment of individuals to a specific investor group needs to be considered as a rough attribution. To assess the individual situation in retirement in the context of e.g., preparing a tailored financial plan, other factors would need to be included in order to get a more detailed picture of the individual. For the individual, these factors would include e.g., property value, the inheritance situation, as well as psychological factors such as preferences with regard to the handling of investments or the way financial decisions are taken. The determination of an adequate risk profile and of the appropriate financial strategy would need to be based on a holistic picture of the individual situation.

164

5 Investor retirement survey and outlook on empirical analyses

Investor groups with a below average risk capability

Investor groups with an above average risk capability

Highly-educated

Health-risk Employees

Single Mothers

Well-off Middle-aged

Limited-wealth Self-employed Typical Employees Wealthy

Retirees

Fig. 5.2

Overview of eight investor groups

5.3.1 Introduction of investor groups with a lower than average risk capability Even within the affluent part of the population individuals can be exposed to elevated levels of risk. These risks can be of a social, economic and personal nature or lie in an unfavorable combination of them. The resulting five investor groups with a lower than average risk capability are described below. Health-risk Employees

Since an individual’s health level directly influences his ability to work (full-time) and the kind of jobs he can assume, poor health can imply potential risks with regard to actual and future income. Members of this investor group might have to leave the workforce earlier than planned or stop working full-time with corresponding implications for their eligibility for state pension income as well as the potential to save and build up a wealth stock. Furthermore, they might incur increased financial needs in retirement because they might have to pay for significant costs related to their health – not fully covered by their insurance or the state. Since the fi-

5.3 Investor groups with a particular capability for risk

165

nancial consequences and threats of such a personal risk can be reduced substantially if the individual disposes of a significant asset cushion, a wealth criterion has been added to define this investor group. As a consequence, only those pre-retired individuals have been assigned to the Health-risk Employees who – apart from having a poor or fair health level – also have less than €400k financial wealth. Single Mothers

This group encompasses women who are single, widowed or divorced and at the same time have to look after children. Various studies such as the BMAS 2006b or the OECD 2001 have shown that women traditionally tend to have fewer than the total number of contribution years required for full eligibility for statutory state pension income. Reasons for this observation are the fact that they often take maternity leave or fulfill the caretaker function in the family. Also, women tend on average to have a lower salary, which results in fewer earnings points, partially because of the choice of jobs, partially because of the lower propensity to assume (senior) management positions. Finally, women often work part-time. For these three reasons, their eligibility for state pension might be greatly reduced. 338 This is reflected in the fact that average female state benefits are substantially below those of men. 339 Furthermore, women rely more on statutory state pension as an income source and thus tend to have fewer supplementary income sources that could bridge an eventual gap. 340 338

The Rentenversicherungsbericht 2005 revealed that women have on average 28.9 contribution years with 0.79 earnings points (EPs) per year whereas men have on average 41.2 contribution years with on average 1.06 earnings points (EPs). See BMAS 2006b, p. 22. Furthermore, KORTMANN et al. 2005 mention that women often fail to meet the eligibility criteria for supplementary pension schemes for public service. See KORTMANN et al. 2005, p. 20. 339 Average income levels for men in the age group 65 and over amount to €1,515 per month. Unmarried women have on average €1,189, widowed women with €1,195 about the same. The situation is worst for divorced women with an average of €1,051 per month. See KORTMANN et al. 2005, p. 91. 340 According to the Rentenversicherungsbericht 2005, the share of state pension provision amounts to 68% and 95% for women (for the old and new Bundesländer) while it accounts for only 60% respectively 87% for men. See BMAS 2006b, p. 25. Furthermore, KORTMANN et al. 2005 state that men have traditionally had higher pension income as they “were drawing on several types of income”. KORTMANN et al. 2005, p. 37.

166

5 Investor retirement survey and outlook on empirical analyses

Aggravating these effects, women tend to invest very conservatively as they typically display a high level of risk aversion. 341 Since funds saved for retirement usually have a very long investment horizon and thus can bear more risk, a too-conservative investment strategy leads to foregone profits. Furthermore, women historically have had a lower retirement age and at the same time tend to underestimate their life-expectancy more then men, and thus underestimate the time for which they need to provide retirement income. 342 Lastly, a survey by DEHM/KILBERTH/PSYCHONOMICS 2000 has shown that women also display very dangerous attitudes with regard to providing for their retirement due to fear, lack of motivation and a very pronounced focus on actual consumption in connection with fatalistic approaches. 343 GLASS/KILPATRICK 1998 study the retirement provision behavior of women in the United States and – like the surveys in Germany – they identify a host of economic and psychological reasons that prevent women from providing adequately for their retirement. Specifically, they find that “many women feel retirement planning is a male domain, that they will be taken care of, and feel inadequate at attempting retirement planning.” 344 This feeling of incompetence is also described by SCHOTT/ARBEITER 1998. In addition to these general risks impacting a woman’s financial security in retirement, “Single Mothers” are on their own in terms of income and bear the social and financial responsibility of at least one additional person, the child. Since they must care for one or several children their need 341

See BARBER/ODEAN 2001, p. 261ff. BÖRSCH-SUPAN et al. 2005 find that women on average expect the duration of their retirement to amount to 17.5 years whereas, on the basis of the dynamic life tables used by the Rürup Commission, the actual duration is estimated to be 24.2 years. While life-expectancy for older people can be approximated quite well using the public mortality tables, the dynamic life tables should be taken into consideration for younger individuals. See BÖRSCH-SUPAN et al. 2005, p. 13ff. 343 DEHM et al. 2000 have shown that first, aging per se seems to be a very difficult subject for women due to e.g., the fear from physical limitations, intellectual weakening and social isolation, while for men aging seems to be less of a threat. Second, many women suppress the retirement provision for psychological reasons of fear, unwillingness, lack of motivation or the feeling of helplessness. Third, women seem to show a lower preparedness to trade in consumption today in order to save for retirement, often assume fatalistic attitudes, and HÖLLGER/SOBULL 2001 also find that over half of the women say that they do not have the means to provide for retirement. Lastly, the surveys have also revealed that women often rely on their partner to provide for retirement. 344 See GLASS/KILPATRICK 1998, p. 608. 342

5.3 Investor groups with a particular capability for risk

167

for caretaking activities is increased and their work potential and at the same time their financial income are further reduced. 345 This highlights that this group of individuals is facing sharply increased risks with regard to their financial situation in retirement. Typical Employees

Investors belonging to the third group of individuals with a lower capability for risk are the so-called Typical Employees. They have a reduced risk capability for economic and personal reasons. The tight economic circumstances result from the fact that this group captures individuals who represent the lower border of the affluent segment in terms of wealth, owning less than €150k worth of financial assets. On the personal side, the low capability for risk is further accentuated by the education level, which is at most secondary school level with or without certificate. Such an education does usually not qualify for a generous income and makes accumulation of significant assets over the life cycle rather improbable. Limited-wealth Self-employed

Another investor group with a lower than average capability for risk due to their job situation are the Limited-wealth Self-employed. These are individuals with various types of education who run their own business. Since self-employment is often linked to substantial financial insecurities – such as the lack of a regular income and the need for investments in one’s own company – their capability for risk is curtailed. Self-employment per se is not a criterion that forces individuals to a low capability for risk. 346 If, for example, an individual – mostly with a higher education – has managed to establish himself professionally, collect a significant amount of money and has good prospects to increase his assets before retirement due to a younger age, his objective ability to bear risk can be considered as being much higher than average. However in that regard, the existing financial cushion is the key differentiator. Therefore, the as345

Even if women get subsidies for themselves or for their children, it can be assumed that the amount of this income does not allow for sizable savings as it does not substantially outweigh the expenses. Furthermore, in case of a divorce, they lose retirement benefits that they would have had as married women. 346 This will be proved later in the analysis of the “Wealthy” investor group, which displays a higher than average level of risk capability and also includes self-employed individuals.

168

5 Investor retirement survey and outlook on empirical analyses

signment of an individual to the Limited-wealth Self-employed investor group is not only based on his status as self-employed only but also on the fact that his investable assets are at the maximum €400k. The analysis of retirement-specific FPB of self-employed individuals is also interesting for another reason: Self-employed individuals tend to have different retirement provision systems. As discussed earlier, only a minority of them is covered by the public state system in Germany. Most of them, especially doctors, lawyers, notaries, advisors on tax matters but also farmers can chose to opt out of the system and provide privately in a specific pension scheme (pension funds for particular professionals). That pension scheme is designed in such a way that its compensations are “meant to ensure a level of pension in line with former pensionable income, and to a lesser extent are meant as supplementary income.” 347 Thus, individuals covered by these insurances only have a minimal state pension but often sufficient private coverage. 348 Retirees

The fifth group of investors who have a limited capability for risk are the Retirees. Most retirees have to cope with reduced income streams while their expenses do not decrease to the same extent. This development can be seen in the typical income and expense streams illustrated in Fig. 2.1. Empirical studies have confirmed that expenses do not fall considerably with retirement. Expense streams can be assumed to increase in the longterm specifically due to increased expenses for health problems or longterm care even if costs for items such as transportation or clothes are assumed to diminish. 349 As a consequence, the financial situation of Retirees is exposed to significant risks. In this phase of dissaving, funds need to be accessible short-term and should not be exposed to too much volatility. This is even more accentuated by the fact that the time horizon of retirees is substantially shorter than for pre-retired individuals, further reducing their risk capabilities. Therefore, a lower capability for risk seems adequate for this investor group. Retirees have been defined as a separate investor group since they can be used to highlight inter-generational differences. 347

KORTMANN et al. 2005, p. 22. See BMAS 2006b, p. 25. According to the Rentenversicherungsbericht 2005, less than 1% of all insured individuals are self-employed. See BMAS 2006b, p. 79. 349 See REIMANN 2006, p. 33. 348

5.3 Investor groups with a particular capability for risk

169

Table 5.10 summarizes the criteria that have been used to assign the individuals to the different investor groups with a lower than average capability for risk. The last investor group with a below average risk capability, the Retirees, are described below. Table 5.10 Assignment criteria for investor groups with a lower than average risk capability Differentiator

Qualification criterion

Identifier

Health-risk Employees Retirement status: Health status: Wealth level:

Distinction between retired and pre-retired Pre-retired Indication of self assessed health status Poor or fair health Indication of total value of financial investments < € 400k (excl. real estate and pension assets)

SE_6 SE_5 SE_8

Single Mothers Retirement status: Gender: Age: Marital status: Descendants:

Distinction between retired and pre-retired Distinction between male and female Indication of exact age Distinction between married, single, widowed and divorced Distinction between having no children and having children

Pre-retired SE_6 Female SD_1 45 - 59 years SD_2 Single, widowed or divorced SD_3 One or several children

SD_4

Typical Employees Retirement status: Education level: Wealth level:

Distinction between retired and pre-retired Indication of highest level of school education

Pre-retired Secondary school with or without certificate Indication of total value of financial investments € 100 - 150k (excl. real estate and pension assets)

SE_6 SE_1 SE_8

Limited-wealth Self-employed Retirement status: Employment status: Wealth level:

Distinction between retired and pre-retired Pre-retired Distinction between self-employed and employed Self-employed individuals Indication of total value of financial investments € 100k - 400k (excl. real estate and pension assets)

SE_6 SE_4 SE_8

Retirees Retirement status:

Distinction between retired and pre-retired

Retired

SE_6

5.3.2 Introduction of investor groups with a higher than average risk capability Investors with a higher than average capability for risk are in a rather comfortable situation given their achievements in life or thanks to their background. In the latter case, social, economic or personal circumstances can be the reason why an individual has a higher level of risk-bearing capability. 350 350

A higher level of risk capability based on an objective assessment of the personal, economic and social criteria however is not a satisfactory basis to rec-

170

5 Investor retirement survey and outlook on empirical analyses

Highly-educated

The first group of investors who have an increased capability for risk are the Highly-educated. These individuals have finished at least an A-level education or have even a university degree. Furthermore, they are not selfemployed which would reduce their capability for risk for the reasons pointed out above. As a further criterion, individuals captured in this group are within the age bracket of 45 and 55 years. 351 This relatively young age indicates that they still have a considerable time horizon until they retire. Therefore, they can still ride out any temporary adverse market developments and so can withstand market volatilities. Another reason for attributing a higher risk capability to the Highly-educated are the findings from a survey conducted in Germany among academics. It revealed that these individuals typically have a more critical attitude towards the state pension system than the average population and thus a more pronounced desire for individual retirement provision. 352 Well-off Middle-aged

The second investor group with a heightened risk capability are the Welloff Middle-aged. These individuals are younger than 55 years and at the same time have managed to collect a comfortable level of financial investments of between €150k and €400k. As for the Highly-educated group, the age range of this group indicates a longer investment horizon and thus a higher capability for risk. Furthermore, their ability to bear risk is also ommend a more aggressive strategy or financial plan to these individuals. Rather, such a plan would have to include the analysis of the other elements of the risk profile such as risk appetite and risk sophistication as well as a host of personal situation variables and the individual environment. Only the detailed analysis of the individual and his specifications would allow attributing an individual to the “risk-friendly” segment. Such an attribution as well as the derivation of corresponding investment strategies are however not in the focus of this study. 351 Applying the logic for the derivation of the risk capability from the sum of an individual’s human capital, his financial capital less the personal liabilities, as documented in SPREMANN 1995, it can be concluded that since an individual with a good education has a high level of human capital after a few years of work experience and can calculate with a more or less safe income stream, his human capital makes up a substantial part of his total wealth and thus leads to a higher risk capability. 352 See WERNER/GEISSLER 2000, p. 5f.

5.3 Investor groups with a particular capability for risk

171

heightened by their financial cushion that allows them to dampen shortterm volatilities of capital markets. Wealthy

These investors are not wealthy per se but belong to the wealthiest individuals within the focus of this study, owning more than €400k in financial assets but less than €1,400k. These reserves allow them to feel comfortable with regard to their financial situation in retirement. So their capability for risk is substantially higher than that of an average investor. In order to qualify for this investor group, individuals can be slightly older than the ones in the other two groups with a higher risk capability, mainly due to the comfort of the higher wealth level. Furthermore, in light of this wealth level, even self-employed individuals can be included in this group if they satisfy the other criteria. Risks should decrease as individuals approach retirement to reflect the transition from the saving to the dissaving period and to also mirror changes in the income and expense situation. Therefore, the upper age limit for this group has been set at 58 years. Table 5.11 summarizes the criteria used in the allocation of individuals to the three investor groups with a higher than average capability for risk. Table 5.11 Assignment criteria for investor groups with a higher than average risk capability Differentiator

Qualification criterion

Identifier

Distinction between retired and pre-retired Indication of exact age Indication of highest level of school education Distinction between self-employed and employed individuals

Pre-retired 45 - 55 years A-levels or university Employed

SE_6 SD_2 SE_1 SE_4

Highly-educated Retirement status: Age range: Education level: Employment status: Well-off Middle-aged Retirement status: Age: Wealth level:

Distinction between retired and pre-retired Pre-retired Indication of exact age 45 - 55 years Indication of total value of financial investments € 150k - 400k (excl. real estate and pension assets)

SE_6 SD_2 SE_8

Distinction between retired and pre-retired Pre-retired Indication of exact age 45 - 58 years Indication of total value of financial investments € 400k - 1,400k (excl. real estate and pension assets)

SE_6 SD_2 SE_8

Wealthy Retirement status: Age: Wealth level:

172

5 Investor retirement survey and outlook on empirical analyses

5.3.3 Assignment of individual interviewees to different investor groups All interviewees were analyzed individually and – by applying the above logic to their specific characteristics – assigned to either one of the investor groups with a lower or with a higher capability for risk than the average investor. On this basis, 484 individuals were assigned to investor groups while 44 interviewees did not fulfill the criteria of any of the above defined investor groups. Since several interviewees qualified for more than one investor group, the initial assignments had to be reviewed to exclude any double counting and make the individual groups mutually exclusive. Therefore, all individuals who belonged to more than one investor group were analyzed in detail and then attributed to that investor group whose characteristics were more dominant and more important with regard to their retirement-specific FPB. Fig. 5.3 gives an overview of the hierarchy between the different investor groups. If, for example, a woman was a Single mother but at the same time also Wealthy, she would be attributed to the Wealthy group, since the financial comfort of having more than €400k would allow her to take on more risk than those women with lower income and wealth levels who were typically in the position of a Single mother. This higher risk bearing capability can also be evidenced by the finding of HÖLLGER/SOBULL 2001 that women in higher job positions, women with an academic background or generally women who assume more responsibility and are accustomed to deal with money – all of whom typically fall into this income bracket – tend to be more active in retirement provision and can thus count on a more secure financial situation in retirement. 353 Another example of double assignment is a Limited-wealth Selfemployed who is also assigned to the Well-off Middle-aged investor group because he has already collected between 150k and 400k and is at the same time still rather young (below 55 years old). Even if this looks like a comfortable situation, the risk associated with self-employment is so substantial that the risk level of this individual should still be considered as elevated. Therefore, this individual is attributed to the Limited-wealth Selfemployed and eliminated from the Well-off Middle-aged. If within the group of the investors with a higher risk capability an individual is both Highly-educated and Wealthy, the comfort from having more than €400k of financial wealth is more dominant for his financial position, while the good education is more of a supporting element that rein353

See HÖLLGER/SOBULL 2001, p. 23ff.

5.3 Investor groups with a particular capability for risk

173

forces his potential to accumulate even more funds in the future. This individual is thus assigned solely to the Wealthy group. Individuals with an above average risk capability

Retirees

Wealthy Highly-educated

Increasing dominance

Individuals with a below average risk capability

Single Mothers Limited-wealth Self-employed

Well-off Middle-aged

Health-risk Employee Typical Employee

Fig. 5.3

Hierarchy of allocation between different investor groups

To avoid neglecting any other relevant investor groups, all individuals who were not assigned to any of the above introduced investor groups were analyzed in detail. Specifically, their socio-demographic and socioeconomic attributes were examined to identify patterns that could indicate any other relevant investor group with a higher or a lower capability for risk. While this procedure proved successful in the preceding round to identify the Well-off Middle-aged investor group, the analysis of the remaining 44 non-assigned interviewees did not provide any further insights. Therefore these 44 individuals were not further analyzed. Fig. 5.4 gives an overview of the definitive assignment of the individuals to the different investor groups after the de-duplication. The values represent the absolute numbers of interviewees that correspond to the selection criteria of the respective groups. Due to the re-weighting process needed to ensure a high level of validity of the results, the weights of the different groups may vary considerably from these numbers.

174

5 Investor retirement survey and outlook on empirical analyses Wealthy

Total

528

Unassigned individuals

44

Individuals with an above average risk capability

130

Individuals with a below average risk capability

354

28 55

Well-off Middle-aged

47

Retirees 170 Interviewees

Highlyeducated

Health-risk Employee Single Mothers 34 14 Typical 49 Employee

87 Limited-wealth Self-employed

Fig. 5.4

Size of individual investor groups

Fig. 5.4 shows that the interviewees with a lower capability for risk make up the majority of the sample. One driver of this effect is that all retired individuals, representing 30% of the interviewees and who have been assembled into one group to allow inter-generational comparisons, are considered as having a below average capability for risk. As described above, a selection of socio-demographic and socioeconomic characteristics (specifically the distribution of age, wealth, gender and retirement status) of all interviewees was compared to the same characteristics of the affluent segment aged 45 to 70 in Germany, in order to test the validity of the results. The comparison revealed that relative to the distribution of these characteristics in the total affluent population in this wealth and age group, the characteristics of the individuals with a lower capability for risk are overrepresented among the interviewees while those of the higher risk-capability individuals are under-represented. Therefore, individual interviews were re-weighted to ensure the valid representation of the results for the overall population in this wealth and age range of the German affluent segment. Furthermore, Fig. 5.4 shows that some investor groups, such as the Single Mothers or the Wealthy individuals, are rather small. Therefore, in order to allow a more comprehensive analysis, prevent the atomization of results and ensure a good size of the individual samples, 354 the aggregation 354

DEFUSCO et al. 2004 mention that a sample size of 30 can be considered as large enough. See DEFUSCO et al. 2004, p. 312.

5.4 Structure of empirical analyses

175

potential between these different investor groups will be analyzed further in the due course of the study. The aggregation into so-called “investor types” will be based on similar socio-demographic and socio-economic attributes between different investor groups. The corresponding details can be found in the empirical sub-chapter 6.1.

5.4 Structure of the empirical analyses for the examination of the conceptual approach The conceptual approach described in sub-chapter 2.3 has illustrated how this study’s research objective is investigated: It has introduced different groups of individuals with varying risk capability as vehicles of analyses, for which actual FP perspectives and FP actions are analyzed. The comparison of empirical findings about FP actions with the behavioral benchmarks for specific FP actions derived in sub-chapter 4.4 contributes to the identification of a possible gap. On the basis of such a gap, suggestions for levers to improve FPB behavior will be derived for policy-makers, financial planners and the individual. To support this conceptual approach, the empirical analyses structure is outlined in Fig. 5.5, describing the course of analyses in the next chapter. Pooling of investor groups to homogenous 6.1 investor types and characterization of newly defined investor types

6.2

• Planned life in retirement • Financial view on life in

Investors with a lower than average risk capability

Health-risk Employees Single Mothers

Analysis of investor-type specific FP perspectives

Limited-wealth Risk-groups

retirement

• Transaction preferences • Risk profile

Typical Employees Limited-wealth Self-employed

Limited-wealth Self-employed

Retirees

Retirees

6.3

Analysis of investor-type specific FP actions and comparison to the postulated benchmark behavior

• Start of financial planning activities

Investors with a higher than average risk capability

• Understanding of financial situation

• Holding classical saving

Highly-educated Well-off Middle-aged

Wealthy

Fig. 5.5

High-potential

Wealthy

Overview of empirical analyses

products

• Diversification • Risk-return profile • Mitigation of risks 6.4 Scenario analysis for adequate savings rates

176

5 Investor retirement survey and outlook on empirical analyses

First, the different groups of individuals are analyzed empirically with regard to all their socio-demographic and socio-economic attributes in order identify pooling potential between different investor groups. This aggregation between groups makes the following analyses more comprehensible and prevents the atomization of results. As can be seen from the above illustration, this empirical analysis leads to the aggregation of the eight investor groups into five investor types that will be used as vehicles for analysis. Certain investor groups, like the Retirees and the Wealthy, prove to have distinctly different characteristics and are therefore examined as individual investor types in the subsequent analyses. In order to answer research question six, which asks what FP perspectives and FP actions look like and how they differ from the behavioral benchmarks for FP actions, the actual FPB will be analyzed thereafter with its two components FP perspectives and FP actions. In a first step, the FP perspectives are highlighted for the different investor types. In a second step, the FP actions are illustrated and compared to the behavioral benchmarks for the FP actions. This confrontation makes the identification of particular gaps possible. To establish the link to the individual financial optimization problem, provide a behavioral benchmark for the saving rate of individuals and understand if individuals are facing a retirement gap, the financial situation of the average representative of each investor type is then simulated. The simulation analysis takes a detailed look at the different income and expense streams and illustrates the saving rate that would be required during work life to ensure individuals could live the life they anticipate. The four pre-retired investor types have been used as vehicles for analysis here. This approach is further complemented by testing the varying impact of different assumptions on the saving rate and the duration for which the secured financial situation in retirement lasts.

5.5 Summary of introduction to investor retirement survey and empirical analyses This chapter discusses the operationalization (i.e., measurement specifications) of the research questions and introduces the target group of this study as well as the survey that tested individual retirement-specific FPB. • The target group of this research is the German affluent segment encompassing individuals aged 45 to 70 with household assets between €100k and €1,400k. With almost 9m individuals, these people are esti-

5.5 Summary of investor retirement survey and outlook on empirical analyses 177

mated to represent slightly over 10% of the German population and own over half a trillion Euro financial assets (corresponding to over 35% of the financial assets of the private households in Germany captured in the EVS). A total of 528 standardized personal interviews were conducted with individuals from this segment and make up the basis for the empirical investigation of retirement-specific FPB. • Based on selected socio-demographic and socio-economic attributes, each interviewee was assigned to one investor group – either with a below average risk capability (Health-risk Employees, Single Mothers, Typical Employees, Limited-wealth Self-employed, Retirees) or with an above average risk capability (Highly-educated, Well-off Middle-aged, Wealthy). • The pooling of these eight investor groups into the five investor types (Retirees, Limited-wealth Risk-group, Limited-wealth Self-employed, High-potential, Wealthy) forms the basis for future investigation into individual FPB.

6 Empirical analyses of individual retirementspecific FPB

“Most employees feel that they save too little, and many plan to raise their contribution rate in the near future, but few act on these good intentions.” CHOI et al. 2002, p. 104 This chapter describes the findings of the consumer retirement survey on individual FPB and so represents the core of the empirical analysis. In the first sub-chapter, the different investor groups with a higher or a lower risk capability than the average investor are pooled into homogenous investor types, based on similar socio-economic and socio-demographic characteristics. These investor types show statistically distinct profiles, contain a sufficiently high number of individuals and so avoid an atomization of results. They are first characterized with regard to their socio-demographic and socio-economic attributes and then used as vehicles for the further empirical analyses. The FP perspectives of these investor types are described in sub-chapter 6.2. In sub-chapter 6.3, the effective FP actions are analyzed and compared to the principles for FP actions, set-up in the normative part of this study. Sub-chapter 6.4 then introduces a simulation to determine the existence of a retirement gap and the resultant required saving rate for the individual investor types. Furthermore, it discusses different scenarios as to when the financial assets of an individual are ebbing out or which levers individuals can pull to improve the outlook of their financial situation in retirement.

6.1 Pooling of investor groups and characterization of the newly defined homogenous investor types Building on the concept that different groups of individuals with comparable socio-demographic and socio-economic attributes can be used as vehicles for analysis, the logic of investor groups with a higher or a lower risk

180

6 Empirical analyses of individual retirement-specific FPB

capability than the average investor has been introduced. In sub-chapter 5.3, eight intuitively comprehensible groups with distinct profiles have been defined based on logical arguments: Health-risk Employees, Single Mothers, Typical Employees, Limited-wealth Self-employed and Retirees as investor groups with a lower risk capability than the average investor; and Highly-educated, Well-off Middle-aged as well as Wealthy as investor groups with a higher than average risk capability. Since many of the resulting eight different investor groups were quite small (e.g., Single Mothers with only 14 interviewees) and displayed certain similar characteristics, the analysis of their FPB behavior bore the risk of leading to atomized and statistically irrelevant results. Therefore, a further aggregation of the eight investor groups seemed necessary. This sub-chapter analyzes if – apart from the fundamental data used for the original allocation of interviewees 355 – the different investor groups have comparable socio-demographic and socio-economic characteristics that allow such an aggregation into broader classes of individuals with comparatively homogenous characteristics, the so-called investor types. A side condition in the investigation of the pooling potential between different groups is that the distinction between investor groups with a lower and a higher risk capability than the average individual be maintained. The pooling potential is analyzed based on statistically significant differences or on attributes whose distribution is “evidently different”, but cannot be tested adequately due to the distribution of the variables. 356

355

To enhance the clarity of the initial assignment, a set of only nine variables has been chosen for the attribution of an interviewee to one of the eight investor groups. 356 The statistical differences have been tested based on the Chi-square test applied to cross tables. This is an adequate measure since many of the characteristics tested are nominally scaled variables. The validity of the test of statistical significance is however restricted if the test contains less than five cells or if the expected count in one specific cell is below five. Given that the allocation to the most extreme answer options was quite often less frequent, the second criteria was violated in many examinations of statistical significance. If the distribution was significantly different but a minority (less than 30%) of the cells violated the criterion of the expected frequency (to be higher than five), the respective attribute was considered as “evidently different”. Bearing in mind however that the sample was not a random sample in the strict sense, the strengths of the statistical tests needs to be considered as being reduced.

6.1 Pooling of investor groups and characterization of investor types

181

6.1.1 Suggested pooling of investor groups with a lower than average risk capability Four pre-retired investor groups and the group of the Retirees have been identified as investor groups with a lower risk capability than the average investor in this study’s target group. Table 6.1 recaps the selection criteria used for the different groups as well as the weight each group represents. 357 Table 6.1

Overview of five investor groups with a lower than average risk capability

Qualification criterion Health-risk Employee Retirement status: Wealth level: Health status:

16 pre-retired < € 400k poor or fair health

Single Mother Retirement status: Gender: Age: Marital status: Descendants:

Weight

Retirement status: Wealth level: Education level: 14

pre-retired female 45 - 59 years divorced having children

Qualification criterion Typical Employee

22 pre-retired < € 150k most

Limited-wealth Self-employed Retirement status: Wealth level: Employment status:

55

pre-retired < € 400k self-employed

Retiree Retirement status:

Weight

238 retired

In order to identify which groups could be pooled together, the attributes that significantly distinguish the characteristics of the individual investor groups were identified. The socio-demographic and socio-economic attributes of the individuals in the five investor groups with a lower than average risk capability as well as their differences are illustrated in Table 6.2. Attributes with statistically significant differences between investor groups are marked with a filled circle “ ” next to the topic. Those attributes whose distribution between the different groups is not significant is marked with an empty circle “ ”. Since the majority of all questions was asked of all interviewees, the sample size n for most analyses corresponds to the weight of each investor group displayed in Table 6.1. 358 For the attributes displayed in Table 6.2 only two exceptions apply, because the re357

The weights of the individual investor groups differ from the original number of interviewees per group due to the re-weighting process that leads to an increased validity of the sample to represent the target group population (affluent segment aged 45-70 in Germany) as described in section 5.2.1. 358 Except for rounding effects caused by the SPSS program. Also rounding errors can lead to the fact that the sum of the total shares of the sample within one category is slightly below or above 100%.

182

6 Empirical analyses of individual retirement-specific FPB

spective question was not answered by everyone or because the question was not asked of all investor groups. 359 Table 6.2

Distribution of socio-demographic and socio-economic attributes for the five investor groups with a lower than average risk capability Health-risk Employee

Single Mother

Retirees

All groups with below average risk capabilty

16

14

22

55

238

345

SD_1 Gender Female

31%

100%

55%

22%

48%

46%

SD_2 Age (in years) 45 - 49 50 - 54 55 - 59 60 -64 65 - 70 Effective average age

0% 7% 47% 40% 7% 59

50% 29% 21% 0% 0% 52

45% 27% 9% 18% 0% 52

40% 29% 13% 13% 5% 52

2% 5% 8% 30% 55% 64

13% 11% 11% 26% 39% 61

SD_3 Marital status Married/co-habiting Single

81% 19%

0% 100%

77% 23%

80% 20%

71% 29%

70% 30%

SD_4 Having children Have no children Have children

19% 81%

0% 100%

23% 77%

18% 82%

19% 81%

18% 82%

SE_1 Education level Secondary school A-levels University degree

75% 19% 6%

87% 7% 7%

100% 0% 0%

46% 24% 30%

71% 22% 8%

70% 20% 10%

SE_2 Labor intensity Working full-time Working part-time Not employed

80% 20% 0%

79% 21% 0%

82% 18% 0%

91% 9% 0%

0% 0% 100%

26% 4% 69%

0%

14%

0%

100%

N.a.

53%

100% 0% 0%

21% 36% 43%

0% 73% 27%

20% 38% 42%

36% 41% 23%

33% 41% 26%

0%

0%

0%

0%

100%

69%

LimitedTypical wealth Selfemployed Employee

as % of total sample n=

SE_4 Status of (self-)employment Share of self-employed SE_5 Health status Poor/fair Good Very good/excellent SE_6 Retirement status Share of retired individuals

359

The question about the level of mortgages was not answered by all interviewees. Therefore, the sample size for that analysis is smaller with n = 11 for Health-risk Employees, 9 for Single Mothers, 16 for Typical Employees, 44 for Limitedwealth Self-employed and 176 for Retirees. Additionally, the Retirees were not asked about their status of self-employment since they are not working anymore. Therefore, the sample size of this analysis only includes the weights of the four pre-retired investor groups with a total of n = 107 (345-238).

6.1 Pooling of investor groups and characterization of investor types Table 6.2

183

Distribution of socio-demographic and socio-economic attributes for the five investor groups with a lower than average risk capability (continued) Health-risk Employee

Single Mother

LimitedTypical wealth SelfEmployee employed

Retirees

All groups with below average risk capability

as % of total sample 16

14

22

55

238

345

SE_7 Household income < € 45k € 45 - 75k € 75 - 110k € 110 - 140k Average (in € k)

n=

81% 19% 0% 0% 44

60% 33% 7% 0% 50

77% 23% 0% 0% 45

41% 43% 15% 2% 58

73% 23% 4% 0% 47

68% 26% 6% 0% 48

SE_8 Financial wealth € 100 - 150k € 150 - 400k € 400 - 700k € 700 - 1,400k Average (in € k)

31% 69% 0% 0% 228

29% 71% 0% 0% 232

100% 0% 0% 0% 125

18% 82% 0% 0% 248

38% 47% 10% 5% 280

38% 52% 7% 3% 261

SE_9 Housing situation Own their house Rent their house Own a rental property Own a vacation home

50% 50% 38% 13%

43% 57% 40% 13%

68% 32% 14% 9%

75% 25% 41% 29%

68% 32% 28% 16%

67% 33% 30% 17%

SE_10 Property value Average (in € k)

203

181

159

335

245

249

SE_11 Mortgages value Average (in € k)

57

64

70

125

72

80

SE_12 Share of average mortgages value relative to average property value (SE_11/SE_10) Percent 28% 35% 44% 37%

29%

32%

SE_13 Net property value (Average property value (SE_10) - Average mortgages value (SE_10)) Average (in € k) 146 117 89 210

173

169

SE_14 Total wealth Average (in € k)

464

449

347

323

272

519

Remark: Attributes whose distribution between the different investor groups with a below average risk capability is different based on a 10% significance level Attributes whose distribution between the different investor groups is not significantly different

Looking at the socio-demographic and socio-economic attributes, the test of differences of mean reveals that two variables are differently distributed between the investor groups with a 10% level of significance: the distribution of gender as well as the level of self-employment. The gender question has been used for the attribution of individuals to the Single mother group whereas self-employment is a pre-condition for the Limitedwealth Self-employed. Therefore, these factors point out an area where

184

6 Empirical analyses of individual retirement-specific FPB

these two groups are significantly different from the others. In order to decide if the two groups are to be treated separately in the subsequent analyses, the other socio-demographic and socio-economic characteristics were analyzed. Among the other characteristics, marital status, health status and retirement status were evidently different and are thus considered of higher priority in the analysis of the pooling potential. As the statistically significant attributes, these variables were all used for the original attribution of an individual to one of the five investor groups. Their distribution gives an indication of whether different investor groups can be pooled or not. Logical considerations of pooling potential thus include these attributes. As the retirement status has shown to polarize between the different investor groups, it is the first criterion to be considered. Indeed, the investor group of the Retirees sticks out because it captures individuals in a different stage of the life-cycle. They can be affiliated to a different generation because of their age (average of 64 years versus 52-59 for the other groups) and their activity status (i.e., consider themselves as retired (SE_6) and do not work anymore (SE_2)). Furthermore, they show a particular financial profile: With an average of €47k their income level is rather low but corresponds to the expected drop in income level that is typical for retirement. Their financial wealth level on the other hand is at €280k the highest among all the investor groups with a limited risk capability and shows the result of asset accumulation during work life. With regard to their property holdings, 360 another characteristic picture can be identified: While their total property value ranks second with €245k, the share of mortgages relative to the value of property is at 29% below average and results in a substantial stock of net property value. Based on these features

360

Investment in tangibles such as real estate is considered as an inflation hedge and providing long-term growth. Furthermore, it is inked to pride of ownership and can therefore at the same time serve as investments and sources of pleasure. The value of property however depends on its marketability and liquidity. “Marketability means you can find a ready market if you want to sell the investment. Liquidity means the investment is not only marketable and easily accessible but also has a stable price.” SHIM/SIEGEL 1991, p. 232. BECK 2006 put the value of real estate as the right kind of provision for retirement into question for the disadvantages linked to this marketability and liquidity, due to the existence of a chunk risk (one would never invest that much into one single stock) and because the return depends on very specific characteristics such as e.g., the location, while the maintenance and opportunity costs need to be considered as well. Therefore, living in a house is never for free. See BECK 2006, p. 9.

6.1 Pooling of investor groups and characterization of investor types

185

Retirees end up with the second highest level of total wealth. 361 Due to this very distinct profile, and in order to identify inter-generational differences, Retirees are analyzed separately in the subsequent analyses as one investor type. In addition to these qualitative arguments, the size of the investor group with 238 individuals provides a strong quantitative argument for treating Retirees separately. The four remaining pre-retired investor groups need to be analyzed for similarities mainly based on the two variables that have revealed statistically significant differences: the share of women and the status of selfemployment. Since, for obvious reasons, the Limited-wealth Selfemployed are significantly different with regard to the second variable, they are first compared to the other three investor groups: Apart from capturing a lower share of women, their education level, job intensity as well as their income and wealth position show clear differences: The Limitedwealth Self-employed have a significantly better education level: 30% have a university degree (vs. 10% of the individuals with lower risk capability), 24% have an A-level diploma (vs. 20%) and only 46% have a secondary education (vs. 70%). Furthermore, the individuals from the Limited-wealth Self-employed investor group seem to be working full time more often (in 91% of all cases) and longer. 362 Also, their financial profile differs from the other three pre-retired investor groups: With an average income of €58k, they earn by far the most. Their level of financial wealth is somewhat higher than that of their pre-retired peers but still shows a substantial discount versus the financial wealth of the Retirees. With regard to ownership of property, significant differences appear: The Limitedwealth Self-employed have a substantially higher tendency than all the other investor groups with a limited risk capability to own the house they live in, a rental property, and even a vacation home. Correspondingly, the value of their properties is highest among these investor groups, both in gross and net terms. On that basis, the individuals captured in this group dispose of a substantial amount of over half a million Euro total wealth, a comparatively large share of which is captured in real estate assets. Due to 361

The value of total wealth SE_14 represents the weighted average of the separately derived distribution of total wealth rather than the sum of the weighted average of total financial wealth and the net property value. This choice is based on the fact that only in analyzing the entire distribution of total wealth the significance in the differences of means between various groups can be tested. 362 The age distribution of this investor group reveals that 5% of the interviewees are older than 65 and still working (at least part-time). This is a phenomenon confirmed by KORTMANN et al. 2005 who find that a higher share of self-employed individuals is still gainfully employed at the age of 65. See KORTMANN et al. 2005, p. 34.

186

6 Empirical analyses of individual retirement-specific FPB

these substantial differences in socio-demographic and socio-economic attributes it is justified to treat the Limited-wealth Self-employed as a separate investor type for the further analyses. Of the remaining three investor groups, the significant gender attribute suggests testing whether the characteristics of the Single Mothers are different enough from those of the Health-risk Employee and the Typical Employee to warrant a separate treatment. In the examination of age, education and health level, the distribution of the attributes for the Single Mothers are between the respective distributions for the other two investor groups. It is only with regard to the marital status, the question of having children and the part-time work that this investor group stands out. Since these factors are not statistically significant, they do not necessarily require a separate treatment of the Single Mothers. Furthermore, also the two evidently differently distributed characteristics (health status and marital status) do not point at a clear separation of the Single Mothers. Looking at the financial side, it is interesting to note that Single Mothers with €50k have a slightly higher average income compared to the other groups with €44k and €45k respectively. 363 Additionally, they have a slightly higher level of financial wealth but, compared to the Health-risk Employees, a markedly lower property value, partially due to a higher tendency to rent rather than own a home. This financial situation results in a total wealth position in-between the Typical Employees and the Health-risk Employees. Overall, these observations reveal that the Single Mothers stand somewhere between the Health-risk Employees and the Typical Employees and can thus be considered as comparable to them. Furthermore, the sample size and therefore the weight of the Single Mothers are limited and therefore bear the risk of atomization of results. As a result, in subsequent analyses the Single Mothers will be analyzed together with the Health-risk Employees and the Typical Employees as one investor type. Since all these individuals display certain risk factors and have a comparatively lower level of financial wealth, they are termed Limited-wealth Risk-groups.

363

A possible distorting effect leading to this higher average income level might stem from the fact that 21% of the women captured in the Single mother group are widowed and thus also receive an additional survivor’s pension.

6.1 Pooling of investor groups and characterization of investor types

187

6.1.2 Suggested pooling of investor groups with a higher than average risk capability Table 6.3 recaps the selection criteria and the weights for the three investor groups with a comparatively higher risk capability than the average investor. Table 6.3

Overview of three investor groups with a higher than average risk capability

Qualification criterion

Retirement status: Age: Education level: Employment status:

pre-retired 45 - 55 years A-levels or university degree employed

Qualification criterion Wealthy Retirement status: Age: Wealth level:

Weight 66

pre-retired 45 - 58 years > € 400k

43

Well-off Middle-aged Retirement status: Age: Wealth level:

Weight 41

Highly-educated

pre-retired 45 - 55 years € 150k - 400k

Table 6.4 illustrates the distribution of the socio-demographic and socioeconomic attributes for the three investor groups with a comparatively higher risk capability than the average investor. As in the analysis for individuals with a lower risk capability, the distribution of these attributes as well as the identified significant differences are the basis of determining if any of the investor groups can be pooled together. The sample sizes in all but the question regarding mortgages relate to the total sample n, corresponding to the weight of the different investor groups. 364

364

Here too, minimal differences in the total sample sizes occur due to rounding effects in the SPSS program. The sample size for the question regarding mortgages is also smaller and amounts to 29 for the Highly-educated, 25 for the Well-off Middle-aged and 63 for the Wealthy.

188 Table 6.4

6 Empirical analyses of individual retirement-specific FPB Distribution of socio-demographic and socio-economic attributes for the three investor groups with a higher than average risk capability Highlyeducated

Well-off Middle-aged

Wealthy

All groups with above average risk capability

as % of total sample 41

43

66

150

SD_1 Gender Female

n=

29%

31%

40%

35%

SD_2 Age (in years) 45 - 49 50 - 54 55 - 59 Effective average age

65% 30% 5% 49

67% 30% 2% 48

45% 37% 18% 50

57% 33% 10% 49

SD_3 Marital status Married/co-habiting Single

80% 20%

79% 21%

69% 31%

75% 25%

SD_4 Having children Have no children Have children

25% 75%

21% 79%

27% 73%

25% 75%

SE_1 Education level Secondary school A-levels University degree

0% 51% 49%

100% 0% 0%

31% 9% 60%

42% 18% 40%

SE_2 Labor intensity Working full-time Working part-time Not employed

88% 12% 0%

86% 12% 2%

90% 10% 0%

88% 11% 1%

0%

0%

44%

20%

7% 46% 46%

16% 42% 42%

14% 64% 23%

13% 53% 35%

0%

0%

0%

0%

SE_7 Household income < € 45k € 45 - 75k € 75 - 110k € 110 - 140k > € 140k Average (in € k)

44% 44% 5% 2% 5% 58.8

63% 37% 0% 0% 0% 47.4

22% 27% 36% 3% 12% 79.9

40% 34% 17% 2% 7% 64.9

SE_8 Financial wealth € 100 - 150k € 150 - 400k € 400 - 700k € 700 - 1,400k Average (in € k)

23% 78% 0% 0% 241

0% 100% 0% 0% 275

0% 0% 70% 30% 702

6% 50% 31% 13% 455

SE_4 Status of (self-)employment Share of self-employed SE_5 Health status Poor/fair Good Very good/excellent SE_6 Retirement status Share of retired individuals

N.a.

6.1 Pooling of investor groups and characterization of investor types Table 6.4

189

Distribution of socio-demographic and socio-economic attributes for the three investor groups with a higher than average risk capability (continued) Highlyeducated

Well-off Middle-aged

Wealthy

All groups with above average risk capability

41

43

66

150

65% 35% 32% 17%

51% 49% 21% 10%

76% 24% 69% 28%

66% 34% 45% 20%

SE_10 Property value Average (in € k)

256

178

417

305

SE_11 Mortgages value Average (in € k)

113

115

178

148

43%

49%

SE_13 Net property value (Average property value (SE_10) - Average mortgages value (SE_10)) Average (in € k) 143 63

239

157

SE_14 Total wealth Average (in € k)

909

613

as % of total sample n=

SE_9 Housing situation Own their house Rent their house Own a rental property Own a vacation home

SE_12 Share of average mortgages value relative to average property value (SE_11/SE_10) Percent 44% 65%

418

344

Remark: Attributes whose distribution between the different investor groups with an above average risk capability is different based on a 10% significance level Attributes whose distribution between the different investor groups is not significantly different

In the analysis of the differences between the investor groups with a higher risk capability than the average investor, education level, status of self-employment, health status as well as the housing situation show statistically significant differences. The education criterion has been used to differentiate the Highly-educated from the Well-off Middle-aged and leads to a very distinct profile between these two groups. Self-employment is a criterion that distinguishes the Highly-educated and the Well-off Middleaged on the one hand and the Wealthy on the other. The reason for this is that the definition of the first two investor groups excludes selfemployment to avoid the associated business risks, while the definition of the Wealthy allows for self-employment due to the substantial financial cushion of this investor group. 365 In the self-assessed health status, it be365

All self-employed individuals who do not dispose of more than €400k investable assets are caught in the Limited-wealth Self-employed group. Since having more than €400k financial wealth can be considered as providing a safe finan-

190

6 Empirical analyses of individual retirement-specific FPB

comes evident that the Highly-educated and the Well-off Middle-aged are a bit younger since they have a substantially higher share of individuals with a very good or even excellent health level compared to the Wealthy. With regard to the housing situation, the Wealthy show the highest propensity to own their house. On top of that, almost 70% of the individuals in this group own a rental property and almost one third owns a vacation home. These observations suggest treating the Wealthy as a separate investor type. However, it remains unclear if the Highly-educated and the Welloff Middle-aged should be pooled. This question needs to be clarified by analyzing the other attributes. The other attributes that are evidently different are the distribution of the age groups, where the Wealthy have a substantially higher share of individuals aged 55 to 59 (due to the original attribution criteria), the financial wealth and the property value. Looking at the financial side it becomes evident that the Highly-educated and the Well-off Middle-aged show more comparable characteristics than the Wealthy. The latter display a substantially higher income level (€80k versus €59k and €47k), an average financial wealth that surpasses the one of the other two groups by a factor of 2.5-3.0 and – given their different ownership structures – a substantially higher value of property. Overall, this leads to a pronouncedly higher financial cushion for the Wealthy, which will undoubtedly influence their retirement-specific FPB. This confirms the findings from above. Thus, the investor type of the Wealthy is examined separately in the subsequent analyses due to very different characteristics and specifically a substantially larger financial cushion. Examining the distribution of the Highly-educated and the Well-off Middle-aged shows that the Highly-educated have the higher average income but the Well-off Middle-aged have the higher amount of financial wealth leading to a quite comparable financial situation. This is reinforced by similarities in the gender distribution, age, marital status, children, job intensity and their identical status as employed individuals. Therefore, the Highly-educated and the Well-off Middle-aged are pooled to one investor type. The resulting investor type is termed High-potential because first, it contains the youngest group of individuals within the age bracket analyzed and second, they can expect a solid financial position or increase of wealth going forward. This can be derived from either a very good educational basis without the risk inherent in self-employment or the fact that in their previous earnings histories the individuals in the Well-off Middle-aged cial cushion in retirement (as opposed to an average of €248k for the Limitedwealth Self-employed) and since these individuals are on average younger, they can be assumed to have a higher capability for risk.

6.1 Pooling of investor groups and characterization of investor types

191

group have already proven they can collect a substantial amount of financial assets (€150k – €400k) with only a secondary education. 6.1.3 Characterization of the resulting five investor types In order to better understand the characteristics of the five investor types for which the retirement-specific FPB will be analyzed, their socioeconomic and socio-demographic attributes need to be analyzed. A first result of such an analysis reveals that a majority of the attributes is substantially different for the five investor types – and this with a statistical significance of 10%. This is proof that the pooling of the eight investor groups has indeed improved the relevance of the subsequent analyses. Table 6.5 and Table 6.6 display the socio-demographic attributes of the five investor types. The sample sizes n used within the individual analyses represent the sum of the weight of the aggregated investor groups. 366 Table 6.5

Socio-demographic attributes of resulting five investor types: Distribution of gender and age LimitedLimitedwealth Risk- wealth Selfemployed groups Retirees

Highpotential

Wealthy

All investor types

as % of total sample 238

53

55

83

66

495

SD_1 Gender Female

n=

48%

60%

22%

30%

40%

42%

SD_2 Age (in years) 45 - 49 50 - 54 55 - 59 60 - 64 65 - 70 Effective average age

2% 5% 8% 30% 55% 64

32% 23% 25% 19% 2% 54

40% 29% 13% 13% 5% 52

66% 30% 4% 0% 0% 49

45% 37% 18% 0% 0% 50

26% 18% 11% 18% 27% 57

Remark:

366

Analysis based on questions A. 6 and H. 12 Attributes whose distribution between the five investor types is different based on a 10% significance level

As above, also in this analysis minimal differences in the total sample sizes appear due to rounding effects in the SPSS program. Furthermore, a reduced sample size (36 for the Limited-wealth Risk-groups, 44 for the Limited-wealth Selfemployed, 176 for the Retirees, 54 for the High-potential and 63 for the Wealthy) results for the mortgage question because not all interviewees answered it. Additionally, since the question about the status of self-employment was not posed to retired interviewees, the sample size of that analysis is reduced by the weight of the Retirees.

192

6 Empirical analyses of individual retirement-specific FPB

With regard to the gender distribution (SD_1) two things are important to highlight. First, the share of women in the total sample is only 42%. This is substantially less than the average share of women in the overall population (slightly over 50%). This result is not driven by the fact that there are fewer women in the 45 to 70 age bracket (on the contrary, the share of women in this segment amounted to 51% in 2001) 367 but depends on the scope of the survey that focuses on affluent individuals with between €100k and €1,400k investable assets. Since women tend to be less wealthy in general then men, they are underrepresented in the target group of this study. Since all interviews have been re-weighted to reflect the actual share of the attribute within the specific age and wealth bracket in the German population, the resulting 42% women in the sample reflects the share of women in the target group as measured through the omnibus survey. Second, two investor types have an elevated share of women relative to the sample. The first one is the Limited-wealth Risk-groups that include the Health-risk Employees, the Single Mothers and the Typical Employees. This high share of women stems from the fact that – while the Single Mothers are by definition female – the group of the Typical Employees also captures married women with only a secondary education and no substantial wealth level. The second investor type with a higher share of women is the group of the Retirees. This is driven by the longer lifeexpectancy of women and reflects the share of females of 53% in the total population aged 65 to 70. 368 The age distribution (SD_2) is also significantly different. Obviously there is a substantial difference between the Retirees on the one hand and the pre-retired investor types on the other hand. But even within the preretirees, the High-potential and the Wealthy are noticeably younger than the Limited-wealth Self-employed and the Limited-wealth Risk-groups.

367

Both indications about the share of women in the population relate to the year 2001 and are based on the population distribution of the German Statistical Federal Office. See STBA 2005a. 368 Indication about the share of women in the population relates to the year 2001 and is based on the population distribution of the German Statistical Federal Office. See STBA 2005a.

6.1 Pooling of investor groups and characterization of investor types Table 6.6

193

Socio-demographic attributes of resulting five investor types: Distribution of marital status and existence of children LimitedLimitedwealth Risk- wealth SelfRetirees groups employed

Highpotential

Wealthy

All investor types

as % of total sample 238

53

55

83

66

495

SD_3 Marital status Married/co-habiting Single - of which, single - of which, divorced - of which, widowed

n=

71% 29% 5% 10% 14%

58% 42% 10% 22% 10%

80% 20% 4% 12% 4%

81% 19% 9% 10% 0%

69% 31% 6% 17% 8%

72% 28% 6% 13% 9%

SD_4 Having children Have no children Have children Average no of children

19% 81% 1.59

15% 85% 1.55

18% 82% 1.58

23% 77% 1.38

27% 73% 1.55

20% 80% 1.54

Remark:

Analysis based on questions A. 8 and A. 12 Attribute whose distribution between the five investor types is different based on a 10% significance level Attribute whose distribution between the five investor types is not significantly different

The analysis of the marital status (SD_3) and the question of having children (SD_4), as displayed in Table 6.6, provides a good picture about the familial ties of the different investor types. Almost three quarters (72%) of all interviewees are married. Of the remaining 28%, 13% are divorced, 9% are widowed and only a minority of 6% is celibate. Significant differences exist between the investor types with a high share of single individuals. About 42% of the Limited-wealth Risk-groups members are single whereas both the Limited-wealth Self-employed and the Highpotential have only about half that share (~20%). On the other hand, four out of five individuals in the entire sample have at least one child. Contrary to most of the other socio-demographic variables, there is no significant difference between the five investor types with regard to having children. As Single Mothers are included in the Limited-wealth Risk-groups, they clearly drive this investor type’s high share of singles and also the high share of people with children. A surprising finding is that, besides the Retirees, where many individuals are widowed and therefore single, the Wealthy show an above average quote of single individuals. The latter are mostly divorced but quite often also widowed. Furthermore, the Wealthy also show the highest share of individuals without children. This is something that might be connected to their education (higher and longer educa-

194

6 Empirical analyses of individual retirement-specific FPB

tion and thus sociologically a shift in life-stages), their job situation and their financial position and is consistent with other demographic studies. 369 Table 6.7 illustrates the qualitative elements of the socio-economic attributes that reveal substantial differences between investor types. Table 6.7

Socio-economic attributes of resulting five investor types: Distribution of qualitative attributes LimitedLimitedwealth Risk- wealth SelfRetirees groups employed

Highpotential

Wealthy

All investor types

as % of total sample 238

53

55

83

66

495

SE_1 Education level Secondary school A-levels University degree

n=

71% 22% 8%

90% 6% 4%

46% 24% 30%

51% 25% 24%

31% 9% 60%

62% 19% 19%

SE_2 Labor intensity Working full-time Working part-time Not employed

0% 0% 100%

77% 21% 2%

91% 9% 0%

87% 12% 1%

90% 10% 0%

45% 7% 48%

SE_4 (Self-)employment Share of self-employed

N.a.

4%

100%

0%

44%

34%

SE_5 Health status Poor/fair Good Very good/excellent

36% 41% 23%

37% 40% 23%

20% 38% 42%

12% 44% 44%

14% 64% 23%

27% 44% 29%

100%

0%

0%

0%

0%

48%

SE_6 Retirement status Share of retired

Remark:

Analysis based on questions A. 11, A. 2, A. 3, H. 11 and A.4 Attributes whose distribution between the five investor types is different based on a 10% significance level Attribute whose distribution between the five investor types is not significantly different

The analysis illustrates that the five different investor types have significantly different educational backgrounds (SE_1). At least 50% of the Limited-wealth Self-employed, the High-potential and the Wealthy have finished their A-levels or graduated from a university, which is quite striking in comparison with the total sample where only 38% have such an education. This average share however expresses the fact that within the groups of Retirees and (even more pronounced) the Limited-wealth Risk-groups, the dominating share of individuals finished their education after secondary school.

369

FABRICIUS 2001, for example, confirmed that individuals with academic education tend to get married later and also have a lower probability to have children.

6.1 Pooling of investor groups and characterization of investor types

195

The labor intensity (SE_2) is evidently differently distributed and also an indicator for the retirement status (SE_6). All Retirees indicate they have stopped working, while most of the other individuals indicate they are working at least part time. As the distribution of the labor intensity indicates, the highest propensity to work part-time is among the Limitedwealth Risk-groups. This is clearly driven by their circumstances: A poor health that limits their capacity to work full-time, or child rearing activity in addition to working. With regard to employment status (being self-employed or employed – SE_4), the different pre-retired investor types show significant differences. By definition, the Limited-wealth Self-employed are self-employed and the High-potentials are employed. Interesting to note, however, is the high share of self-employed individuals in the investor type of the Wealthy (44%), which reflects that self-employment was explicitly allowed for this investor type. At the same time, their financial position also partially illustrates the motivation structure behind self-employment. The health status (SE_5) also reveals significant differences, with the Limited-wealth Risk-groups and the Retirees showing the highest share of a poor/fair health, while the High-potential and the Wealthy, the two youngest investor types, consider their health to be mostly good or better. Table 6.8 illustrates one specific aspect of the investor groups’ socioeconomic attributes: the distribution of the most common job types.

196

6 Empirical analyses of individual retirement-specific FPB

Table 6.8

Socio-economic attributes of resulting five investor types: Distribution of most common job types LimitedLimitedwealth Risk- wealth SelfRetirees groups employed

Highpotential

Wealthy

All investor types

as % of total sample n=

238

53

55

83

66

495

Professional (freelance) occupations (doctors, architects, lawyers), owner of medium sized or large companies

7%

4%

44%

0%

36%

13%

Senior management occupations, senior civil servant (e.g., management/board member, director, professor, chief physician, associate director)

17%

7%

2%

17%

21%

15%

Owner of small scale businesses (e.g., kiosk, secretarial services, convenience store, small handicraft business)

11%

6%

47%

0%

9%

12%

Middle Management, middle civil servant occupations (e.g., head of group or department, product manager, teacher)

28%

30%

4%

53%

21%

29%

Lower Management, civil servant occupations (e.g., clerk, sales person)

16%

26%

0%

10%

10%

13%

Skilled Trades Occupations (e.g., apprenticeship, professional training)

12%

20%

0%

16%

3%

11%

Other (e.g., unskilled trades occupations, agriculture, farming, fishing, unemployed, home maker)

8%

7%

4%

5%

0%

6%

SE_3 Job type

Remark:

Analysis based on question A. 7 Attribute whose distribution between the five investor types is not different based on a 10% significance level

Analyzing the job types (SE_3), the distribution reflects pretty much the fundamental criteria highlighted above. Since the Limited-wealth Selfemployed, based on their indication, are self-employed, it is evident that they describe their jobs mostly as independent occupations or owners of small businesses. A high level of self-employment has also been identified for the Wealthy, which is reflected in over a third of them indicating they have independent occupations. Job types also reflect the education level: The High-potential and the Wealthy individuals, who have a higher education level, also tend to have jobs at the middle or senior management level. The Limited-wealth Risk-groups on the other hand are mostly working on the middle or lower management level or in skilled trades occupations in accordance with the lower education level. The last occupation of Retirees

6.1 Pooling of investor groups and characterization of investor types

197

was mostly middle or senior management, which is influenced by the level of seniority someone reaches towards the end of his career and the fact that the target group of this study is the affluent segment and thus individuals who typically have more responsibility on the job as they approach the end of their working careers. Looking at the quantitative elements of the socio-economic attributes (Table 6.9), very distinct profiles can be identified for the different investor types, even within the affluent segment of the German population. Apart from the significantly different housing situation, financial wealth, property value and total wealth are evidently differently distributed. Table 6.9

Socio-economic attributes of resulting five investor types: Distribution of quantitative attributes LimitedLimitedwealth Risk- wealth SelfRetirees groups employed

Highpotential

Wealthy

All investor types

as % of total sample 238

53

55

83

66

495

SE_7 Household income < € 45k € 45 - 75k € 75 - 110k € 110 - 140k > € 140k Average (in € k)

n=

73% 23% 4% 0% 0% 46.8

74% 25% 2% 0% 0% 45.9

41% 43% 15% 2% 0% 57.9

54% 39% 4% 1% 2% 53.4

22% 27% 36% 3% 12% 79.9

59% 28% 9% 1% 2% 53.5

SE_8 Financial wealth € 100 - 150k € 150 - 400k € 400 - 700k € 700 - 1,400k Average (in € k)

38% 47% 10% 5% 280

60% 40% 0% 0% 186

18% 82% 0% 0% 248

11% 89% 0% 0% 259

0% 0% 70% 30% 702

29% 51% 14% 6% 319

SE_9 Housing situation Own their house Rent their house Own a rental property Own a vacation home

68% 32% 28% 16%

56% 44% 28% 11%

75% 25% 41% 29%

58% 42% 27% 13%

76% 24% 69% 28%

67% 33% 35% 18%

SE_10 Property value Average (in € k)

245

179

335

211

417

265

SE_11 Mortgages value Average (in € k)

72

65

126

114

178

102

SE_12 Share of average mortgages value relative to average property value (SE_11/SE_10) Percent 29% 36% 37%

54%

43%

38%

SE_13 Net property value (Average property value (SE_10) - Average mortgages value (SE_10)) Average (in € k) 173 114 210 97

239

164

SE_14 Total wealth Average (in € k)

909

500

Remark:

464

322

519

380

Analysis based on questions H. 9, H. 4, H. 1, H. 2 and H. 3 Attributes whose distribution between the five investor types is different based on a 10% significance level Attributes whose distribution between the five investor types is not significantly different

198

6 Empirical analyses of individual retirement-specific FPB

The clearest position with regard to the quantitative socio-economic position can be identified for the Wealthy individuals. They achieve the highest average level of income (€80k), dispose of the largest amount of financial wealth and also have the largest value of net real estate assets, which encompasses the house they live in, but very often also rental properties or vacation homes. This results in a total asset position of €~910k, almost twice the average. At the other end of the spectrum stand the Limited-wealth Risk-groups. With €46k, they have the lowest income level (explained by the higher tendency to work part-time and their lower education level). Furthermore they also dispose of the lowest level of financial wealth, which, given the fact that they are older than the other pre-retired investor types, is a sign that they have not managed to save as much as the others. Their limited financial means are also reflected in the comparatively highest propensity to rent rather than own a home. Consequently, their average value of net property is limited, while their mortgages are also very small. The total wealth of this investor type at €~320k is the lowest of all analyzed investor types. This shows that they have the smallest financial cushion and thus confirms their position as being an investor type with limited risk capability. The Limited-wealth Self-employed display a very distinct profile with regard to their actual financial position, as already highlighted in the discussion of the investor groups with limited risk capability (section 6.1.1). As mentioned above, they have a higher level of income (€58k) which is topped only by the income of the Wealthy and is influenced by their selfemployment status. Their average level of financial wealth however is below average but balanced by a high net property value. They thus end up with the second highest total wealth level and the highest share of real estate assets (both primary home and secondary property for wealth accumulation or wealth preservation purposes). But even with total assets of €~520k, the risks of self-employment need to be kept in mind and the comfort from this high level of total wealth needs to be put into perspective. Therefore, they need to be considered as an investor type with below average risk capability. The High-potentials have an average income level of €53k which – bearing in mind their young age – reflects the profile of a successful group of individuals. Furthermore, they dispose of a substantial amount of financial wealth. Interestingly, their strategy with regard to home ownership seems to be similar to the one of the Limited-wealth Risk-groups with a high share of home renters. However, if they own property, the gross value of their homes is substantially higher compared to the latter (€~210k relative to €180k). On the other hand, the value of their mortgages relative to

6.2 Analysis of investor type specific FP perspectives

199

the value of property is highest of all investor types. One explanation for this is the fact that they are still at an early stage of the life cycle and so have a higher share of debt (i.e., people in the age group between 20 and 30 are most keen to buy home ownership). 370 Another explanation can be found in the permanent income hypothesis from FRIEDMAN 1957 according to which individuals are making their consumption decisions based on their expected life-time income: By definition, these individuals can expect a substantial income growth in the future and thus anticipate higher consumption possibilities or the prospect of being able to redeem mortgages in the future more easily. The finding of a higher share of mortgages for younger individuals and a lower share for older individuals can also be confirmed from other studies. 371 Since their mortgages substantially diminish their gross property value to the lowest net value of all investor types, this group has a surprising low level of total wealth of €~380k, even if their income is at the average. However, as the name of this investor type indicates, they have substantial potential to increase their wealth level going forward. This confirms their placement as having a higher capability for risk than the average individual. The Retirees also have a very special profile that has already been partly addressed above (section 6.1.1). They have a low level of income (€47k) and a high amount of financial wealth. Furthermore, it should be pointed out that the value of their mortgages is lowest relative to the value of their property, something that might also reflect their investment behavior and will be analyzed in the context of FP actions (see sub-chapter 6.3). With an overall substantial wealth level of €465k, their situation reflects the fact that they followed the typical life-cycle model and were able to accumulate savings during their work life and might now slowly be dissaving the assets. Due to their shorter time-horizon however, they have a lower risk capability than the average investor.

6.2 Analysis of investor type specific FP perspectives The knowledge aim of this study is to get a better understanding of individual retirement-specific FPB and to identify levers to enhance it. To do this requires an analysis of the perspectives (life plans, objectives and expectations) individuals have about their life in retirement. This sub-chapter aims to shed light on the different investor types’ FP perspectives by describing the four FP constructs defined in sub-chapter 2.2: a qualitative 370 371

See BORGMANN 2005, p. 3ff. See SIERMINSKA et al. 2006, p. 16.

200

6 Empirical analyses of individual retirement-specific FPB

perspective on the planned life in retirement, the financial view on life in retirement, the preferences for transactions and the subjective elements of the risk profile. 6.2.1 Analysis of the planned life in retirement As in the ideal financial planning process, where an individual’s life aims and financial objectives are investigated at the outset of the process, the analysis of individual FP perspectives starts with the review of an individual’s qualitative perspective on life in retirement. More specifically, an understanding of individual life plans and financial objectives is aspired. This includes issues such as when people envisage retiring, what activities they want to perform in retirement, what financial aims they have and how they intend to deal with financial limitations. 6.2.1.1 Planned timing of retirement

The first element of this qualitative perspective relates to the question of when individuals plan to retire and is displayed in Table 6.10. Table 6.10 Share of individuals planning to retire or actually having retired at a specific age range LimitedLimitedwealth Risk- wealth Selfemployed groups Retirees

Highpotential

Wealthy

All investor types

as % of total sample n=

238

53

55

83

66

495

40% 58% 2%

17% 79% 4%

13% 76% 11%

17% 82% 1%

27% 63% 10%

29% 67% 4%

59

61

62

61

61

60

PL_1 Retirement age Early retirement (before 60) Normal retirement (60 to 65) Late retirement (above 65) Effective average retirement age

Remark:

Analysis based on question A. 19 for the pre-retirees and A. 17 in combination with H. 12 for the Retirees Attribute whose distribution between the five investor types is not significantly different based on a 10% significance level

The distribution of early (before 60), normal (between 60 and 65) and late (after 65) retirement among the five investor types is evidently different, even if the effective average retirement age is comparable across the five types. At first sight, an inter-generational shift can be identified with the older generation retiring at a younger age (with 59 years on average) than the pre-retirees. But also the pre-retirees intend to retire at 61 or 62

6.2 Analysis of investor type specific FP perspectives

201

years on average, clearly before the official retirement age of 65 years. This confirms the trend towards early retirement in Germany, also reflected in the average actual retirement age of 60. 372 Given the recurring discussions about increasing the retirement age and the respective reforms underway (i.e., Beschluss des Bundeskabinetts to raise the official retirement age to 67), 373 the plans of the current generation of pre-retirees might seem surprising. However, they can be explained by typical human tendencies such as anchoring (e.g., taking the retirement age of parents or a peer group as a reference point), perception biases (such as selective memory) that lead to an insufficient adaptation of mental constructs to regulatory changes underway and unbounded optimism, inducing individuals to believe that an increasing retirement age is only relevant to others. With regard to the four pre-retired groups substantial differences can be identified. Over a quarter of the Wealthy intend to retire early, but one out of ten intends to continue working after the age of 65. This finding may on the one hand be linked to the financial cushion of the Wealthy. On the other hand it hints at a more pronounced willingness to keep on working found especially among individuals with a good educational background and relevant work experience, who have been financially successful, and are often self-employed. That self-employment induces individuals to keep on working after the official retirement age can also be observed with the Limited-wealth Self-employed investor type, of which 11% intend to retire after the age of 65. 374 This attitude also explains why the Limited-wealth Self-employed end up with the highest average retirement age. The retirement plans of the High-potentials are comparable to those of the Limitedwealth Risk-groups, but the latter display an even more pronounced preparedness to retire after 65 (4% versus 1%). This could be an indication that these individuals are aware of the tightness of their financial situation in retirement and plan to retire later accordingly. This reasoning is consistent with MITCHELL/MOORE/PHILIPPS 2000 who identified financial constraints as a key restriction for the transition into retirement and thus a motivation to continue working. 375 372

According to BÖRSCH-SUPAN et al. 2005 the average retirement age is 60 in Germany. Indication relates to the years 1999 and 2001. See BÖRSCH-SUPAN et al. 2005, p. 19. 373 See RASONYI 2006, p. 23 and RASONYI 2007, p. 23. 374 This can also be observed in daily life. KORTMANN et al. 2005, for example, find that a high percentage of self-employed individuals is still working at the age of 65 years. See KORTMANN et al. 2005, p. 34. 375 New paths to retirement are emerging. They involve “‘bridge’ jobs and gradual transitions through various labor market stages.” “That is, many older people follow unconventional tracks, some working forever, some gradually winding

202

6 Empirical analyses of individual retirement-specific FPB

6.2.1.2 Individual life plans

As the second element of the qualitative FP perspectives, the activities planned for retirement are analyzed to assess financial needs. Table 6.11 Share of individuals planning to undertake or actually undertaking a specific activity in retirement LimitedLimitedwealth Risk- wealth Selfemployed groups Retirees

Highpotential

Wealthy

All investor types

as % of total sample n=

238

53

55

83

66

495

56% 29%

52% 31%

58% 11%

67% 14%

36% 25%

55% 24%

PL_2 Life plans in retirement Spend more time with the family Provide childcare for the family Perform voluntary/charitable activities Travel extensively Spend extended time periods abroad Move abroad Pursue indoor hobbies (e.g., reading) Pursue outdoor hobbies (e.g., sports, walking, hiking) Study Continue to work (part-time)

Remark:

15%

10%

15%

14%

36%

17%

58%

66%

64%

74%

90%

66%

17% 0%

13% 6%

40% 11%

20% 5%

18% 13%

20% 5%

74%

75%

56%

61%

57%

68%

68% 12% 11%

58% 12% 23%

78% 15% 43%

71% 18% 22%

78% 18% 24%

70% 14% 19%

Analysis based on question C. 1 Attributes whose distribution between the five investor types is different based on a 10% significance level Attributes whose distribution between the five investor types is not significantly different

Table 6.11 illustrates that individuals intend to be very active in retirement: Over two thirds plan to pursue outdoor hobbies, indoor hobbies, or travel extensively. These findings mirror the outcome of a major consumer trend survey conducted by the GOTTLIEB DUTTWEILER INSTITUT (GDI)/FRICK 2005 in Germany, where almost the same age group as the interviewees of the current study was investigated. 376 down on the same job and some finding a ‘bridge’ job to move into at older ages. […]Gradual labor market withdrawal patterns […][are appearing as] people may reach retirement age with inadequate saving, and find that they must remain employed to make ends meet.” MITCHELL et al. 2000, p. 2f. 376 This research aims at identifying changes in views, attitudes and behaviors by comparing positions of an individual today and earlier in his life, his position relative to his parents, or just his general views on younger and older members of society. The study was conducted with 60 people aged 40 to 80. See FRICK 2005, p. 64ff.

6.2 Analysis of investor type specific FP perspectives

203

FRICK 2005 finds that the generation of the “new old”, the Generation Gold, has a much stronger constitution and substantially different life plans than their predecessors. Constitution needs to be considered from both an objective and a subjective perspective: Objectively, these people are physically and mentally five years younger and in most cases old age ailments seem not to affect greatly daily life before the age of 80 anymore. On the subjective level, the effect of this “rejuvenation” is even more pronounced as the increased physical and mental fitness induces these individuals to feel about fifteen years younger. As a consequence, today’s retirees believe to have gotten almost “a second life”. 377 Since the ability to enjoy this second life is very much health-dependent, the focus on health has increased among this group of individuals and become a core value of life. 378 This is reflected by the fact that the majority of all interviewees plan to pursue outdoor hobbies (such as sports, walking and hiking) that are typically associated with a good health. In addition to the outdoor hobbies, the other popular activities such as indoor hobbies and travel are also symptomatic of other values and life plans identified by FRICK 2005: She observes a very strong focus on the individual, with an ever increasing importance of activity and action, a high level of self-determination, autonomy and curiosity, and finally the wish for pleasurable consumption. With regard to the latter phenomenon, the extensive travel plans are an indication that these individuals now have the time, energy and – given the concentration of a high share of wealth in this generation 379 – also the money needed to make their dreams come true. This highlights that the hedonistic Generation Gold will become one of the key drivers of consumption within the European economies. 380 The high level of activity gives this generation one of its nicknames: OPALS – Older People with Active Lifestyles. 381 With regard to life plans, the GDI study reveals that life models are no longer seen as linear and sequential (i.e., from education to work to family and finally retirement) but characterized by parallel modules. As a conse377

The renowned old-age researcher Paul B. Baltes even spoke about this phase in retirement as the third and fourth life. See MEIER-RUST 2006, p. 70. 378 Therefore, health will not only remain a central theme going forward, but will even increase in importance. This is because not only is being healthy important, but also because health-related expenses will increase. See FRICK 2005, p. 80. This can also be seen in the fact that the “new old” generation spends significantly more on health than younger generations. See BOSSHART et al. 2004, p. 23. 379 See for example HUNT et al. 2005 or BRAUN et al. 2002. 380 See BERNET 2005a, p. 27. 381 See FRICK 2005, p. 16.

204

6 Empirical analyses of individual retirement-specific FPB

quence, people are reinventing themselves several times in their life. The fact that 19% of all interviewees of this study plan to continue to work and 14% plan to study in retirement mirrors this idea. This is also consistent with DYCHTWALD 2004’s notion of the “cyclical life in which it’s becoming more normal for people to reinvent themselves and try new things than to simply go up the mountain and , at about the age of 50, start the tedious descent down.” 382 Besides these highly individualistic trends, FRICK 2005 also finds that the role of family and friends has increased in importance. This finding is reflected in the FP perspectives too, as spending time with the family ranks fourth in popularity and 55% of all interviewees mention this as a plan for retirement. An analysis of the different life plans reveals that eight out of ten suggestions for life in retirement show significantly differently distributions among the five investor types. The Retirees display a substantially lower propensity to travel extensively, continue to work (part time) or move abroad, which could be an indication that inter-generational shifts are underway. Also, this finding suggests that individuals are planning to be very active in retirement both with regard to enjoying life (e.g., by traveling) and earning additional income (e.g., by continuing to work), but then upon retirement they lose energy and scale back their plans – a phenomenon usually caused by overconfidence and unbounded optimism. Apart from these inter-generational developments, the four pre-retired investor types have differing foci. The Limited-wealth Risk-groups stick out because they are keener on indoor hobbies (like the Retirees) and have the least pronounced preference for outdoor activities. Here, their comparatively worse health status explains these preferences. Furthermore, almost a third of them is planning to provide childcare for the family (similarly to the Retirees and influenced by the higher share of women in both these investor types). Relative to the Retirees however, the Limited-wealth Risk-groups show a higher propensity to continue to work, which might be related to financial restrictions as discussed in the comment above about late retirement. The Limited-wealth Self-employed show the strongest propensity to continue to work after retirement, which is in line with their view on the retirement age shown above. They have a strong focus on outdoor activities and plan to spend a lot of time abroad, both of which reflect a high activity level. However, very few intend to provide childcare, even if spending time with the family and doing charity work seems important to them. This reflects this investor type’s low share of women, who have an inher382

DYCHTWALD 2004, p. 70.

6.2 Analysis of investor type specific FP perspectives

205

ently higher tendency to perform childcare. Also, their good educational background would rather induce them to continue to work and – corresponding to the idea of specialization on comparative advantages – leave child care activities to others. Among the High-potentials, two thirds plan to spend more time with the family and a fifth wants to study in retirement. They are also quite active in other dimensions, with a high willingness for extensive traveling and outdoor activities. As the pre-retired investor type with the lowest percentage planning for a late retirement (PL_1), the High-potential are also the least willing to continue to work (part-time): Even so, one in five is planning to do so. The Wealthy express the strongest desire for extensive traveling (90%). Similarly to the Limited-wealth Self-employed, they have a pronounced preference for outdoor versus indoor hobbies (78% versus 57%). It is also noteworthy that over a third of them plan to perform charitable activities. The latter feature, together with their extensive traveling plans, must be seen as a clear indication of the financial cushion these individuals enjoy. 6.2.1.3 Individual coping strategies

Having understood to which extent the pre-retired in particular plan to be active and spend their money in retirement, the question arises whether they would be prepared to reduce their living costs or tap into their investments in order to compensate for financial limitations. These so-called coping strategies are displayed in Table 6.12 and can be differentiated according to changes of the life circumstances, continuation of work or various financial strategies.

206

6 Empirical analyses of individual retirement-specific FPB

Table 6.12 Share of individuals being ready to engage in a specific coping strategy during retirement LimitedLimitedwealth Risk- wealth SelfRetirees employed groups

Highpotential

Wealthy

All investor types

as % of total sample n=

53

55

83

66

257

N.a. N.a.

29% 13%

43% 9%

35% 15%

34% 15%

35% 14%

N.a.

70%

56%

71%

61%

65%

N.a.

57%

63%

54%

58%

57%

N.a.

74%

81%

80%

76%

78%

N.a. N.a.

55% 67%

55% 63%

71% 80%

64% 65%

62% 70%

N.a.

23%

26%

22%

39%

27%

PL_3 Coping strategies Changes in life conditions Moving to a less expensive area or smaller property Moving in with the family Restricting life-style (e.g., holidays) Changes in working patterns Continue to work (part-time or full-time) Financial strategies Releasing investments made (e.g., mutual funds) Selling a second property (e.g., vacation home) Selling an investment property Releasing some equity in the home (e.g., taking out a mortgage, transferring it for an annuity)

Remark:

Analysis based on question C. 9 Attribute whose distribution between the five investor types is different based on a 10% significance level Attributes whose distribution between the five investor types is not significantly different

Overall, the results show that a very high share of individuals is prepared to undertake certain steps in order to cope with a more restricted financial situation. Releasing investments is the most popular coping strategy for all pre-retired investor groups (78% are prepared for this step), followed by selling an investment property (70%). Besides these clearly financially focused strategies, almost two thirds of interviewees are also ready to restrict their lifestyle. This as a consequence raises questions regarding the extensive travel plans mentioned above: It indicates that the plans represent a “nice-to-have” element that can be eliminated if required. Correspondingly, this flexibility also improves the outlook on the financial situation in retirement substantially. Additionally, while only 19% of all interviewees indicated to plan to continue to work in retirement (PL_2), 57% would be prepared to continue

6.2 Analysis of investor type specific FP perspectives

207

to work if it is financially necessary. 383 This preparedness of pre-retirees to continue to work might be a sign of a changing view of retirement and anticipation of an increased individual responsibility in retirement. At the same time this preparedness to continue to work after retirement raises the political question of whether the economy provides enough opportunities for these individuals to do so. While this question will not be discussed here, it represents a field for further research. 384 Also noteworthy is the coping strategy that enjoys the least popularity: moving in with the family. Aversion for this step is particularly pronounced for the Limited-wealth Self-employed. This general finding reinforces the trend observed by FRICK 2005 for a stronger focus on the individual coupled with the preferences for self-determination and autonomy. Not moving in with the family means continuing to have an independent lifestyle and guaranteeing autonomy in deciding when to spend time with the family – something that is planned by 55% of the interviewees (PL_2). In this way the increasing importance of friends and family identified by FRICK 2005 can be smoothly integrated into this new life-concept. Overall financial coping strategies seem more attractive than the adaptation of life circumstances. The only financial strategy that enjoys a low popularity is releasing home equity. Only the Wealthy show a marked preparedness for such a measure (39%). This could be because this strategy is not well known among the interviewees and therefore only imaginable for those individuals with an elevated level of financial sophistication. Releasing part of the home equity is the only strategy with a significantly different willingness among the four pre-retired investor types. Due to the lack of significant differences, the other approaches for coping with financial restrictions are not detailed for the individual investor types. 6.2.1.4 Financial objectives in retirement

Life plans and respective coping strategies provide a qualitative perspective on life in retirement and contribute to the determination of financial 383

As highlighted by the comparison of the share of Retirees continuing to work with those of the other four pre-retired investor types, there still seems to be a long way from the preparedness to work to actually working after retirement even considering that an intergenerational shift might be happening. This might also be driven by the lack of suitable job positions. 384 The efforts of the German BMAS to promote further education of older employees, the reintegration of long-term unemployed, as well as the avoidance of early exclusion of older people from the working process, subsumed under the term “Generation Arbeit – Initiative 50plus”, point in this direction. See BMAS 2006a.

208

6 Empirical analyses of individual retirement-specific FPB

needs in retirement. Also, an individual’s financial objectives for retirement substantially influence the retirement-specific budget as they determine the use and availability of assets. Table 6.13 illustrates the financial objectives with which the various investor types mostly identify. Table 6.13 Share of individuals expressing a specific financial objective for retirement LimitedLimitedwealth Risk- wealth SelfRetirees groups employed

Highpotential

Wealthy

All investor types

as % of total sample who are agreeing (strongly) to the respective financial objective n=

238

53

55

83

66

495

37%

33%

38%

36%

33%

36%

63%

62%

59%

46%

63%

60%

89%

88%

85%

86%

98%

89%

32%

24%

28%

24%

47%

31%

11%

3%

16%

11%

24%

12%

PL_4 Financial objectives I can spend all my assets as I do not need to leave an inheritance I intend to keep some of the assets aside to leave an inheritance I intend to keep a financial reserve to cover uncertain future events I intend to continue to save in retirement I am expecting (several) large items of discretionary spending and need to provide accordingly

Remark:

Analysis based on question C. 2 Attributes whose distribution between the five investor types is different based on a 10% significance level Attributes whose distribution between the five investor types is not significantly different

It is very clear that individuals are afraid of uncertainty: By far the most important financial objective is to keep a reserve to cover uncertain future events. Due to the high importance of this financial objective, with almost 90% of all interviewees agreeing (strongly) about it and no significant differences among the investor types, this element will also be taken into consideration when simulating the individual financial situation and retirement gap in sub-chapter 6.4. Combining this financial objective with the life plans and the changed values identified for the Generation Gold, the reserves could be seen as a way to maintain independence and have the freedom to carry out preferred activities. Saving for others is the second strongest motivation reining back consumption, with 60% of interviewees wanting to leave an inheritance, so this motive is also taken into account in the simulation analysis in sub-

6.2 Analysis of investor type specific FP perspectives

209

chapter 6.4. 385 On the other hand, 36% of all individuals feel they do not necessarily need to leave an inheritance and can spend their assets. This dissaving attitude indicates a changing notion of the financial situation in retirement as more individuals are starting to move away from the traditional notion of saving for others towards the classical life-cycle prediction of dissaving in retirement. BERNET 2005a also mentions another more sociological reason for this change, namely the fact that the notion of the head of the clan providing for his descendants is decreasing. 386 It is also interesting that over 30% of all interviewees intend to continue to save in retirement, meaning that these individuals are counting on expenses below their income level. This is understandable for the Wealthy, given their substantial wealth and its corresponding proceeds, and for the Limited-wealth Self-employed, who have shown a more pronounced readiness to continue to work in retirement. However, the fact that about a quarter of the Limited-wealth Risk-groups are intending to continue to save in retirement raises some question marks about the sensibleness of their financial objectives and their grasp of their overall situation. From a different perspective, one could interpret the fact that 32% of the Retirees are intending to save as an indication that the current state pension system is too generous. This discussion however would go beyond the scope of this study but might be a topic for further research. Lastly, only a minority of 12% of all individuals expects large items of discretionary spending in retirement for which they need to provide. This reflects that most individuals consider themselves as well set with regard to large discretionary items such as a house, while they do not seem to draw a direct link between their life plans (e.g., extensive traveling) and the corresponding financial expenses. Only the Wealthy show a higher probability of 24%, which again reflects their varying aspirations for retirement (with an even more consumption intensive attitude) and a slightly more consequent financial approach. 6.2.2 Analysis of the financial view on life in retirement The financial view on life in retirement sheds light on the individual expectations about retirement from a quantitative perspective and so complements the qualitative view discussed above. It can also be taken as an 385

With regard to the primary motive of keeping a reserve, the base case of the simulation analysis assumes that 30% of the current financial wealth level is kept as a reserve. With regard to the inheritance motive, the simulation analysis presumes that real estate assets are retained for inheritance. 386 See BERNET 2005a, p. 27.

210

6 Empirical analyses of individual retirement-specific FPB

indicator of an individual’s financial astuteness and his understanding of the overall financial optimization problem. As an introduction to the problem of the retirement income gap to be discussed in sub-chapter 6.4, a comparison of anticipated expense and income streams assesses whether individuals are expecting a retirement gap. This self-assessed retirement gap in turn will be contrasted with the perceived feeling of financial preparedness for retirement to highlight mental consistency. 6.2.2.1 Analysis of the expense side (income needs) in retirement

The quantitative dimension of consumption is tested in the form of expense streams. The amount of income individuals expect to need in retirement is surveyed in two ways. First, individuals were asked to estimate their last pre-retirement income and determine what percentage of it (in relative terms) they needed in retirement. Second, the individuals were asked about the absolute Euro amount of their income needs in retirement. The ability to make estimates in relative and absolute terms indicates how well individuals cope with the inter-temporal financial optimization problem. Relative estimate of income needs in retirement

Table 6.14 focuses on the relative estimate of consumption in retirement, showing the average estimates for the last pre-retirement income and the percentage of it individuals expect to need in retirement. The multiplication of these two values that are evidently differently distributed provides the absolute Euro amount required in retirement. For comparability, the actual average income level (SE_7) is reported as well.

6.2 Analysis of investor type specific FP perspectives

211

Table 6.14 Average expected last pre-retirement income and share of individuals expecting to need a specific replacement rate in retirement LimitedLimitedwealth Risk- wealth SelfRetirees groups employed

Highpotential

Wealthy

All investor types

as % of total sample n=

53

55

83

66

257

45.4

54.1

49.1

72.0

55.4

0% 2% 12% 15% 35% 10% 27%

0% 4% 20% 24% 31% 9% 11%

0% 2% 5% 31% 37% 19% 6%

2% 10% 13% 40% 24% 10% 3%

0% 4% 12% 28% 32% 12% 11%

86%

80%

83%

77%

81%

38.8

43.3

40.7

55.1

45.0

45.9

57.9

53.4

79.9

53.5

Expected annual household FV_1 income prior to retirement Average (in € k)

N.a.

Percentage of last pre-retirement FV_2 income needed in retirement < 50% 50 -< 60% 60 -< 70% 70 -< 80% 80 -< 90% 90 -< 100% 100% Weighted average

N.a.

Income needed in retirement (Weighted average in % * FV_1) Average (in € k) For reference: SE_7 Average income in 2005 (in € k)

Remark:

46.8

Analysis based on questions C. 4 and C. 5 Attributes whose distribution between the five investor types is not significantly different based on a 10% significance level

The results for the last pre-retirement income (FV_1) show that individuals from all investor types expect to earn less on a net basis shortly before retirement than they do today. 387 The expected falls in salary range from 1% for the Limited-Wealth Risk-groups to 10% for the Wealthy. This is surprising insofar as one would expect future nominal income to be at least at the level of the actual income level. Furthermore, most individuals, especially the High-potential, should expect salary rises above the inflation 387

Both the average expected last pre-retirement income and the average actual income were calculated in the same way. Therefore, averaging cannot be an explanation for this difference. Since inflation was not mentioned explicitly in the interviews and due to the human difficulty calculating with inflation (i.e., money illusion), the answers are assumed to be in nominal terms. Applying a calculatory discount to reflect the impact of inflation would result in a net real value of the last pre-retirement income that is even lower. As a consequence, the decrease from today’s income level to the last pre-retirement income would be even more pronounced. For Retirees, the current income level corresponds to their retirement income.

212

6 Empirical analyses of individual retirement-specific FPB

rate until retirement. 388 An expected substantial increase in the tax rate could be an explanation for this phenomenon, as the indications are net and not gross. Additionally, individuals could be assuming that the closer they get to retirement, the higher the chances are that they work part time or in functions with less responsibility and thus have to face a reduction in salary. Moreover, survey-related distortions such as the formulation of the question, its position within the questionnaire or the level of confidentiality could be reasons for why the future income is expected to be lower. 389 Nevertheless, even allowing for these distortions, the fact that the last preretirement income is expected to be so much lower than the actual level of net income is a clear sign that all investor types have trouble estimating absolute future values. The overall level of the second variable, the percentage of last working income needed in retirement (FV_2) is a relatively high 81%. This contrasts indications of various authors and organizations that assume the income needed in retirement to be 70% of the final take-home pay. 390 Pension systems were based on this assumption and designed so that the standard individual pension income equaled 70% of the pre-retirement salary. 391 A rate of 70% makes sense in light of specific work-related expen-

388

KIENBAUM 2001 and KIENBAUM 2004 have analyzed the development of salaries in Germany between 2001 and 2004 and shown that they outgrew inflation by 0.2 – 1.1% p.a. in real terms, depending on the education level and amount of responsibility of an individual. See KIENBAUM 2001, p. 32ff and KIENBAUM 2004, p. 30ff. 389 The estimation of the last pre-retirement income (FV_1) was asked during the interview while the indication of the household income (SE_7) was surveyed in the confidential part of the questionnaire. During the interview, the question about the last pre-retirement income was posed in an open way and only if individuals could not give an estimate they were shown different income ranges from which they could choose. Furthermore, it was asked as monthly income while the income level was enquired on a yearly level (which might be higher as it includes a Christmas bonus). In the confidential part, individuals were more familiar with the topic and the different financial constituents as they filled it in at the end of the survey. Finally, tests have shown that individuals tend to give more accurate indications about their own financial situation if confidentiality is guaranteed rather than being asked the same question by the interviewer. 390 See EISENBERG 2006, p. 35. 391 See for example, SHIM/SIEGEL 1991, p. 343 or the “Rentenschätzer” from the DIA 2006b. BANKS et al. 1998 find a pronounced drop in the standard of living after retirement in the UK which they partially attribute to external shocks. See BANKS et al. 1998, p. 769ff.

6.2 Analysis of investor type specific FP perspectives

213

diture no longer being necessary 392 or changes in household demographics (e.g., children leaving home). However, since only 16% of all interviewees indicate requiring 70% or less, it is clear that this official tag is not anchored in people’s mind. On the other hand, it is noteworthy that most official estimations of the retirement gap might underestimate the true gap by assuming a income need that is too low. To counteract this effect and to give as realistic a picture as possible, the simulation analysis used in subchapter 6.4 uses the more aggressive average estimates of the individual interviewees. To avoid miss-estimating the last pre-retirement income, this value is calculated on the basis of current average income, remaining work years and an education-specific real salary growth rate. As regards the results by pre-retired investor type, the results are evidently different but the differences lack statistical significance. Although all of them lay above the traditional 70%, the Wealthy show the lowest relative value (77%), while the Limited-wealth Risk-groups show the highest (86%). This reflects the fact that while it is easier for households with a high income to live with a lower percentage of their pre-retirement income, individuals whose household budget is already stretched before retirement have fewer options to reduce expenses. Absolutely speaking, the Limited-wealth Risk-groups’ indicated share of income needs (derived by multiplying their last pre-retirement income with the 86%) is the lowest absolute amount of income needed in retirement. Given however that they also have the least financial cushion, the relationship between income needs and available total assets is highest for this investor type, pointing at a financial situation that is most at risk. The other two investor types lie between these two estimates. Absolute estimate of income needs in retirement

The second approach to measure income needs in retirement is by asking the individuals about the absolute net amount of income needed to live comfortably in retirement. The respective results are displayed in Table 6.15. Compared to the relative indication (FV_2), the required income in absolute terms is even higher at 87% of the last pre-retirement income on average (compared to 81% in the relative indication). As the alternative scenario in sub-chapter 2.1 has shown (Fig. 2.1), an increase in the consumption level in retirement to the pre-retirement consumption level is 392

Reduction in expenses due to changes in labor-market status (e.g., reduced expenses for transportation and clothing). See REIMANN 2006, p. 33.

214

6 Empirical analyses of individual retirement-specific FPB

conceivable. However, bearing in mind that most individuals’ preretirement income tends to exceed their consumption before retirement, allowing them to save, this 87% seems overestimated. Furthermore, the findings about the estimate of the last pre-retirement income (FV_1) have shown the difficulties individuals have with estimating future absolute amounts. Therefore, these absolute indications are disregarded in the simulation analysis in sub-chapter 6.4. Table 6.15 Share of individuals expecting to need a specific income to live comfortably in retirement LimitedLimitedwealth Risk- wealth Selfemployed groups Retirees

Highpotential

Wealthy

All investor types

as % of total sample n=

238

53

55

83

66

495

< € 45k € 45 - 75k € 75 - 110k € 110 - 140k

69% 27% 3% 1%

83% 17% 0% 0%

63% 31% 6% 0%

71% 26% 0% 2%

45% 43% 12% 0%

67% 29% 3% 1%

Average (in € k)

47.8

43.5

49.2

47.3

54.9

48.4

102%

96%

91%

96%

76%

87%

Income needed to live comfortably FV_3 in retirement

As share of last pre-retirement income (FV_1); for Retirees relative to average income in 2005 (SE_7)

Remark:

Analysis based on question H. 5 Attribute whose distribution between the five investor types is not significantly different based on a 10% significance level

Interesting to note is that the Retirees claim to need slightly more than their current income level (102%, relative to their average retirement income in 2005) to live comfortably. Since their current retirement income level is lower than the amount they need to live comfortably, Retirees cannot, on average, continue to save in retirement. This raises question marks about the financial objective of “continuing to save” expressed by 32% of all Retirees (PL_3). This inconsistency might be influenced by individuals’ difficulty in estimating financial flows or by the above mentioned observation distortions. Anyhow, it pinpoints limitations in people’s realistic assessment of their financial future, and suggests unbounded optimism. Overall, the analysis of income needs (FV_1 and FV_2) demonstrates that individuals are struggling to estimate future absolute amounts and also with providing relative indications: The last pre-retirement income tends to be underestimated and the absolute income needs tend to be overestimated. This can be seen as an indication of the problems individuals face if they

6.2 Analysis of investor type specific FP perspectives

215

have to deal with the distinction between real and nominal terms (a phenomenon described as money illusion in sub-section 4.2.3.2) and might also be relevant for the differentiation between net and gross values. Based on these analyses, the actual financial sophistication of individuals is questionable and it becomes clear that most individuals lack a careful approach to planning their financial income and expense streams. This also supports the principle established in section 4.4.2 that everyone should have a specialist financial advisor to help him solve the financial optimization problem with regard to retirement and deal with the difficulties of estimating future financial flows and in addition distinguish between real or nominal and gross or net terms. 6.2.2.2 Analysis of the income side in retirement

In order to analyze the income situation during retirement, different income sources are first investigated qualitatively in order to understand their nature. Then, the anticipated income is analyzed quantitatively both from a relative and an absolute perspective as demonstrated above for the expense streams. Qualitative assessment of income sources in retirement

Table 6.16 illustrates the primary income source for the five investor types, the importance of complementary income sources and finally an indicator for an individual’s pension arrangement complexity. The analysis of the primary income source (FV_4) reflects the set-up of the German retirement system, namely that the statutory state retirement income is the dominating source of income for most individuals. 393 There are two exceptions: One is based on the fact that self-employed individuals can opt out of the SSP and correspondingly provide themselves for retirement. The second relies on the digressive nature of the German retirement system (see Fig. 3.5) which induces specifically individuals with a salary above the “Beitragsbemessungsgrenze” to provide individually to cover the difference in income. This is why only a minority of the individuals with the highest income levels and the highest share of self-employment, the Limited-wealth Self-employed and the Wealthy, see the state pension 393

According to KORTMANN et al. 2005 90% of male and 82% of female retirees receive statutory pension income in the Alte Bundesländer. Additionally, 46% of men but only 9% of women receive occupational pension income in the Alte Bundesländer. See KORTMANN et al. 2005, p. 66ff.

216

6 Empirical analyses of individual retirement-specific FPB

as the main income source. 394 Indeed, a substantial share of the individuals within these two investor types relies on private pension or income from savings and investments as a major source of income. Conversely, 46% of the Limited-wealth Self-employed and 41% of the Wealthy see the state pension as complementary income source. Table 6.16 Share of individuals with specific primary and complementary retirement income sources LimitedLimitedwealth Risk- wealth SelfRetirees groups employed

Highpotential

Wealthy

All investor types

as % of total sample n=

238

53

55

83

66

495

75% 6%

87% 4%

33% 33%

79% 6%

44% 39%

68% 13%

1%

0%

2%

0%

0%

1%

6% 3% 8% 2% 0%

6% 0% 2% 0% 2%

0% 0% 19% 4% 9%

6% 2% 2% 1% 4%

3% 6% 2% 3% 3%

5% 2% 7% 2% 2%

14% 46%

13% 58%

46% 44%

20% 67%

41% 36%

22% 49%

27%

23%

16%

35%

27%

27%

26% 39% 90% 38% 8%

25% 34% 94% 28% 23%

7% 26% 81% 50% 33%

22% 33% 96% 30% 25%

9% 49% 98% 73% 27%

21% 38% 92% 42% 18%

2.9

2.9

3.0

3.3

3.6

3.1

Primary source of retirement FV_4 income State pension Private pension Employer-based contributory pension Employer-based defined benefit pension Inheritance Income from savings/investments Income from second property Income from continued work Complementary sources of FV_5 retirement income State pension Private pension Employer-based contributory pension Employer-based defined benefit pension Inheritance Income from savings/investments Income from second property Income from continued work Complexity of pension FV_6 arrangements Average number of different income sources

Remark:

394

Analysis based on questions A. 14 a and b Attributes whose distribution between the five investor types is different based on a 10% significance level Attributes whose distribution between the five investor types is not significantly different

The fact that still 33% of the Limited-wealth Self-employed indicate the state pension to be their primary income source relies on the fact that the question was formulated so as to include mandatory corporate pensions for specific professions such as provisions for medical doctors (e.g., Aerzteversorgung).

6.2 Analysis of investor type specific FP perspectives

217

With regard to complementary income sources (FV_5), Table 6.16 illustrates that income from savings and investments is by far the most prevalent (92% and evidently differently distributed), followed by private pension arrangements or annuities (49%), income from second property (42%) and inheritance (38%). The latter highlights the importance that the current “money in motion” transfers have for the next generation of retirees (especially for the Wealthy where half of the individuals are counting on this income source). But as shown above (PL_4) a majority of the current generation of pre-retirees plans to leave an inheritance themselves. Therefore, even for the following generation inheritance is likely to be an attractive income source. 395 The breadth of these complementary income sources can partially be explained by the digressive German retirement system and the above average income level of the individuals analyzed. Furthermore it illustrates that individuals are aware of the need to diversify their income sources and that many have already started to provide accordingly, thus demonstrating some adequate FPB. As the statistics illustrate, several of these complementary income sources vary significantly in importance for the five investor types. For example, private pensions and employer-based contributory pensions are of most importance to the High-potential (a sign that these sources are becoming increasingly meaningful for younger individuals). The fact that the Retirees have the highest rating for employer-based final salary pension further illustrates the current shift between DB and DC plans in Germany. The Limited-wealth Self-employed who own a lot of property (SE_10), logically see the second property as an important complementary income stream. Furthermore, their preparedness to continue to work is also reflected in the corresponding income source. These two factors, and inheritances as mentioned above, also hold good for the Wealthy. Lastly, the Limited-wealth Risk-groups show a rather average picture with an above average importance of private pensions, of DB versus DC pension plans and of contribution work, which again reflects their preparedness to continue to work in case of financial restrictions. The complexity of pension arrangements (FV_6), shown at the bottom of Table 6.16 and displaying an evidently different distribution, counts the number of complementary pension arrangements the individual has undertaken and hints at the diversification level of income sources. The Limitedwealth Risk-groups and the Retirees demonstrate the least complexity of pension arrangements and thus with 2.9 also the lowest level of diversifi395

Due to the lower values of bequest that results from the very pronounced consumption attitude of today’s pre-retirees however, the following generation could still be a “Lost Generation” as termed in BERNET 2005a, p. 27.

218

6 Empirical analyses of individual retirement-specific FPB

cation among retirement income sources. The Wealthy are at the top end of the spectrum and have the most complex approach with on average 3.6 out of 8 possible complementary income sources. This reflects the fact that the higher the income level the more supplementary income is needed to bridge the gap between current earnings and the statutory state pension. The High-potential also show an increased complexity of their pension arrangements of 3.3, which illustrates a hedge against the reforms underway that tend to affect the youngest individuals most. Finally, with a complexity indicator of 3.0, the Limited-wealth Self-employed are in between the other investor types, perhaps because they do not rely on state pension income very often (only 33% indicate it as main income source) and thus already list unconventional income sources as the primary source of income. Quantitative assessment of income sources in retirement

The qualitative assessment of the importance of the various income sources is now complemented with a quantitative perspective. As with the issue of consumption and its corresponding income needs discussed above, also the income streams have been surveyed in a relative and absolute way. On the relative measure of income (as percent of the last pre-retirement income), the individuals were even asked to differentiate between the three income pillars; state pension, employer-based pension and private pension. The question about the absolute expected income was a more general one. Table 6.17 shows the respective results.

6.2 Analysis of investor type specific FP perspectives

219

Table 6.17 Share of individuals estimating specific ranges for their relative and absolute income in retirement LimitedLimitedwealth Risk- wealth Selfemployed groups Retirees

Highpotential

Wealthy

All investor types

as % of total sample n=

(238)

53

55

83

66

257 (495)

N.a.

45.4

54.1

49.1

72.0

55.4

8% 13% 65% 13%

43% 25% 24% 8%

6% 30% 54% 10%

25% 29% 40% 6%

19% 25% 47% 9%

Expected annual household FV_1 income prior to retirement Average (in € k) Percentage of last pre-retirement income expected to receive in FV_7 retirement Income from state pension 0 - < 25% 25 - < 45% 45 - < 65% > = 65% Weighted average from statutory state pension

N.a.

53%

38%

49%

44%

46%

Weighted average from employer based pension

N.a.

13%

12%

12%

11%

12%

Weighted average from private pension

N.a.

21%

35%

22%

27%

26%

Weighted average of the sum of all three income sources taken together at the level of the individual

N.a.

85%

79%

84%

79%

82%

Income expected in retirement (Weighted average of the sum in % * FV_1) Average (in € k)

N.a.

38.7

43.0

41.3

56.9

45.5

< € 45k € 45 - 75k € 75 - 110k € 110 - 140k > € 140k

73% 24% 3% 0% 0%

85% 15% 0% 0% 0%

64% 33% 4% 0% 0%

75% 23% 1% 0% 1%

35% 50% 12% 3% 0%

68% 27% 4% 0% 0%

Average (in € k)

46.4

43.0

48.5

46.5

58.9

48.0

Calculated as share of last preretirement income (FV_1)

N.a.

95%

90%

95%

82%

87%

FV_8 Retirement income

Remark:

Analysis based on questions C. 6, C. 6a and C. 6b as well as H. 6 Attribute whose distribution between the five investor types is different based on a 10% significance level Attributes whose distribution between the five investor types is not significantly different

It is quite comforting to see that less than 10% of all interviewees expect to get 65% or more of their last pre-retirement income as income from state pension. The average expected by all interviewees is 46%, a surprising result in light of the widely quoted historical replacement rate for the standard retiree of 70%. However, these estimates reflect the fact that indi-

220

6 Empirical analyses of individual retirement-specific FPB

viduals understand two major properties of the statutory state income. First, that the system is digressive and that even without the reforms they would not get the full 70% replacement rate of their income as their income is well above the average income of the standard retiree 396 and even above the “Beitragsbemessungsgrenze”. Second, that the reforms underway will further decrease the replacement rate. Therefore, these estimates indicate that the affluent segment in Germany has a basic understanding of income expectations from the statutory state pension. But these estimates are still much higher than the more realistic rates resulting from the simulation analysis in sub-chapter 6.4. 397 Considering the different human tendencies, these overestimations of statutory state retirement income could be an effect of unbounded optimism, combined with a perception bias that leads to the insufficient adaptation of mental frames. Following the arguments of EDWARDS 1968 that individuals adjust their mental expectations in the right direction but just not far enough, this could be interpreted as conservatism. This inability to assess their income streams is another reason for relaxing the assumptions of rationality inherent in the life-cycle hypothesis and illustrates that individuals need help in financially planning their retirement. Comparing the different pillars of pension income, the weighted averages corroborate the findings of FV_4 and FV_5, namely that more individuals have a private than an employer-based pension provision with weighted average contributions of 26% and 12% respectively. This also reflects the varying importance of the income sources as described in the fundamentals of the German pension system in sub-chapter 3.2. It also shows the greater relative importance of the private and the employerbased pension compared to the state pension – a circumstance reflecting the affluent characteristics of the individuals analyzed. 398 Significant intertype differences can only be perceived with the income from private pensions, which is most pronounced for the Limited-wealth Self-employed and the Wealthy and therefore consistent with the findings above. 396

Fur further details see also sub-chapter 3.2. The replacement rates of statutory state pension income relative to the last real net pre-retirement income are 35% for the Limited-wealth Risk-groups, 26% for the Limited-wealth Self-employed, 27% for the High-potential and 17% for the Wealthy. 398 In sub-chapter 3.2, where the pension income sources of an average individual in Germany are described, statutory state pension contributes around 85% to an average retiree’s income with 10% stemming from private pensions and 5% coming from employer-based pensions. For the total expected income of the affluent individuals represented in this sample, the figures are 55% from state pension, 30% from private pensions and 15% from employer-based pensions. 397

6.2 Analysis of investor type specific FP perspectives

221

Overall the weighted average of the sum of all three pension income sources 399 ends up at 82%. Compared to the historical 70% and actual averages of 60% 400 this amount is very high and once again illustrates the human tendency for unbounded optimism and conservatism. Comparing relative expectations (FV_7) with absolute income forecasts (FV_8) reveals similar patterns to those observed in the estimation of the expense streams: the absolute indications tend to be higher. One explanation for this might lie in the underestimation of the last pre-retirement income and correspondingly the lower basis for the relative calculation. Another explanation is the different foci of the two questions: In the relative income question, individuals were asked about the incomes from state pension, private pension and employer-based pension separately, and the results then added up. In the absolute question, individuals were asked only about the income in Euro they expected to get in retirement. No details were provided about the sources of this income. Therefore, it is conceivable that individuals would also consider income from real estate or the yields from their investments in this absolute measure, so it paints a more complete picture of the income side of the inter-temporal financial optimization problem expressed in Equation 2.3. This is one reason why the consideration of the retirement gap in the next section will be based on the indicated absolute forecasts for the consumption (income needs) and income streams (FV_3 and FV_8 respectively). 6.2.2.3 Analysis of the retirement gap based on individually estimated income and expense streams

The retirement gap analysis investigates whether the income streams expected by the individuals are high enough to satisfy the income needs resulting from consumption plans. As indicated above, the retirement gap is calculated on the basis of the absolute indications of the income and expense streams since they are more complete and thus better map the individual financial optimization problem that individuals face in retirement (Equation 2.3). The comparison of absolute indications also allows for a more comprehensive analysis since answers are available for all interviewees, and not just the pre-retirees. Also, the potential bias in the answers was further reduced as the absolute numbers were asked in the confidential 399

The values do not correspond to the sum of the weighted averages of the state pension income, the employer-based and private pension income, as the sum has been calculated on the individual level and only thereafter has the average been derived. 400 See PEAPE 2004, p. 11ff.

222

6 Empirical analyses of individual retirement-specific FPB

part of the survey and as the interviewee had to note the required needs and the income expectations immediately after each other. So the chances are high that the interviewee would have mentally compared these values directly with each other, which would lead to a better quality estimate of a possible retirement gap. Table 6.18 displays the respective results. Table 6.18 Share of individuals with a specific (positive or negative) retirement gap calculated from their expected absolute income and expense streams LimitedLimitedwealth Risk- wealth SelfRetirees groups employed

Highpotential

Wealthy

All investor types

as % of total sample n=

238

53

55

83

66

495

2% 14% 68% 14%

0% 8% 77% 15%

6% 9% 65% 15%

2% 10% 67% 19%

9% 17% 55% 18%

3% 12% 66% 16%

3%

0%

6%

2%

2%

3%

16% 68% 17%

8% 77% 15%

15% 65% 20%

12% 67% 21%

26% 55% 20%

15% 66% 18%

Retirement gap (in absolute terms: FV_8 income - FV_3 FV_9 expenses) Incomes greater by more than €15k Incomes greater by up to € 15k Incomes equal expenses Expenses greater by up to € 15k Expenses greater by more than €15k Total positive retirement gap Incomes equal expenses Total negative retirement gap

Remark:

Analysis based on questions H. 5 and H. 6 Attribute whose distribution between the five investor types is not significantly different based on a 10% significance level

Two thirds of those interviewed do not think they will have a retirement gap because their income will match their expenses. This result – surprising as it might be – is consistent with the analysis above where the average anticipated expenses (€48.4k; FV_3) and the average expected income in retirement (€48.0k; FV_4) were similarly high. This result could be due to a lack of careful and considerate financial planning approach, in that most individuals have not given their income or expense streams in retirement a detailed thought and so assume them to be identical. Among those individuals who expect a difference between the income needs and the effective income, 18% expect a negative retirement gap where the income streams do not satisfy the expenses needed, whereas a slightly lower 15% expect a positive one, allowing for further savings.

6.2 Analysis of investor type specific FP perspectives

223

The picture looks different for various investor types even if the results are not statistically significantly different. The differences and conclusions are confirmed in the simulation analysis in sub-chapter 6.4. Among the Wealthy, more individuals expect a positive than a negative retirement gap (26% vs. 20%). Given that the Wealthy already have substantial financial and real estate assets that might also yield good returns in retirement, 401 that they have further complemented their income sources with e.g., private pensions and that they also count on substantial inheritances, not expecting a retirement gap might indeed reflect the real situation for many of them. This could be true even bearing in mind that their expense streams are substantially higher on an absolute basis than those of other individuals analyzed. Among all the other investor types, more individuals expect to have a retirement gap than not. For the Retirees, the difference between individuals reckoning on a negative and a positive retirement gap is least pronounced (17% versus 16%). This is probably realistic since at the moment they benefit from the existing pension regulations. For the Limited-wealth Risk-groups, the Limited-wealth Self-employed and the High-potential however, the risk of having a negative retirement gap looks more imminent. Among the Limited-wealth Risk-groups, the largest share of individuals (77% compared to an average of 66%) do not expect a retirement gap, which – given that this is the easiest answer – might also be an indicator of the lack of an intensive examination of their financial flows in retirement. Among those that do take a stance, 8% expect a positive retirement gap while 15% count on an income that will not satisfy their needs. These circumstances point to the fact that this investor type is at substantial risk with regard to a secured financial situation in retirement. Of the Limited-wealth Self-employed, 20% expect to have a negative retirement gap versus 15% expecting a surplus. This result is particularly telling as the income side is supposed to include also the rental income, which plays an important role for this investor type. This suggests that in spite of their substantial financial cushion in property holdings, the situation for this investor type in retirement does also not look as secure as first sight would indicate. This thus reconfirms their positioning as an investor type with a below average risk capability. The High-potential, of whom 21% show a negative retirement gap (versus 12% that expect a surplus), have again very different circumstances. These individuals tend to have a higher coverage of private pensions and 401

Even considering that the share of equity investments will decrease as the individual approaches retirement to reflect a more conservative risk approach.

224

6 Empirical analyses of individual retirement-specific FPB

employer-based contributory pensions than the average individual. Therefore they can expect more income from these complementary sources. At the same time, they expect to need between 83% (FV_2) and 96% (FV_3) of their last pre-retirement income to live comfortably, which corresponds to a rather expensive lifestyle. In spite of all the ambitious plans for retirement however this investor type has shown the most pronounced preparedness to restrict his lifestyle (even so far as to moving in with the family), sell a second property or release other investments. From this, it can be concluded that their expense side is particularly variable and would thus help to absorb a possible negative retirement gap. Consequently, their overall situation can be considered as second least risky after the Wealthy. These findings show that even if there are slightly more individuals expecting a negative than a positive retirement gap, most do not fear that one day they won’t be able to cover their old age expenses with their retirement income. The Wealthy are in by far the best situation. The Highpotential seem to be least at risk from the other investor types due to their flexibility on the expense side and many complementary income sources. The Limited-wealth Self-employed seem to benefit from a certain security due to their property but overall have more risk than the High-potential due to their specific job risk and high living expenses (FV_3). The Limited-wealth Risk-groups finally are the individuals that are most at risk because of a very thoughtless financial planning approach and the least pronounced complementation of their retirement income with other sources. 6.2.2.4 Comparison of retirement gap with feeling of financial preparedness for retirement

To close the description of the financial perspectives on life in retirement and specifically illustrate the investigated retirement gap from another dimension, the feeling of financial preparedness of individual investor types is analyzed. Table 6.19 displays the level of preparedness of the five investor types that is not statistically significantly different.

6.2 Analysis of investor type specific FP perspectives

225

Table 6.19 Share of individuals expressing a specific feeling of financial preparedness for retirement LimitedLimitedwealth Risk- wealth Selfemployed groups Retirees

Highpotential

Wealthy

All investor types

as % of total sample n=

238

53

55

83

66

495

Individuals who feel/felt well prepared for retirement

68%

55%

79%

59%

77%

68%

Individuals who feel/felt neither well prepared nor unprepared

28%

34%

15%

32%

20%

27%

3%

11%

6%

9%

3%

5%

FV_10 Feeling of financial preparedness

Individuals who feel/felt unprepared for retirement

Remark:

Analysis based on questions C. 18a for pre-retirees and C. 18b for Retirees Attribute whose distribution between the five investor types is not significantly different based on a 10% significance level

The majority of all individuals (68%) feel or felt financially well prepared for retirement. Given that the analysis of the retirement gap has revealed that most individuals expect their income to equal their expense streams (66%) and that on average a further 15% count with a positive retirement gap, this result is understandable. Bearing in mind however that over 30% of all individuals intended to continue to save (PL_4), this attitude raises certain questions. What is really astonishing is that only 5% feel unprepared for retirement but 18% of all individuals reckon on having a negative retirement gap. This is a clear sign of a human limitation caused by perception biases such as unbounded optimism. Furthermore, it illustrates a lack of realism, a very thoughtless financial planning approach and can be considered as an expression of mental dissonance. Among the five investor types, the Limited-wealth Risk-groups and the High-potential seem to be the most worried with 11% and 9% respectively indicating they feel unprepared. However, these percentages also fall short of the individuals whose income and expense streams lead to a negative retirement gap (15% and 21% respectively in FV_9). This overly optimistic result is surprising in light of another finding from FRICK 2005. She investigated the individual level of happiness and found that the 40 to 80 year old Germans are overall “fairly happy” with their lives. The only area where they think that the generation of their parents was better off is precisely pension provision. 402 Therefore, one could 402

See FRICK 2005, p. 34, 38.

226

6 Empirical analyses of individual retirement-specific FPB

expect that more of them would feel financially unprepared for retirement. But, as the results show, optimism dominates once more. This discussion leads to the investigation of the extent to which human intuition – in the form of the feeling of preparedness – can be trusted with regard to taking individual retirement-specific financial planning decisions. One way to shed light on this question is to compare the level of perceived preparedness before retirement with the actual financial preparedness of Retirees. Table 6.20 Felt financial preparedness versus actual financial preparedness of Retirees Retirees who felt well prepared

Retirees who felt neither prepared nor unprepared

Retirees who felt unprepared

All Retirees

as % of total sample n=

164

66

8

238

97%

22%

0%

73%

2%

74%

0%

22%

1%

5%

100%

5%

Actual financial preparedness of FV_10 Retirees Individuals who were financially well prepared for retirement Individuals who were neither financially prepared nor unprepared for retirement Individuals who were financially unprepared for retirement

Remark:

Analysis based on question C. 18b Attribute whose distribution between the five investor types is not significantly different based on a 10% significance level

Table 6.20 clearly shows that a vast majority of the interviewees who were able to make an assessment ended up in retirement in the situation they had predicted (97% of those that felt well prepared were actually well positioned financially in retirement and 100% of those that initially felt unprepared were badly off). Among the undecided individuals, more ended up with a positive situation than vice versa (22% turned out to have been well prepared and 5% felt they were financially unprepared for retirement). Therefore, it can be concluded that – at least for the current generation of retirees – most individuals were positively surprised by their situation in retirement and thus their feeling of being well prepared was confirmed and reinforced. This reflects that the system in place has worked quite well un-

6.2 Analysis of investor type specific FP perspectives

227

til now, since it has managed to meet its goal and reach replacement rates that were substantial. 403 However, due to the major changes underway, the current generation of pre-retirees has a very different perspective on retirement. Therefore, anchoring their attitudes and behavior in the experiences of the actual generation of Retirees would lead to wrong decisions and must be avoided. A second indicator as to the quality of human intuition in the form of the feeling of preparedness is the extent to which it reflects the size of the selfassessed retirement gap. Table 6.21 sheds light on the connection between the size of the retirement gap (FV_9) and the feeling of financial preparedness (FV_10). Table 6.21 Feeling of financial preparedness for retirement versus retirement gap calculated from expected absolute income and expense streams Individuals expecting a negative retirement gap

Individuals Individuals expecting a positive expecting no retirement gap retirement gap

All investor types

as % of total sample n=

76

328

90

495

Individuals who feel/felt well prepared for retirement

80%

68%

56%

68%

Individuals who feel/felt neither well prepared nor unprepared

13%

27%

38%

27%

7%

5%

6%

5%

Feeling of financial FV_10 preparedness

Individuals who feel/felt unprepared for retirement

Remark:

Analysis based on questions C. 18a for pre-retirees and C. 18b for Retirees and FV_9 Attribute whose distribution between the five investor types is not significantly different based on a 10% significance level

The analysis reveals that there is only a weak relationship between the self-assessed size of the retirement gap and the feeling of preparedness. This indicates an unthinking approach to assessing the feeling of preparedness or estimating the income and expense steams. While it is explicable that 7% of those with a positive retirement gap may feel unprepared because they are very worried or insecure individuals, it is quite alarming that 56% of those individuals who expect a negative retirement gap still feel well prepared. These individuals might be influenced by overconfidence and unbounded optimism and seem to lack the ability to objectively 403

According to the OECD 2001 historic replacement rates amounted to around 90% relative to the income of people aged 18 and over in Germany in the mid 80s and mid 90s. See OECD 2001, p. 27.

228

6 Empirical analyses of individual retirement-specific FPB

assess their situation. Another explanation could be that these individuals are prepared to dissave and thus do not necessarily need to feel unprepared. Since, on the other hand, dissaving as financial objective in retirement registered a popularity level of 36% (compared with keeping a reserve (89%) or leaving an inheritance (60%), PL_3), this explanation can hardly suffice for all these specific cases. Therefore, even if some explanations for this attitude exist, this problematic feeling of preparedness still persists and needs to be addressed with the utmost urgency. Overall, these findings underscore the importance of the six principles defined in sub-chapter 4.4, and more specifically that a realistic understanding of one’s own financial situation in retirement is essential and that due to the typical human limitations individuals need help in financial planning for retirement. 6.2.3 Analysis of the transaction preferences Apart from the qualitative perspective on life in retirement and the expected financial streams, the FP perspectives illuminate the attitudes individuals have with regard to taking financial decisions in retirement. Understanding the way individuals like to collect information for, or decide on, retirement-specific financial matters is important for a comprehension of their behavior. Furthermore, their preferences with regard to transactions tend to be a good indicator of the image the various groups have of themselves and as such show how these individuals should be approached. 6.2.3.1 Preferences for information gathering and decision making

The first analysis of transaction preferences sheds light on how individuals like to collect information and make decisions in the process of financial planning for and in retirement (TP_1). Table 6.22 illustrates the different answer options representing degrees of delegation that are evidently differently distributed between the five investor types.

6.2 Analysis of investor type specific FP perspectives

229

Table 6.22 Share of individuals indicating different levels of delegation in their decision making LimitedLimitedwealth Risk- wealth Selfemployed groups Retirees

Highpotential

Wealthy

All investor types

as % of total sample n=

238

53

55

83

66

495

59%

54%

60%

51%

58%

57%

15%

15%

16%

22%

13%

16%

20%

22%

22%

23%

7%

19%

6%

9%

2%

4%

21%

7%

Delegators

Advice seekers

Self Validators directed

TP_1 Decision making Individuals who prefer to collect information from various sources and make decisions themselves Individuals who prefer to collect information from multiple financial professionals and make decisions themselves Individuals who prefer to collect information from one financial advisor but make decisions themselves Individuals who have a relationship with one financial advisor and rely on this advisor to make the best decisions for them

Remark:

Analysis based on question D. 1 Attribute whose distribution between the five investor types is not significantly different based on a 10% significance level

The dominant strategy for all five investor types is the collection of information from various sources combined with a decision making by the individual. This preference indicates self-directed and self-motivated behavior and reflects the increasing importance of the element of self determination identified by FRICK 2005. But even so, there are substantial differences. The Limited-wealth Self-employed are the most self-directed, with 60% of them expressing this preference – a transaction behavior that reflects their employment situation and therefore seems logical. Individuals of the Wealthy and the Retirees types also score highly on the selfdirected behavior scale (59% and 58%). The High-potential and the Limited-wealth Risk-groups have a below average share of self-directed individuals, but with 51% and 54% respectively this preference still accounts for the majority of the individuals assigned to these investor types. Looking at the other three alternative ways of information-gathering and decision-making – all of which are linked to more delegation – further different patterns appear. The Wealthy show the most pronounced differences with more than one in five delegating the information collection and decision-making to one financial advisor. This approach corresponds to the way investment decisions are taken in a managed portfolio set-up and reflects that the Wealthy individuals tend to be most frequently targeted with

230

6 Empirical analyses of individual retirement-specific FPB

these mandates as their portfolios have the required size. The Limitedwealth Risk-groups also have a relatively high preference for delegation, but the argument for a mandate-relationship can be ignored here due to the limited size of their portfolio. A possible explanation is that these individuals delegate decisions because they do not feel themselves to be sufficiently knowledgeable about the issue, which would put the Limitedwealth Risk-groups interviewees in a situation of extreme dependency. Should this be the case, it would substantially reinforce the second principle defined in section 4.2.2 that demands an adequate individual understanding of the financial situation in retirement but at the same time the need for more stringent standards for advisors to avoid this dependency being exploited. 6.2.3.2 Decision preferences in the family context

The second element of these transaction preferences investigates the role of the family in the context of making a decision (TP_2). Table 6.23 Share of individuals expressing specific decision preferences in the family context LimitedLimitedwealth Risk- wealth SelfRetirees groups employed

Highpotential

Wealthy

All investor types

as % of total sample n=

238

53

55

83

66

495

Individuals who take decisions together with their partner

54%

50%

40%

67%

43%

53%

Sole decision taker

46%

50%

60%

33%

57%

47%

Decision preferences in the TP_2 family context

Remark:

Analysis based on question A. 10 Attribute whose distribution between the five investor types is different based on a 10% significance level

A slight majority (53%) of individuals prefer to make decisions jointly with their partner. The results in Table 6.23 are significantly different for the five investor types. The High-potential are the most likely to make financial decisions with their partner (67%), illustrating the importance this investor type attaches to the family, which is also evident in their strong desire to spend time with their family upon retirement (PL_2). The Limited-wealth Self-employed show the most pronounced propensity to be a sole decision taker (60%). This reflects their strong sense of self-direction observed with regard to TP_1, their responsibility in the job as well as the plan to continue working in retirement and to retire late

6.2 Analysis of investor type specific FP perspectives

231

(PL_1, PL_2). This illustrates that this investor type is very much a Do-ItYourself-Type who also believes himself to be knowledgeable enough to perform the activities himself. 6.2.4 Analysis of the risk profile The fourth construct within the FP perspectives is the investor type specific risk profile. As shown in Fig. 2.4, the study-specific definition of the risk profile relies on three elements: the objective risk capability, the subjective risk appetite and the subjective risk sophistication. The logic of the objective risk capability was used to derive the original eight investor groups that were pooled into five investor types with distinctly different profiles based on similarities in their socio-demographic and socio-economic attributes (sub-chapter 6.1). Having the largest financial cushion, the Wealthy have been identified as the investor type with the highest risk capability. The High-potential, whose financial cushion is substantially less comfortable, rank second due to a younger age, their educational background and recent experiences that point to a substantial wealth potential. Both of these investor types have an above average risk capability. The Limited-wealth Self-employed do have a solid financial cushion but need to be acknowledged as an investor type with a below average risk capability due to their job situation. The Retirees have an even lower risk capability because of their status in the life-cycle, even if they dispose of a substantial financial cushion now that they can use for dissaving in retirement. The Limited-wealth Risk-groups finally have the lowest risk capability, which is driven by a combination of the smallest financial cushion and various personal risks. 6.2.4.1 Analysis of self-assessed risk appetite

The self-assessed risk appetite is the basis of numerous client segmentations in financial services, and as an indicator for the adequacy of an individual’s investment strategy it is a key element of the client advisory process. 404 The risk appetite builds on the risk-return trade-off, where a higher 404

Interviews with GAST 2005 and FISCHER 2006. In practice, the concept of risk appetite is used in such a way that wealth is allocated to different wealth pots with different time horizons and different risk appetites, to each of which the appropriate investment strategy is tailored. See e.g., TRACHSLER 2001, p. 93. Similarly, also SPREMANN 1999 argues for a distinction of assets into lunch money and smart money according to primary and secondary investment goals. See SPREMANN 1999, p. 22.

232

6 Empirical analyses of individual retirement-specific FPB

level of assumed risk is compensated for by a higher than expected return. The self-assessed risk appetite measures the degree to which individuals are willing to accept a certain loss if at the same time, they can expect their return to increase in the long-term. Table 6.24 describes the different risk-return options that individuals could choose based on their preferences and are evidently differently distributed between the five investor types. Table 6.24 Share of individuals assessing themselves as having a specific risk appetite LimitedLimitedwealth Risk- wealth SelfRetirees groups employed

Highpotential

Wealthy

All investor types

238

53

55

83

66

495

Completely risk averse

Individuals who are not prepared to accept any losses on their capital over even shorter periods and so invest only in cash type investments and deposits

57%

53%

40%

45%

12%

47%

Risk averse

as % of total sample n=

Individuals who would be prepared to risk a 0% p.a. return (but no worse), if they could generally expect to make returns of 5%-7% p.a. in the long run

31%

32%

29%

31%

38%

32%

Individuals who would be prepared to risk small losses of up to 5% p.a. if they could expect to make up to 10-12% p.a. return

9%

11%

22%

18%

30%

15%

Individuals who would be prepared to risk up to 10% p.a. if they could expect to make up to 20% p.a. return

2%

4%

9%

6%

20%

6%

Self-assessed risk appetite

Comfortable with risk

Somewhat comfortable with risk

RP_1

Remark:

Analysis based on question B. 3 Attribute whose distribution between the five investor types is not significantly different based on a 10% significance level

Table 6.24 illustrates that almost half of all interviewees are completely risk averse and another third chooses the risk averse option. Only 21% seem to be comfortable with assuming risk. This implies that the affluent segment in Germany can be considered very risk averse. Per se, risk aversion is consistent with the assumptions about rationality in the standard economic theory and implies that individuals need to be compensated with a positive security equivalent (i.e., a higher expected return if they are to accept a higher risk level). 405 Furthermore, this risk aversion also explains 405

See TVERSKY 1990, p. 73.

6.2 Analysis of investor type specific FP perspectives

233

the low share of equity holdings in Germany compared to countries such as the UK or the US. 406 As the distribution of the answers indicates, there are substantial differences in the risk appetite among the five investor types, but before discussing these findings, the four levels of self-assessed risk appetite need to be understood better. Due to the nature of the different answer options, it is assumed that the statements refer to nominal values. Furthermore, the proposed risk-return trade-offs must be considered as strictly indicative and conceptual. It is not the purpose of this research to judge whether it is realistic to expect a 5-7% return p.a. in the long run if one is not willing to accept a negative performance in any year. The first two options are particularity interesting not only because they have been chosen by so many individuals but because of the messages they convey: 407 The consequences of both statements with regard to negative performance is identical: There can be no nominal losses, so capital preservation is their primary investment goal. 408 At the same time these statements are an indication of the individual’s knowledge about the functioning of capital markets and suggests what kind of products individuals are interested in. With regard to knowledge about capital markets mechanisms, the first statement may indicate that the surveyed individuals are not suffi406

See DAI 2006 that states that 17% of the British population were stockholders in 1992 while in the US the average household had 19% of their assets in stock holdings and a further 10% in mutual funds in 1996 already. The German share for 1996 amounted to 9% and has since increased slightly with a growing importance for the equity mutual funds and a lower share of direct equity holdings. According to SIERMINSKA et al. 2006 the US households exhibit the highest preference for financial assets as around 35% of total assets are held in financial assets, over two thirds of which are held in risky investments such as stocks or mutual funds. See SIERMINSKA et al. 2006, p. 15. 407 The exact German translation of the first two options of question B. 3 reads as follows: Option 1: “Ich bin nicht bereit, Verluste auch über kurze Zeiträume hinzunehmen und investiere deshalb in sichere Anlagen wie Sparbuch, Festgeld, Bundesschatzbriefe, usw.” Option 2: “Ich wäre bereit, in schlechten Jahren auf eine Rendite zu verzichten, solange kein Kapitalverlust eintritt und ich insgesamt (über die gesamte Laufzeit, also Ausgleich schlechterer Erträge in einem Jahr durch höhere Erträge in anderen Jahren) eine Rendite von 5%-7% pro Jahr erwarten kann.” The complete questionnaire can be found in Appendix 3. 408 As mentioned in the risk profile (section 2.2.3), the subjective risk appetite alone is not a broad enough base on which to decide the investment strategy and the concrete product recommendations for an individual. Such a proposal would need to take into consideration also the objective risk capability and the subjective risk sophistication. The analogy to investment goals and investment strategy is laid out here for information only.

234

6 Empirical analyses of individual retirement-specific FPB

ciently aware of a risk-return trade-off. They solely focus on the shortfall risk. Alternatively put, they only have a one-dimensional perspective on risk. The interviewees who choose the second option also want to avoid capital losses but acknowledge that even with a very limited risk appetite, the return can be enhanced by leveraging the appropriate capital market products. Therefore it can be assumed that they have a two dimensional (risk and return) perspective. With regard to product choices, individuals choosing the first option only invest in cash type investments, saving accounts, treasury bills and fixed-term deposits. Interviewees opting for the second statement also have guaranteed funds or other capital-guaranteed structured products in their focus. 409 Overall, these two attitudes show that an income-focused investment strategy might best fit these individuals. Nevertheless, it needs to be considered that this self-assessed risk appetite is only indicative and that an investment decision needs to be individually verified and furthermore adapted to the objective risk capability and the subjective risk sophistication. The considerations of capital-market related knowledge and an adequate product range can also be extended to the third and the fourth categories of risk appetite. These individuals’ awareness of the risk-return trade-offs indicates a heightened level of knowledge of capital market mechanisms. The third option is termed “somewhat comfortable with risk” and implies that these interviewees are not only aware of the risk-return trade-off but also open to most financial products. Here, the investment goal is a combination of capital preservation and asset growth and the adequate investment strategy is a yield strategy. Arrangements such as portfolio insurance (investments with limited downside risk) or other investment products with a floor that limits the downside risk are interesting products for individuals being somewhat comfortable with risk. For individuals of the fourth category, who are comfortable with risk and whose investment goal focuses on long-term capital growth, options and leveraged products could also be appropriate investment solutions. The investor types most likely to be either completely risk averse or risk averse are the Limited-wealth Risk-groups and the Retirees (85% and 88%). For the Retirees, this attitude reflects the fact that an individual’s risk appetite tends to decrease with retirement. 410 In the Limited-wealth

409

See also BERNET 2005a, p. 28 who suggests leveraging a better integration of the financial- and risk markets in order to create products with such a risk protection. 410 “If you are retired, you might favor save investments providing fixed yearly returns. Appreciation in the price of a security is not as important as stable, guar-

6.2 Analysis of investor type specific FP perspectives

235

Risk-groups many individuals are exposed to specific risks without having the comfort of a solid financial cushion, so it is somewhat rational that they intend to balance these life-risks with a conservative financial stance. Furthermore, it should be considered that these investor types have the highest share of women, who tend to have a lower risk appetite. 411 However, another perspective is required here: Interestingly enough, over 50% of these two investor types opt for the completely risk averse solution. This suggests that financial knowledge or awareness of capital market mechanisms that could help to enhance the expected long-term return is limited in a majority of these two investor types. This is especially daunting with regard to the Limited-wealth Risk-groups who are still in their working life and so have a considerable saving period in front of them, while at the same time facing a lack of income sources to supplement statutory state retirement income (see FV_4 and FV_5). These findings highlight that, especially for people who are not familiar with the capital market mechanisms, education could improve individual retirement-specific FPB. Individuals who are completely risk averse and therefore do not want to accept losses even over very short time horizons can even be found among the Limited-wealth Self-employed (40%) and the High-potential (45%). However, compared to the above two investor types, where only between 11% and 15% are willing to accept some risk, the share of individuals being (somewhat) comfortable with risk within these two investor types is much higher: 31% of the Limited-wealth Self-employed and 24% of the High-potential are prepared to incur certain losses in order to enhance the expected return of their portfolios. Therefore it can be concluded that the High-potential and specifically the Limited-wealth Self-employed have a more pronounced risk appetite and also a higher level of understanding of financial mechanisms. The Wealthy have the most accentuated risk appetite. Half of its individuals believe they are (completely) risk averse – 12% and 38% respectively – and so focus on capital preservation. Of the other half, 30% are prepared to accept some losses and are somewhat comfortable with risk while 20% are ready to assume the risk required for a capital growth stratanteed income. Risky investments are undesirable due to uncertainty.” SHIM/SIEGEL 1991, p. 233. 411 CLARK et al. 2004 find that “almost half of the women [in their survey ]indicated that they were either conservative or moderately conservative investors, as compared to 44% of the men. This finding is consistent with other surveys that report women as more likely to elect lower risk-lower return investment choices than men.” CLARK et al. 2004, p. 191. See also GLASS/KILPATRICK 1998, p. 611.

236

6 Empirical analyses of individual retirement-specific FPB

egy and are comfortable with risk. With the overall most pronounced risk appetite, the answers of this investor type reflect the finding that individuals dare to assume more risk as they get wealthier. Furthermore, their education and financial experience induces them to understand that a longterm saving strategy can or even should include an elevated risk level to maximize returns in the long run. 6.2.4.2 Analysis of risk sophistication

The second subjective element in an individual’s risk profile is the risk sophistication. The risk sophistication is driven by the individual’s selfassessed level of financial sophistication and subjective experience with risks. The latter includes the awareness of specific risk types and the translation of this awareness into an expressed interest in hedging the risks with specific financial products. Overall, the risk sophistication can be seen as an indicator of the willingness to deal with financial and specifically risk issues. Self-assessed financial sophistication

The individual level of financial sophistication is investigated by asking interviewees to assess their own financial sophistication relative to the level of financial knowledge of the average investor with a similar background. Table 6.25 shows the distribution of the self-assessed financial sophistication level. Almost half of all individuals (46%) attribute an average financial sophistication level to themselves. What is interesting to note is that more individuals believe themselves above average than below (31% versus 22%). This is a typical sign of the human tendency to overconfidence discussed in the sub-section on the positive bias with the example of driving skills (4.2.2.2) and thus confirms the assumption that FPB is very prone to overconfidence.

6.2 Analysis of investor type specific FP perspectives

237

Table 6.25 Share of individuals assessing themselves as having a specific financial sophistication level LimitedLimitedwealth Risk- wealth Selfemployed groups Retirees

Highpotential

Wealthy

All investor types

as % of total sample n=

238

53

55

83

66

495

Individuals who assign themselves a below average level of financial sophistication

23%

19%

15%

18%

34%

22%

Individuals who assign themselves an average level of financial sophistication

51%

55%

43%

47%

27%

46%

Individuals who assign themselves an above average level of financial sophistication

27%

26%

43%

35%

39%

31%

Self-assessed financial RP_2 sophistication

Remark:

Analysis based on question B. 2 Attribute whose distribution between the five investor types is different based on a 10% significance level

Table 6.25 also shows significant differences between the five investor types. The Wealthy show the most pronounced propensity to stand out and attribute an above or below average financial sophistication to themselves. Given that this investor type has generally been understood as being financially educated, it is surprising that 34% of the Wealthy think they have a below average financial sophistication. This high share could be explained by the relevant peer group (i.e., they compare themselves with other wealthy individuals who tend to be more financially sophisticated) or by a more pronounced awareness about the complexity of the individual financial optimization problem. Combining this observation with the preferences for transactions might explain the comparatively higher share of Wealthy preferring to delegate the information collection and decisionmaking process to an advisor (See TP_1 in sub-section 6.2.3.1). However, should these individuals really have a below average financial sophistication and prefer to rely on advisors, these circumstances would again emphasize the need for an independent quality control for financial advisors. On the other hand 39% of the Wealthy believe they have an above average level of financial sophistication, which corresponds to the second highest share of above average knowledge. The Wealthy’s share of above average sophistication is topped only by the Limited-wealth Self-employed, where 43% assess themselves as having a better financial knowledge than their peers. Although a majority of

238

6 Empirical analyses of individual retirement-specific FPB

the High-potential, the Limited-wealth Risk-groups and the Retirees, also attribute to themselves an above average level of financial sophistication, the percentages are substantially lower (only 35%, 27% and 26%) than those of the Wealthy and the Limited-wealth Self-employed. Combining these observations with the other findings from the survey leads to the conclusion that – in spite of the sample’s evident overconfidence – the share of individuals with an above average self-assessed financial sophistication is a guide as to the true level of financial knowledge. The Wealthy and the Limited-wealth Self-employed have the highest level of financial sophistication based on their solid education, asset volumes that make it necessary to look into the subject of investment management and financial planning earlier, and their overall job situation. They tend to have more (financial) responsibility and – specifically for self-employed – chances are high that the creation of one’s wealth was supported by investor knowledge and risk-taking experience, suggesting that a successful entrepreneur enjoys a higher level of financial sophistication. The Highpotential can be assumed to have a medium level of actual financial sophistication based on their education and their age. They also dispose of a lower wealth level which reduces their potential for financial experiences. Lastly, the Limited-wealth Risk-groups and the Retirees can be expected to have the lowest level of financial sophistication due to their age (for the Retirees) or their education and wealth situation (for the Limited-wealth Risk-groups). To complement the assessment of the individual risk sophistication, it is also necessary to understand which risks individuals are most concerned about and if this level of concern translates into an interest for financial products to hedge them. “Worry indicator” as quantitative measure for an individual’s risk awareness

To give an overview of the level of concern, the total number of risks an individual acknowledges as somewhat, very or fairly important to his financial situation in retirement is analyzed. The weighted average number of all risks acknowledged in Table 6.26 can be considered as a “worry indicator” measuring the amount of anxiety the individuals feel with regard to their retirement. This worry indicator is important because it is commensurate with the motivation individuals have to hedge a specific risk because as “people have difficulty envisioning their life, health situation and

6.2 Analysis of investor type specific FP perspectives

239

finances far into the future, […] they may not be motivated to address these issues” 412 when they do not think that risks will happen to them. Table 6.26 Share of individuals acknowledging a specific number of risks as somewhat, fairly or very important for their financial situation in retirement (worry indicator)

Retirees

LimitedLimitedwealth Risk- wealth Selfgroups employed

Highpotential

Wealthy

All investor types

as % of total sample n=

238

53

55

83

66

495

1% 18% 38% 43%

0% 10% 19% 71%

4% 9% 31% 56%

1% 8% 29% 61%

0% 6% 50% 44%

1% 13% 35% 51%

8.7

10.3

9.4

9.8

9.2

9.2

Worry indicator: Number of risks recognized as somewhat, very or RP_3 extremely important 0- 1 2- 5 6- 9 10 - 14 Average number of risks acknowledged

Remark:

Analysis based on question C. 11 Attribute whose distribution between the five investor types is not significantly different based on a 10% significance level

With an average worry indicator of 9.2 (out of 14 possible risks), it can be concluded that the interviewees are on the whole very concerned about the different risks. 413 This is consistent with the dominance of (completely) risk averse individuals identified above, showing that this worry indicator is closely linked to the self-assessed risk appetite (RP_1). There exist evident differences between the five investor types. The Limited-wealth Risk-groups, followed by the High-potential, show the highest levels of concern and should be considered very worried with regard to their financial situation in retirement. These results mirror the selfassessed risk appetite, in that 85% and 76% of the interviewees choose a (completely) risk averse strategy. This analogy cannot be drawn for the Retirees. They show the highest propensity to be (completely) risk averse (88%). At the same time they display the lowest level of concern about the different risks with an average worry indicator of 8.7. One potential explanation for this behavior is 412 413

DRINKWATER/SONDERGELD 2004, p. 282f. This high awareness also reflects the fact that the survey question was not asked in an open way (“Which risks do you acknowledge as relevant?”) but as aided questions, where a list of potential risks was offered. As a consequence, the total number of risks individuals are aware of tends to be higher.

240

6 Empirical analyses of individual retirement-specific FPB

that these individuals do not assume the majority of risks are relevant to them anymore given their shorter time horizon, which might be related to the human tendency to underestimate one’s own life-expectancy and thus the probability that a particular risk-event could still happen. Furthermore, this result could also be influenced by a lower overall level of concern about retirement since today’s Retirees were prepared for retirement as good as or even better than they anticipated (see Table 6.20, FV_10). Another explanation could be that most of the current generation of Retirees, having lived through the experiences or aftermath of the Second World War, see their retirement in a completely different light and is more content with it. Among the pre-retired investors however, the parallel between worry indicator and self-assessed risk appetite holds good. The Limited-wealth Self-employed, who think they have an above average risk appetite, show a lower level of concern about the various risks than the Limited-wealth Risk-groups or the High-potential. This mirrors their overall situation as they have a substantially larger financial cushion than either of these two which allows them to assume more risk. However, as with the selfassessed financial sophistication that indicates overconfidence for this investor type, it is important that they also do not remain too optimistic with regard to risk. They particularly need to consider the risks they are exposed to due to their self-employment. With an indicator of 9.2, the Wealthy show the lowest level of concern among the pre-retired investor types. Since this is the investor type with the highest objective risk capability and the greatest ability to cope with risks, the result is not surprising. Therefore, even if the Wealthy acknowledge specific risks, they might not judge them as relevant to themselves. This assessment would also explain why their subjective risk appetite is so pronounced. Drivers of risk consciousness and individual awareness about different kind of risks

To get a better understanding of the perspectives individuals have on retirement, their awareness is now differentiated according to three risks types: capital market related risks, personal risks and regulatory risks. 414 414

The capital market related risks are associated with changes in the macro-economic circumstances (e.g., interest rates or inflation level) that might lead to a decrease in asset values. The second type of risks encompasses risks that are very individual and relate directly to the interviewee. They include health prob-

6.2 Analysis of investor type specific FP perspectives

241

The awareness of individual risks is displayed in Table 6.27 and confirms that the Limited-wealth Risk-groups and the High-potential are the most worried investor types. The comparison of the average awareness of all risks across all individuals illustrates the drivers of risk awareness. For all interviewees, there is most awareness of the risks that health care will run down assets (82%), they may have to live in a retirement home, and inflation will erode their buying power (both with 81%). This awareness level is influenced by the fact that the first two risks in particular are highly individualized: The individual suffers twice over, once because he is sick or needs to live in a retirement home, and then because of the capital drain. Furthermore, being sick and living in a retirement home seems very menacing, as it represents a threat to the values of health, activity, self-determination and independence expressed in the life plans. This also reflects the observation by WEBER 2004 that risk perception is often driven by affective processes. This high awareness could also be a result of the learning effect should individuals see, for example, their parents in retirement homes or using up their assets for medical bills. This would also explain why the personal risk that individuals face but that is not very present in today’s society – the longevity risk – attracts only a limited awareness. 415 This limited awareness about the risk of outliving one’s assets could also be influenced by the fact that individuals are more worried about not living long enough than about living too long, 416 since they tend to underestimate their life-

lems which might lead to a reduced work capacity or increased health care costs. Furthermore, there is the risk of longevity, the risk of outliving one’s assets that has gotten more attention recently with the demographic shifts underway. These are termed personal risks. Third, there are the so called regulatory risks that are linked to the country-specific pension and state system, the conditions of that system and possible changes. 415 The old age poor is specifically not a problem in Germany where the state system ensures that only a minority of individuals is poor. However, countries like the UK where the state pension system provides less income know a substantially higher share of poor old people. See OECD 2001. 416 “The primary mortality risk facing people during their working years is dying too soon, a fact that boosts the demand for traditional life-insurance. For retirees, by contrast, the primary mortality risk is dying later than expected, or living longer than financial resources can support people’s desired standard of living. Longevity risk can thus be defined as the possibility that a person will outlive his savings and be forced to reduce his living standard.” DRINKWATER/SONDERGELD 2004, p. 275.

242

6 Empirical analyses of individual retirement-specific FPB

expectancy as BÖRSCH-SUPAN/ESSIG/WILKE 2005 have shown. 417 Furthermore, due to hyperbolic discounting, individuals value short-term risks such as health care costs more than long-term risks such as longevity. Lastly, the alertness for specific risks might be influenced by the saliency bias. This means that individuals are more alert to risks that have often been the subject of public discussions or featured prominently in the media, such as health care costs or the danger of inflation. In this respect the way retirement has been promoted to date (e.g., old happy people on a cruise ship, old people running marathons) conveys a far too positive picture. A different communication strategy might make sense, as AnnaMaria Lusardi puts it: “The mutual fund companies show pictures of cruises. You’ve got to show a nursing home and they’ll give it some thought. Tell them poverty at retirement is hell.” 418 An international comparison to the survey conducted by DRINKWATER/SONDERGELD 2004 reveals that the awareness in this study mirrors the concerns expressed by individuals in the US, albeit on a higher level in Germany, confirming once more an elevated risk awareness and risk aversion in Germany. Building on the comparison of the quantitative overall worry indicator and the discussion of different factors influencing risk awareness, the three types of risks are now described in detail.

417

Additionally DRINKWATER/SONDERGELD 2004 state that women tend to be less optimistic than men. They also cite a survey in which 11% of the individuals examined had already outlived their earlier determined planning horizon. See DRINKWATER/SONDERGELD 2004, p. 276. For further research it would be interesting to analyze how many individuals have already outlived their life-expectancy in Germany. 418 N.N. 2006c, p. 71.

6.2 Analysis of investor type specific FP perspectives

243

Table 6.27 Share of individuals expressing awareness of specific capital market related, personal and regulatory risks LimitedLimitedwealth Risk- wealth Selfemployed groups Retirees

Highpotential

Wealthy

All investor types

as % of total sample n=

Individuals who find the capital market risks rather, very or RP_4 extremely important Inflation will erode the buying power of my retirement savings

238

53

55

83

66

495

80%

87%

85%

87%

73%

81%

My savings will be reduced due to unfavorable market developments (e.g., negative performance)

71%

74%

82%

80%

79%

75%

Income from my savings will be lower than expected (e.g., due to low interest rates, poor performance)

70%

81%

80%

78%

91%

76%

Surplus/Profit participation of pension or life insurance will be lower than anticipated

51%

83%

76%

82%

76%

66%

58%

72%

67%

63%

62%

62%

Individuals who find the personal risks rather, very or extremely RP_4 important I will outlive my wealth and financial assets before I die (i.e., the longevity risk) Poor health and medical bills will run down my retirement assets

80%

83%

87%

81%

83%

82%

I will need to pay to live in a retirement or nursing home for an extended period

82%

75%

72%

80%

89%

81%

My money will be tied up and unavailable when I need it for specific expenses

43%

56%

49%

51%

42%

46%

I will not leave as valuable an estate behind after my death as I intended

37%

60%

43%

61%

55%

47%

69%

92%

67%

90%

67%

75%

73%

81%

76%

81%

87%

78%

76%

89%

69%

95%

70%

79%

59%

72%

73%

73%

53%

63%

Individuals who find the regulatory risks rather, very or RP_4 extremely important I will not receive the state pension currently expected (e.g., due to legislative changes) An increase in tax rates will erode the buying power of my retirement savings The value of the state pension will not increase in line with earnings I will not have a source of guaranteed retirement income

Remark:

Analysis based on question C. 11 Attributes whose distribution between the five investor types is different based on a 10% significance level Attributes whose distribution between the five investor types is not significantly different

244

6 Empirical analyses of individual retirement-specific FPB

As mentioned in the discussion of the drivers of risk consciousness above, dangers stemming from inflation are the capital market related risks of which most individuals are aware. At first glance this result surprises since behavioral finance has found that individuals have problems assessing the impact of inflation (i.e., money illusion, sub-section 4.2.3.2). A possible explanation is that individuals are aware they have trouble assessing inflation and that for this reason they are afraid of it. Furthermore, the saliency bias (sub-section 4.2.2.1) might induce individuals to recall the relatively high 4% average inflation level of the years 2001/2002 or the prominent discussion of how to keep inflation under control. Besides inflation risk, three quarters of all interviewees are worried about a reduction of their saving stock or savings income due to adverse market developments. The level of concern about the risk of a lower profit participation of the life-insurance is the lowest (66%). Given that not all individuals have a life-insurance to worry about and that the link between the interest rate risk and the surplus participation is not that evident, this awareness ratio still appears very high. Among the personal risks the increasing medical costs or the costs of living in a retirement or nursing home have the highest level of awareness (81 and 82% respectively) as pointed out in the discussion of drivers of risk consciousness. This is a very high level given that personal risks are an area that is prone to a positive bias. DRINKWATER/SONDERGELD 2004 illustrate this tendency to underestimate the probability of negative consequences and at the same time overestimate the chances of a good future for one’s self with the following example: If individuals are asked with what probability it is very likely or somewhat likely that an average 65 year old would have to spend at least some time in a nursing home before death the answer amounts to 69%. When asked about the probability that the surveyed individuals themselves would spend time in a nursing home, the very same interviewees come up with an estimate of 43%. 419 With only an average score of 62% the longevity risk does not seem at the forefront of many individuals’ minds. As illustrated above, many different explanations exist for this observation (e.g., focus on the present, hyperbolic discounting, underestimating of life-expectancy, no learning effect). The fact that “money will be tied up and unavailable” as well as the danger of “having to leave a lower value of estate than expected” seem to be less relevant, but since between 43% and 61% of the pre-retired investor types still mention the latter, it confirms that the bequest motive in this segment of the German population is very important. Therefore, leaving an 419

See DRINKWATER/SONDERGELD 2004, p. 276.

6.2 Analysis of investor type specific FP perspectives

245

inheritance is a prominent feature of the simulation analysis in sub-chapter 6.4. Given that over 60% of the Retirees intend leaving an inheritance (PL_4), the low rating for the risk of leaving a lower value estate than anticipated (37%) is a sign that these individuals believe it to be irrelevant to them since they do not reckon on having a retirement gap. With regard to the regulatory risks, the main concern of most individuals does not seem to be the danger of not having a guaranteed source of income. Instead they fear this income will not be enough because of a slower increase compared to expenses and the standard of living (79%), of an increase in taxes (78%) or simply because it will not match expectations (75%). Given the reforms underway, specifically with regard to the adaptation of the cRVt or the transition to deferred taxation, the two regulatory risks with the highest awareness level also mirror a real threat. The fact that the Limited-wealth Risk-groups and the High-potential show the highest level of concern about these risks also reflects that state retirement income is their main income source (for 87% of the Limitedwealth Risk-groups and 79% of the High-potential; FV_4) and they are thus over proportionally affected by changes in this income stream. Furthermore, it is logical that the awareness about the risk of an increased tax rate is most pronounced for the Wealthy, who would be most affected. For the Limited-wealth Self-employed on the other hand, the risk of not having a guaranteed income level logically represents a comparatively larger risk. Risk hedging – Translation of risk awareness into product interest

Insights into the awareness about a specific risk is not enough to understand the attitudes of individuals with regard to financial planning for retirement and providing against the respective threats. Instead, it needs to be examined whether this awareness also translates into interest for buying specific products. 420 Table 6.28 summarizes the expressed interest for buying financial products that protect against the specific risks selected for a more focused analysis, also termed risk hedging. To test the impact of confronting individuals with a higher life-expectancy, some questions have been asked again. The change in the answer pattern can be seen as an indicator for how effective challenging individual’s assumptions about lifeexpectancy can be in changing their risk awareness and enhancing their product interest. 420

The next step within this “funnel analysis”, the question of which risks have effectively been hedged, is analyzed in the context of FP actions. The corresponding results can be found in section 6.3.6.

246

6 Empirical analyses of individual retirement-specific FPB

Table 6.28 Share of individuals expressing an interest in a financial product hedging a specific risk LimitedLimitedwealth Risk- wealth Selfemployed groups Retirees

Highpotential

Wealthy

All investor types

as % of total sample n=

238

53

55

83

66

495

70%

71%

76%

77%

77%

73%

Inflation risk: increasing living costs will erode the buying power of my retirement savings

75%

79%

85%

82%

75%

78%

Performance risk: My savings will be reduced due to unfavorable market developments (e.g., negative performance)

66%

56%

74%

69%

84%

69%

Short-term interest rate risk: Income from my savings will be lower than expected due to low short-term interest rates

63%

64%

75%

67%

72%

67%

Long term interest rate risk: Surplus/profit participation of pension or life insurance will be lower than anticipated due to lower long term interest rates

60%

64%

74%

77%

76%

67%

Average level of interest (before prompting with longer live expectancy) Individuals interested in a financial product that would protect them from the following RP_5 capital market risks

Individuals interested in a financial product that would protect them from the following RP_5 personal risks Longevity risk: I will outlive my wealth and financial assets before I die

68%

67%

65%

70%

84%

70%

After prompting with longer life-expectancy Longevity risk: I will outlive my wealth and financial assets before I die 73%

72%

70%

78%

91%

76%

Health care risk: Poor health and medical bills that are not covered by the health insurance will run down my retirement assets

85%

83%

91%

89%

82%

86%

91%

87%

94%

92%

82%

90%

After prompting with longer life-expectancy Health care risk: Poor health and medical bills that are not covered by the health insurance will run down my retirement assets

6.2 Analysis of investor type specific FP perspectives

247

Table 6.28 Share of individuals expressing an interest in a financial product hedging a specific risk (continued) LimitedLimitedwealth Risk- wealth Selfemployed groups Retirees

Highpotential

Wealthy

All investor types

as % of total sample n=

238

53

55

83

66

495

69%

83%

69%

87%

70%

74%

After prompting with longer life-expectancy Regulatory retirement gap - i.e., the risk that my pension income will be reduced due to legislative changes 71%

88%

72%

89%

73%

76%

Individuals interested in a financial product that would protect them from the following RP_5 regulatory risks Regulatory retirement gap - i.e., the risk that my pension income will be reduced due to legislative changes

Remark:

Analysis based on questions C. 14 and C. 15 Attributes whose distribution between the five investor types is different based on a 10% significance level Attributes whose distribution between the five investor types is not significantly different

The results show that when individuals have a high awareness about the different risks, they express a correspondingly pronounced interest for financial products that mitigate them. The product with the highest popularity is one that mitigates the risk of poor health and medical bills (86%) before the one offering inflation protection (78%) and the one hedging against a longer life-expectancy (70%). The first two risks rate the highest level of awareness, and if products to protect against them generate the highest interest, it is a sign of a rational translation of risk consciousness into product interest. With regard to the longevity risk, the product interest ranks even higher than the risk awareness (70% versus 62%) which implies that people are very receptive to product-protection in this area even if they would not say it is a major concern. Overall, the interest expressed for products mirrors the level of concern quite nicely. As a consequence, the individuals analyzed can be considered as showing the right attitude and knowledge with regard to risk mitigation – an encouraging finding for the analysis of individual FPB.

248

6 Empirical analyses of individual retirement-specific FPB

Another comforting finding is that the confrontation with the objective and statistical increases in life-expectancy 421 raises an individual’s interest for a specific product. When individuals are asked the identical question after having been confronted with the increase in life-expectancy, the interest for a specific product has risen between +2% and +6% in absolute terms. The highest increase is for products protecting from the longevity risk which clearly shows the effect of an underestimation of the individual life-expectancy but also illustrates how easy it is to correct this. There exist however substantial differences between investor types. The Retirees, with overall the lowest level of product interest, are most interested in products that protect them from a substantial reduction in their asset base due to poor health and medical bills. The situation for the Limitedwealth Risk-groups is astonishing as they have the highest “worry indicator” but the lowest product interest among the pre-retired investor types. They show a pronounced product interest only for protection against legislative changes which is in line with the fact that state pension income is very important for them and correspondingly the risks associated with the pension system are very relevant. However, these relative positions demonstrate that this investor type has the lowest level of actual financial sophistication (i.e., they do not translate their risk awareness into product interest) and needs substantial support with risk management. While the Limited-wealth Risk-groups and the High-potential show the highest risk awareness, the Wealthy and the High-potential, closely followed by the Limited-wealth Self-employed show the highest product interest. The consequent translation of the risk awareness of these three investor types into the respective interest in hedging products confirms a higher level of actual financial sophistication for these individuals. Summary of type-specific risk profiles

On the basis of these analyses, the risk profile of the different investor types can be summarized as follows. The Limited-wealth Risk-groups have a low capability for risk and show a very high awareness of all kind of risk types – which also reflects the fact that they emerge as the most (completely) risk averse investor type. On the other hand, they show a lower interest for specific products compared to the other investor types. Budget constraints are a potential explanation for

421

For women, old-age life-expectancy is 84 years, for men 81 years. See C. 15 and STBA 2005c.

6.2 Analysis of investor type specific FP perspectives

249

this behavior but it can also be seen as a hint that external support is required to improve risk management for these individuals. The Retirees, where most individuals have indicated they are completely risk averse, have the lowest number of risks that they acknowledge as being important for them. This can be an expression of not seeing themselves affected by these risks anymore. But it could also be a sign that the understanding of the impact of the various risks is not developed enough. With regard to products hedging specific risks, they mostly show a below average interest level. The Limited-wealth Self-employed show a higher capability for risk than both the Limited-wealth Risk-groups and the Retirees. At the same time, these individuals show a very high awareness of the relevance of certain risks for them. As they have complemented or replaced their state pension provision with other income sources, they consistently assess the development of the state pension system as less important but are worried about not having a guaranteed level of pension income. Therefore, their risk-profile makes sense. With regard to their demand for products, they show a very high interest for protection from capital market related risks and health care costs, while protection from legislative changes plays a lesser role. This behavior points to a sound understanding of the risk problematic and supports the finding that this investor type has a higher actual financial sophistication than the average individual. The High-potential have an above average objective risk capability based mostly on their future potential. They have a very pronounced risk awareness and level of concern, which also translates into the highest level of product interest. This illustrates a very worried attitude but a consistent risk management approach. Given these features, this investor type can also be assessed as having an above average actual financial sophistication. At the same time, this risk awareness and its translation into products hedging the respective risks represent an ideal base for enhancing individual retirement-specific FPB. Finally, the Wealthy are individuals with the highest level of risk capability. Nevertheless, they also acknowledge the importance of different risks for them. They show (together with the High-potential) the highest level of product interest. This illustrates that these individuals might be very receptive to financial products. Overall, the have a very developed risk management approach and can also be assessed as having the highest actual financial sophistication level.

250

6 Empirical analyses of individual retirement-specific FPB

6.3 Analysis of investor type specific FP actions and comparison to benchmark behavior As outlined in sub-chapter 2.3, this study compares actual behavior with the principles for individual FP actions to identify possible gaps and derive suggestions for individuals, financial planners or policy-maker to improve individual retirement-specific FPB. This sub-chapter sheds light on the existence of possible gaps between actual and recommended FP actions by comparing the indication of individual interviewees about their FP actions with the behavioral benchmarks derived in sub-chapter 4.4. 6.3.1 Comparative analysis: Start of financial planning activities The recommended benchmark behavior with regard to the start of financial planning activities in section 4.4.1 reads as follows: Start to plan your financial situation in retirement the very day you enter work life Averaging across different education levels, an individual usually starts work life in Germany around his early 20s. To identify when individuals actually begin to think about their financial situation in retirement, individual interviewees were asked this very question. Table 6.29 Share of individuals who began or will begin to think about their financial situation in retirement at a specific age LimitedLimitedwealth Risk- wealth Selfemployed groups Retirees

Highpotential

Wealthy

All investor types

as % of total sample n=

238

53

55

83

66

495

18% 29% 48% 5%

25% 25% 45% 6%

27% 38% 27% 7%

30% 50% 15% 5%

18% 52% 30% 0%

22% 36% 37% 5%

48

46

44

41

44

46

Start of financial planning ST_1 activities Below 40 From 40 to below 50 From 50 to below 60 At 60 or older Average of actual age, at which individuals started or will start to think about their financial situation in retirement

Remark:

Analysis based on questions A. 20 for pre-retirees as well as A. 18 and H. 12 for Retirees Attribute whose distribution between the five investor types is not significantly different based on a 10% significance level

6.3 Analysis of investor type specific FP actions

251

Table 6.29 illustrates the answers of the five investor types that are evidently different. Compared to the benchmark behavior of starting to think about the financial situation in retirement the day an individual enters work life, the actual indications of the interviewees are daunting. Only a minority of 22% starts to think about retirement before they turn 40. Even after that, awareness about the need to provide financially for their in retirement seems to filtrate through to society only gradually: More than a third (36%) start between their 40th and 50th birthdays, whereas the largest share of individuals (37%) initiate their retirement-specific financial planning process between their 50th and 60th birthdays. And 5% of all interviewees indicate having started after their 60th birthday. The average of the actual timing of retirement-planning indications422 differs somewhat between the five investor types: The High-potential start earliest (at ~41 years), followed by the Wealthy and the Limited-wealth Self-employed (both starting on average at the age of 44). Possible explanations for this observation are that these individuals tend to come across retirement topics and related opportunity costs in their education; that they are confronted with financial questions earlier and more frequently through their social environment (e.g., wealth planning or inheritance questions in an affluent family); that their job situation enables them to take on more financial responsibility at younger ages 423 or that their employment status induces them to think about their provision for retirement. The latter rea422

This average was calculated based on the actual indications of all interviewees of the age at which they started or plan to start their financial planning for retirement. It is not the average of the different ranges in order to increase the preciseness of the estimate. For a minority of individuals who had not yet started to think about their financial situation in retirement and who have not given an estimate about when they intend to start their financial planning activities, the missing indication was assumed to equal their actual age. This assumption is based on the fact that in the very moment these individuals are interviewed about their financial planning behavior, they are forced to think about their financial situation in retirement. Compared to the population that this sample is representing however, this assumption will lead to a slightly younger average age indication than can be expected in the overall population. Therefore, it needs to be taken into consideration that in the overall population people start even a bit later than postulated by these numbers. This finding further highlights the gap in individual FPB. 423 DEHM et al. 2000 and HÖLLGER/SOBULL 2001 for example have observed the retirement provision of women in Germany and found that those women who have job positions with more responsibility are also more active with regard to financially providing for their retirement.

252

6 Empirical analyses of individual retirement-specific FPB

son could specifically be of high relevance for the self-employed since they are mostly not covered by the state retirement system and thus need to provide individually for retirement. The pre-retired investor types with the latest start of retirement-specific financial planning (with 46 years on average) are the Limited-wealth Riskgroups. Within this investor type, there are two kinds of individuals with distinct behavior: On the one hand, a quarter of them starts before their 40th birthday and thus shows a quite high level of awareness about the need to plan for a secure financial position in retirement. On the other hand, 45% start only between their 50th and 60th birthdays. The inertia of the latter group is alarming because this investor type has the most pronounced risk profile and thus the most urgent need amongst all pre-retired groups analyzed to provide individually for a secure financial situation in retirement. Not surprisingly, the investor type that started the latest to think about their financial situation in retirement are the Retirees. The distribution of their answers shows that almost half of them started between their 50th and 60th birthdays. This illustrates that financial planning for retirement was not a priority for older generations and that they were not confronted with the topic until shortly before retirement. These results can be compared with the practical approaches of Private Banks providing retirement financial planning advice in Switzerland: While WEGELIN 2006 proposes starting the financial plan for retirement at the age of 45, UBS’s pension advisors are asked to contact their clients at the age of 40 in order to discuss retirement financial planning. 424 This is a much less aggressive approach than stipulated by the behavioral benchmark. However, given that UBS’ client advisors appear to get positive respondent rates in only about 20% of the cases if they contact clients after their 40th birthday, 425 it becomes clear that individuals are not prepared to think about the implicit fact of getting old and passing away one day, which is required for considering their financial situation in retirement. The empirical results from the AXA 2006a survey, which asks whether individuals have already started to prepare for retirement, demonstrate a more optimistic picture: It investigates a broader share of the German population and finds that people have started at 30 or 31 and those that have not started, intend to start at 41 to think about their retirement.426 The 424

According to FISCHER 2006 client advisors were asked earlier to contact the clients around their 50th birthday with the proposals for retirement provision. Recently however, there has been a tendency to start approaching them earlier with this topic, at the age of 40. 425 According to BENENNI 2006. 426 AXA 2006a, p. 60.

6.3 Analysis of investor type specific FP actions

253

differences between the two surveys could be caused by the observation instruments used (e.g., the way to collect data, the exact formulation of the question, etc.) or the choice of the target group. 427 However, in both surveys individuals indicate a timing that is much later than the behavioral benchmark set up in sub-chapter 4.4 stipulates. Overall the empirical results reveal a clear gap between benchmark behavior and actual FP actions. With procrastination, inertia and hyperbolic discounting, behavioral finance research provides many explanations for this outcome. It also illustrates that planning for retirement is a very emotional task and often triggered by certain life-events. Negation of the need to provide individually for a secure financial situation in retirement or just the unwillingness to think about retirement, getting old and the need to estimate one’s expected life-time seems to be wide spread. The current generation of Retirees has shown a tendency to only start thinking about the financial implications of retirement when it is imminent, and so face substantial opportunity costs. As the comparison of the results of the preretirees to the Retirees has revealed, an intergenerational shift seems to be happening, where the current generation of pre-retirees starts to think about their retirement earlier. This shows that change is happening in the right direction. But compared to the benchmark behavior, pre-retirees still start their individual financial planning for retirement too late. Worryingly, the gap is most pronounced for a part of the Limited-wealth Risk-groups – individuals for whom an early start is specifically important because they cannot hope to compensate the earlier missed opportunities with a substantial salary increase later on. This illustrates that there is a strong need for corrective actions with regard to the first principle of adequate financial planning for retirement. 6.3.2 Comparative analysis: Overall understanding of the individual financial situation in retirement In light of the complexity associated with the individual financial optimization problem and different human tendencies that represent obstacles to objective decision making, section 4.4.2 has illustrated the need to build a sound understanding of one’s financial situation in retirement. Ideally, this sound understanding is based on two pillars: First, the individual should 427

Since this study focuses on the affluent segment, the individuals in this target group can be assumed to have a higher level of financial sophistication, which in return would lead to the expected start at a younger age. See KENNICKELL et al. 1997, p. 2.

254

6 Empirical analyses of individual retirement-specific FPB

maintain a relationship with an expert advisor who can provide holistic advice leading to the development of an integrated financial plan. Second, the individual himself should consult different kinds of information sources to obtain a sufficient level of knowledge, enabling him to develop an independent and critical view on any proposed retirement-specific FP actions. Correspondingly, the recommended benchmark behavior with regard to the overall understanding of the individual financial situation in retirement derived in section 4.4.2 reads as follows: Understand the issues and solutions related to your financial situation in retirement by both leveraging the advice of experts and by educating yourself through specific information sources To compare the extent to which the actual FP actions correspond to this behavioral benchmark, three elements are examined: whether individuals have a relationship with an expert advisor, how importantly individuals rate holistic advice leading to an integrated financial plan and finally, the use of information sources. Table 6.30 displays the existence of a relationship with a financial advisor with whom individuals can discuss the financial aspects of their retirement. Table 6.30 Share of individuals maintaining a relationship with an advisor to discuss the financial aspects of retirement LimitedLimitedwealth Risk- wealth Selfemployed groups Retirees

Highpotential

Wealthy

All investor types

as % of total sample n=

238

53

55

83

66

495

75%

68%

74%

65%

76%

73%

DS_1 Use of financial advisor Individuals with an advisor

Remark:

Analysis based on question D. 5 Attribute whose distribution between the five investor types is not significantly different based on a 10% significance level

With 73% of all individuals having an advisor, take-up of these specialist services is high, albeit the fact that the benchmark behavior recommends a full coverage. This encouraging observation is reinforced by the fact that there are no statistically significant differences in coverage between the various investor types. However, there exist some inter-type differences: The Wealthy followed by the Retirees and the Limited-wealth Self-employed show the highest

6.3 Analysis of investor type specific FP actions

255

advisor penetration. An explanation for this observation is that Retirees are the “natural” customers of a retirement-specialized advisor. The Wealthy and – to a lesser extent – the Limited-wealth Self-employed might have a higher coverage because their assets tend to attract advisors or because they themselves show a more active behavior with regard to financially planning for retirement and thus approaching a retirement advisor. At the other end of the spectrum are the Limited-wealth Risk-groups and the High-potential. Their weaker coverage can be explained by the lower amount of total assets (€322k and €380k compared to an average of €500k) or by the younger average age of these investor types (54 and 49 years compared to an average of 57). Furthermore, self-esteem can be expected to have an impact on the question of having an advisor: Only if individuals consider themselves worthy enough or feel that having an advisor is appropriate for them they will also get in contact with a specialist. Therefore, approaches from both advisors to individuals and vice-versa could be an explanation for these differences in coverage. 428 Overall, these results reveal that the coverage with expert retirement advisors can be considered as quite good, even if it is particularly telling that the individuals with the highest risk exposure, the Limited-wealth Riskgroups, have the second lowest level of penetration. As a second element, the interest individuals express for holistic advice leading to an integrated financial plan is investigated as an indicator of the understanding of the complexity of financially planning for one’s own retirement. A key element of the financial planning process, an integrated financial plan covers all the different aspects (i.e., the different income and expense streams, the different wealth pots as well as the risk assumptions of the individual) and gives direction to the financial decisions. It also includes specific recommendations for actions. Table 6.31 illustrates the level of interest in this concept of holistic advice leading to an integrated financial plan.

428

For example, individuals themselves might feel that their assets are not sufficient to warrant financial planning and on the other hand the advisors might have specifications to focus their efforts on individuals within a specific age group. See age-indications of WEGELIN 2006 and the interviews with FISCHER 2006 and BENENNI 2006 from UBS.

256

6 Empirical analyses of individual retirement-specific FPB

Table 6.31 Share of individuals expressing an interest in holistic advice leading to an integrated financial plan LimitedLimitedwealth Risk- wealth Selfemployed groups Retirees

Highpotential

Wealthy

All investor types

as % of total sample n=

238

53

55

83

66

495

13%

13%

13%

17%

18%

14%

25% 62%

27% 60%

16% 71%

23% 61%

20% 62%

23% 63%

Interest in an integrated financial DS_2 plan Very/fairly unimportant Neither important nor unimportant Fairly/very important

Remark:

Analysis based on question D. 2 Attribute whose distribution between the five investor types is not significantly different based on a 10% significance level

Overall, all investor types express similar degrees of interest for an integrated financial plan. 63% of all interviewed individuals judge holistic advice to be very or fairly important. The investor type that shows the most pronounced interest is the Limited-wealth Self-employed (71%), which might be driven by a more pronounced individual responsibility for his financial situation in retirement coupled with a more complex financial situation due to e.g., mixing professional and private assets. At the same time, this interest could be seen as an explanation for the higher coverage of the Limited-wealth Selfemployed with retirement-specific advisors. The result that is surprising is the comparatively higher share of Wealthy individuals (18% versus an average of 14%) that find holistic advice very or fairly unimportant. The wording of the question 429 might be a possible explanation for this outcome since it could lead to a bias that those individuals who already have had advice are not interested in further advice. Given that the Wealthy show the highest penetration with advisors, the probability that they might already have had holistic financial advice is also highest. But even if this was the case, it would not be a good sign since, as the section 2.2.1 has shown, financial planning shouldn’t be a one-off but an ongoing process. Besides this possible bias for the Wealthy, the results still show that 35% of the interviewees do not find holistic advice important. Since the importance individuals attribute to the question of an integrated financial plan influences their motivation to approach this topic, this result high429

D 2: How important do you find holistic advice for financially planning for retirement?

6.3 Analysis of investor type specific FP actions

257

lights the need to further clarify the urgency for continuous financial planning with all investor types. In other words: “If a large subset of the working population fails to take an active interest in retirement planning, retirement plans that rely on participants’ voluntary decisions will be limited in their ability to assure retirement security.”430 The comparison of individuals with and without advisors shows that having an advisor leads to a significantly higher interest in advice. 73% of those individuals with an advisor find holistic advice leading to an integrated financial plan very or fairly important. On the other hand, only 35% of those without an advisor agree with this statement. 431 This illustrates that advisors contribute to a higher interest in financial planning or that those individuals interested in financial planning have a higher probability of contacting an advisor with whom they can discuss the financial aspects of their retirement. All these observations show that the behavior of individuals with regard to the first pillar of understanding of the financial situation in retirement is heading in the right direction, even if there is leeway for further improvement: The penetration with specialized advisors needs to be increased and the awareness about the requirement for holistic advice should to be improved. The second pillar of an adequate individual understanding relies on whether individuals consult different kinds of information sources to obtain a critical level of knowledge, enabling them to develop an independent and critical view on proposed retirement-specific FP actions. To acquire a basic knowledge of the retirement system and specifically his own likely financial situation in retirement, the individual can build on generalized information sources (print media or the Internet) and more immediate and personalized information sources such as friends and family as well as different kinds of general financial advisors. In doing so, the individual should focus on content (i.e., the understanding of retirement-specific mechanisms relevant to one’s own situation) rather than just the reporting of the performance of his retirement portfolio. Therefore, an appropriate behavior would be to use the more generalized information sources at least monthly, and advisors less frequently. The analysis first sheds light on the use of the different sources (Table 6.32) before the frequency of use is explored (Table 6.33).

430 431

MACFARLAND et al. 2004, p. 114. The comparison of the results for individuals with and without advisor can be found in Appendix 1.

258

6 Empirical analyses of individual retirement-specific FPB

Table 6.32 Share of individuals using specific information sources to obtain general financial information LimitedLimitedwealth Risk- wealth Selfemployed groups Retirees

Highpotential

Wealthy

All investor types

as % of total sample n=

DS_3

238

53

55

83

66

495

Public information sources Investment magazines Money pages of newspaper

31% 74%

27% 52%

51% 82%

49% 61%

55% 60%

39% 69%

Internet

16%

19%

37%

39%

44%

26%

54%

85%

61%

71%

65%

62%

Use of information sources

Face to face information sources Friends and family Any kind of general financial advisor - of which bank-employed financial advisor - of which insurance-employed financial advisor working for one company - of which insurance-employed financial advisor working for several companies - of which IFA

Remark:

86%

87%

98%

88%

100%

90%

78%

72%

75%

70%

93%

78%

38%

48%

49%

63%

40%

45%

13% 15%

13% 13%

15% 26%

12% 16%

23% 45%

14% 20%

Analysis based on question B. 1 Attributes whose distribution between the five investor types is different based on a 10% significance level Attribute whose distribution between the five investor types is not significantly different

Table 6.32 illustrates that a financial advisor is the source most often used to obtain general financial information, to support a specific decision or to generally stay up to date. Compared to the above question (DS_1) investigating the use of a specialized advisor with whom individuals can discuss the finances of their retirement, this question shows that the share of individuals who maintain contact with any kind of financial advisor is even higher (90% relative to 73%). Within the personal channels, friends and family are the most sought after singular information source, being mentioned by 62% of all interviewees. With regard to generalized information, the money pages of newspapers are the most popular information source among the print media. Investment magazines and the Internet lag considerably behind. The penetration of general financial advisors across different investor types shows a similar picture to the coverage with retirement-specific advisors: The Wealthy and the Limited-wealth Self-employed have the highest coverage (98% respectively 100%) while the High-potential and the Limited-wealth Risk-groups have a substantially lower probability of hav-

6.3 Analysis of investor type specific FP actions

259

ing an advisor (87% and 88%). Only the Retirees show a different position in that they rank second in the penetration with retirement-specialized advisors (DS_2) while they show a below average coverage with these more generally understood financial advisors. This observation can be explained by their status in the life-cycle and them being natural clients of retirement-specific advisors. Overall, the high penetration level confirms that most individuals maintain contacts with advisors and that thus advisors represent a good way to target the individuals. 432 Within these financial advisors, the bankemployed advisors enjoy by far the highest popularity, followed by the insurance-employed advisors and the IFAs. With regard to the differences in coverage, the bank-employed advisors, the insurance employed advisor working for one company and IFAs show a significantly different penetration among the five investor types. The Wealthy (100% advisor coverage) have a very pronounced coverage by the bank-employed advisor and a relatively higher share of IFAs and insurance brokers working for more than one company. The Limited-wealth Selfemployed have also a comparatively higher share of IFAs while the Highpotentials are comparatively much more likely to be served by an insurance advisor working for only one firm. With regard to the public information sources, where newspapers are very widely used, but investment magazines and the Internet less so, the frequency of use becomes a very interesting topic. It is displayed in Table 6.33. Table 6.33 differentiates the frequency of use for the public information sources (i.e., investment magazines, newspaper, and the Internet) and face to face information sources such as friends and family and financial advisors in general. Overall, public information sources seem to be most frequently used to obtain general financial information, support a specific decision or to generally stay up to date on at least a monthly basis – with the newspaper being the most popular source for all investor types. The frequency of searching the Internet monthly is comparable to the probability of talking to a general financial advisor – be it a bank-employed client advisor, an insurance broker working for one or more firms or an IFA. It is interesting to note that friends and family are more often consulted than advisors and that they have reached the same level of popularity as investment magazines. Despite the fact that fewer individuals quote friends and family as information sources, the frequency of their use is higher than the use of 432

Therefore, the implications for how financial planners can help improve individual FPB are detailed separately.

260

6 Empirical analyses of individual retirement-specific FPB

advisors. This illustrates the potential impact individuals can have to influence retirement-specific financial planning of their friends and family. This is especially important for the Limited-wealth Risk-groups and the High-potential. Therefore, also this point has been considered in deriving implications for how the individual can improve individual FPB. Table 6.33 Share of individuals consulting a specific information source at least monthly LimitedLimitedwealth Risk- wealth SelfRetirees groups employed

Highpotential

Wealthy

All investor types

as % of total sample n=

238

53

55

83

66

495

Public information sources Investment magazines Money pages of newspaper

19% 71%

15% 47%

31% 72%

31% 57%

52% 60%

27% 65%

Internet

13%

10%

28%

23%

44%

20%

27%

29%

24%

29%

23%

27%

20%

15%

30%

14%

24%

20%

20%

35%

18%

34%

22%

24%

DS_3 Monthly or weekly use of information sources

Face to face information sources Friends and family Any kind of general financial advisor Share of individuals that do not consult any of these information sources at least monthly

Remark:

Analysis based on question B. 1 Attributes whose distribution between the five investor types is different based on a 10% significance level Attribute whose distribution between the five investor types is not significantly different

There are significant differences with regard to the frequency of use of the selected information sources denoted with a full circle in Table 6.33. More than half of the Wealthy consult investment magazines, but only a third of the High-potential and the Limited-wealth Self-employed and less than every fifth Retiree or Limited-wealth Risk-groups member do so. For the Internet, a similar pattern can be observed, but only on a slightly lower level. 433 The Limited-wealth Self-employed and the Retirees are heavy consumers of newspapers, while the Limited-wealth Risk-groups also in this dimension show the lowest level of use. Overall a fifth of the inter433

Since these investor types can be considered as more sophisticated, this finding also corresponds to the results of the OECD report on financial literacy, namely that “more financially sophisticated consumers prefer the internet.” OECD 2005, p. 54.

6.3 Analysis of investor type specific FP actions

261

viewees that use an advisor as an information source maintain monthly contacts with him. The Wealthy and the Limited-wealth Self-employed show particular activity in information consumption. This observation can be combined with the findings from MACFARLAND/MARCONI/UTKUS 2004, according to whom “planner type investors”, i.e., those interested in and oriented towards money management and providing for retirement, tend to use vast sources of information while those not interested do not consult the different sources. They also state the correlation between “planner type investors” and assets, income and age. On this basis, the behavior of the Limited-wealth Self-employed and the Wealthy can be seen as a sign of sophisticated retirement financial planning behavior. Building on these considerations, the gap in the second pillar of an adequate understanding of an individual financial situation in retirement can be assessed. With regard to the recommended focus on content, Table 6.33 indicates that with the exception of the Limited-wealth Risk-groups, over 50% of the individuals read at least the newspaper – with the Retirees and the Limited-wealth Self-employed showing by far the highest penetration with over 70% consulting it at least monthly – and many of them also consult investment magazines and the Internet regularly. Here, specifically the Wealthy show the highest activity level followed by the Limited-wealth Self-employed and the High-potential, which can be considered as a more active and sophisticated approach. The Limited-wealth Risk-groups show the lowest activity level in all these dimensions and thus will also display a lower information status. It can be presumed that reading investment magazines contributes mainly to the understanding of different financial concepts and is thus more specific whereas the relevant pages of the newspaper help to understand the basic mechanics of the system. However, since certain retirement-specific mechanisms will be more broadly discussed in the relevant pages of the newspaper, they are also needed to complement the understanding of the financial situation. Further research would be required to assess the quality of the information consumed and the understanding of the respective content. Furthermore, the analysis has revealed that the frequency of contacting advisors is lower compared to the high level of penetration – a situation that is adequate since a good financial strategy should have a more longterm focus and does not require monthly interaction with an advisor. As a consequence, the frequency and choice of information sources can be considered as appropriate and in line with the related principle. Nevertheless, it needs to be kept in mind that almost a quarter of the individuals use information sources less than monthly. The behavior of the Limited-wealth

262

6 Empirical analyses of individual retirement-specific FPB

Risk-groups in particular raises concerns: 35% neither read investment magazines or newspapers regularly, nor do they consult the Internet or talk with an advisor about financial issues. They however seem to have a larger propensity to rely on friends and family for financial information. This illustrates that these individuals have a clear gap in understanding their financial situation in retirement. 6.3.3 Comparative analysis: Holding of classical pension savings products Complementing retirement financial planning with classical pension savings products can be recommended for various reasons. Section 4.3.3 shed light on findings from behavioral finance that argue for an inclusion of classical pension savings vehicles in the total asset portfolio. Additionally, using different saving vehicles could prove beneficial from the point of view of diversification and hedging against regulatory changes. The resulting recommended benchmark behavior reads as follows: Complement your retirement savings with investments in dedicated pension savings products To compare this principle with reality, the holdings of capital investment products in different households have been examined. Table 6.34 illustrates the holding of private pension insurance (i.e., annuity), savings linked to life-insurance (i.e., unit-linked life) or an employer-based contributory pension plan where the individual saves through conversion of income. 434

434

The exact terms in German are: “Private Rentenversicherung”, “Lebensversicherung” and “betriebliche Altersversorgung, die das Individuum durch Gehaltsumwandlung anspart”.

6.3 Analysis of investor type specific FP actions

263

Table 6.34 Share of individuals holding specific classical pension savings products in the portfolio LimitedLimitedwealth Risk- wealth Selfemployed groups Retirees

Highpotential

Wealthy

All investor types

as % of total sample n=

238

53

55

83

66

495

83%

91%

96%

99%

97%

90%

42%

60%

78%

72%

76%

58%

64%

81%

84%

88%

85%

75%

33%

33%

20%

44%

35%

34%

Holding of classical pension PC_1 saving vehicles Overall analysis Individuals who hold at least one of these products in their portfolio Individual product analysis Individuals who hold annuities in their portfolio Individuals who hold savings linked to life-insurance in their portfolio Individuals who have an employer-based contributory pension plan

Remark:

Analysis based on question A. 15 Attributes whose distribution between the five investor types is different based on a 10% significance level

The overall penetration of classical pension savings products is quite high (90%) and is in line with the principle that individuals should have these products in their portfolio to benefit from the advantages inherent in their characteristics that protect against consumption splurges. Nevertheless, there are significant differences between the five investor types that corroborate the findings about sophistication from other gap analyses: Retirees show the lowest penetration (83%). This could be due to the fact that their classical pension savings products have already matured and been converted into other asset categories (e.g., cash). 435 On the other hand, it illustrates that Retirees do not hedge their longevity risk with annuity products. The Wealthy and the Limited-wealth Self-employed show the highest take-up (96% and 97%) of these products. What is a positive surprise is that almost all High-potential own one of these products. The pre-retired investor type with a substantially lower product penetration is the Limitedwealth Risk-groups (91%). Here again it is alarming that those individuals, who have the most pronounced need to provide an additional income

435

The development that individuals are preparing the transition into retirement and cash-out assets caught in private insurances is also confirmed by DIA 2005d.

264

6 Empirical analyses of individual retirement-specific FPB

stream in retirement for themselves, have the lowest penetration in these products. Comparing the share of individuals holding these products who have an advisor (92%) with the share of individuals without an advisor (84%) also reveals the beneficial impact of financial advisors. 436 This however is clearly influenced by the compensation structure of the latter. Analyzing the different products individually, all investor types show the highest propensity to own savings linked to life-insurance (75%), which illustrates their popularity, mostly linked to tax reasons. All investor types show the lowest propensity to have employer-based contributory pension plans (34% on average). This can be an indicator of the fact that this sort of pension provision is not very advanced and well known in Germany. Interestingly, more than half of all interviewees say they own a personal pension plan or annuity insurance. Given the arguments that individuals made against annuities that were highlighted in section 4.4.3, this is a relatively high penetration and a sign of a more adequate retirement provision. Again, the Limited-wealth Risk-groups stand out negatively since their penetration with this product is the lowest within the pre-retired individuals (60% versus 72%, 76% and 78% of the other types). This is also reflected in the complexity of their complementary income sources (FV_6), where they show the lowest coverage too. 437 Overall, this analysis reveals that affluent Germans’ holdings of classical pension savings products are largely in line with the recommended principle. It also expresses a rather cautious approach that reflects the low risk-aversion but also a high preparedness to save. But, as with the other behavioral benchmarks illustrated above, the Limited-wealth Risk-groups identify themselves as considerably less sophisticated when it comes to adequately providing for retirement. While this observation can be partly explained by their limited income, which makes it difficult for them to save, it is in clear contrast to their high expectations for life in retirement. 6.3.4 Comparative analysis: Diversification The idea behind diversification is the enhancement of the return for a given risk level or the splitting of risks through different holdings. Section 4.4.4 led to the derivation of the behavioral benchmark, based on arguments from finance theory as well as certain behavioral characteristics. The recommended benchmark behavior reads as follows: 436 437

For further details see Appendix 1. See sub-section 6.2.2.2.

6.3 Analysis of investor type specific FP actions

265

Diversify your retirement assets not only across industries and geographies but also across asset classes and different retirement savings vehicles The level of diversification is analyzed through a subjective selfassessment of individuals’ portfolio diversification and an objective measure derived from the total individual wealth pool. The latter analyzes the level of diversification through the simultaneous holding of equity and mutual funds or fixed income and mutual funds and either life-insurance or property in the total wealth portfolio. 438 The above section has already given a good indication that individuals are diversifying their holdings of classical pension savings products, which mitigates certain regulatory risks. Table 6.35 displays the subjective and the objective measures of diversification. Table 6.35 Share of individuals stating they have versus actually having a diversified portfolio LimitedLimitedwealth Risk- wealth Selfemployed groups Retirees

Highpotential

Wealthy

All investor types

as % of total sample n=

238

53

55

83

66

495

89.0%

83.0%

94.4%

88.0%

97.0%

89.9%

54.9%

41.5%

61.1%

44.6%

92.4%

57.4%

Subjective assessment of portfolio PC_2 diversification Individuals who say they have diversified Objective assessment of portfolio PC_3 diversification Individuals whose portfolio is objectively diversified

Remark:

Analysis based on question C. 14 for subjective diversification and question H. 7 for objective diversification Attributes whose distribution between the five investor types is different based on a 10% significance level

Both the subjective and the objective assessment are significantly differently distributed among the five investor types. In the subjective assessments, 90% of all individuals indicate having diversified through the use of different products. This shows that the individuals are aware of the positive aspects of diversification. The Wealthy 438

A portfolio is “objectively diversified” if it has: 1) equity and mutual funds or 2) fixed income and mutual funds and additionally 3) life-insurance or property.

266

6 Empirical analyses of individual retirement-specific FPB

and the Limited-wealth Self-employed have the highest level of diversification with 97% and 94% respectively, while at the other end of the spectrum are once again the Limited-wealth Risk-groups with only 83%. The self-assessed diversification level is 91% for those individuals with an advisor and 86% for those without. 439 Like the argument on the interest in holistic advice, this illustrates that having a specialized advisor increases the grasp of different financial concepts and thus has the potential to improve the quality of financial planning for retirement. As a consequence, the stated level of diversification corresponds to the behavioral benchmark and is positively influenced by the use of financial advisors. Contrasting this subjective assessment with the objective measure of diversification leads to quite different conclusions. The most striking insight is the enormous difference between the selfassessed level of diversification (90% on average) and the objectively measured level of diversification (57% on average). A reason for this difference might lie in the definition of the two measures. While the subjective diversification asks if individuals seek to mitigate risks as a whole by diversifying their assets with regard to product types (e.g., division of savings into life-insurance, property, share based investments), the objective diversification tests if at least two of these elements are included in the portfolio. Also, the higher self-assessed level can be seen as an expression of overconfidence and unbounded optimism. Of the five investor groups, the Wealthy show by far the highest level of actual diversification, further substantiating the financial sophistication of this investor type. The second highest level, even though markedly lower, is for the Limited-wealth Selfemployed – another investor type that has already emerged in earlier analyses as having a high level of sophistication. As in the subjective assessment, the Limited-wealth Risk-groups show the lowest level of diversification. But still, with 42% having an objective diversification, their level is not substantially lower than that of the High-potentials with 45%. This is an indication of a substantial improvement potential for both investor groups. The low real level of diversification for Retirees reflects the fifth principle that postulates a modification of the risk-return profile with increasing age, by reducing the share of equity (both held directly and through mutual funds). As in the subjective measure of diversification, the objective behavior of the five investor types must be considered as statistically significantly different. It follows similar overall patterns with the Wealthy having by far the highest level of objective diversification. The order of ranking thereaf439

See the Appendix 1 for the corresponding analyses.

6.3 Analysis of investor type specific FP actions

267

ter is identical to the one of the subjective diversification. However, there is a substantial gap between the Wealthy and the Limited-wealth Selfemployed which could be influenced by the fact that the proportion of managed portfolios is much more pronounced at the Wealthy. Interestingly, those investor types that are most likely to have an advisor also have the highest level of objective diversification, another confirmation of the positive effect of having an advisor. 440 As far as the subjective element is concerned, individuals are highly aware of diversification, and there is little gap between self-assessed and recommended levels of diversification. However, a gap is clear in the objective measure of diversification, which points to a failure to implement diversification strategies. It also highlights the fact that people tend to suffer from overconfidence and unbounded optimism. Therefore, there is need for action in this area, and specifically for the Limited-wealth Risk-groups and the High-potential. 6.3.5 Comparative analysis: Risk-return profile of the personal asset portfolio As shown in section 4.4.5 the risk-return profile of a total wealth portfolio is measured by its share of equity and its real-estate leverage. The analysis that compares actual with recommended FP actions will be conducted separately for these two measures. The overall recommended benchmark behavior reads as follows: Dare to choose a higher risk-return profile for your retirement assets as long as you are young but continuously reduce this risk level as you approach retirement Based on the idea of inter-temporal diversification, supported by the life-cycle theory and practitioners’ advice, the recommendation is for a decreasing share of equity with increasing age. As mentioned in the normative section, the connection between age and share of equity should also reflect the level of risk appetite of an individual. 441 Consequently, if an in440

Individuals with an advisor have an objectively diversified portfolio with 61% probability compared to 48% for individuals without an advisor. See Appendix 1 for the corresponding analysis. 441 The study does explicitly not analyze the connection between the level of riskiness and one integrated denominator for the overall risk profile of an individual consisting of his risk capability, his risk appetite and his risk sophistication. It only focuses on the relationship between the level of equity and the risk appetite

268

6 Empirical analyses of individual retirement-specific FPB

vestor has a low risk appetite, he should have less equity than an investor whose risk appetite is very pronounced. Therefore the comparative analysis of the average share of equity by investor type is differentiated according to age (Table 6.36); average share of equity holding (Table 6.37); and risk appetite (Table 6.38). The share of equity measured corresponds to the sum of the direct holdings as well as indirect holdings of equity through mutual funds (derived from the Germany-specific share of equity investments within mutual funds). 442 Table 6.36 Average share of equity by age group LimitedLimitedwealth Risk- wealth Selfemployed Retirees groups

Highpotential

Wealthy

All investor types

Average share of equity for respective age group n=

238

53

55

83

66

495

N.m. N.m. 11.1% 10.0% 9.1%

6.6% 10.3% 4.5% 5.1% N.m.

12.5% 13.8% 9.0% 8.1% N.m.

8.7% 4.9% N.m. N.a. N.a.

16.2% 14.2% 13.2% N.a. N.a.

11.1% 10.7% 10.4% 9.3% 8.9%

9.8%

6.6%

11.5%

8.1%

14.9%

10.1%

64

54

52

49

50

57

Equity exposure – Share of equity PC_4 in total wealth portfolio 45 - 49 50 - 54 55 - 59 60 - 64 65 - 70 Weighted average Average age

Remark: N.m. N.a.

Analysis based on questions H. 7 and H. 12 Not meaningful – value has been eliminated as the corresponding sample size is smaller than 5% of the weight of the respective type No data available for this age group

Table 6.36 illustrates the share of equity holdings for different age categories within the various investor types. It illustrates the weighted average share of equity per age group within each of the five investor types. For all individuals together, the distribution of the share of equity corresponds to the behavioral benchmark, in the sense that the share of equity should de-

since the consideration of a more widely understood definition of the risk profile would require the detailed analysis of the relationships and correlations between the three elements. This however is excluded from the focus of this study and is left for further research. 442 As mentioned above, the BVI stated that in 2004 31% of all mutual fund assets were invested in equity and a further 5% in balanced funds. Assuming that balanced funds have on average about a third invested in equity the total proportion of equity investments within mutual funds for Germany amounts to about a third. See SCHARDT/VON BARBY 2005, p. 86.

6.3 Analysis of investor type specific FP actions

269

crease as individuals age (from 11% to 9% on average for all investor types). However, the results by individual investor types only partially correspond to the principle defined in the normative section. With equity at 15% of total assets, the Wealthy investor type – who is on average 50 years old – has a higher share of equity than the Limited-wealth Self-employed (12% equity, average age of 52) and even more so than the Retirees (10% and an average age of 64). These averages follow the dictates of the normative principle. The Limited-wealth Risk-groups and High-potential however are rather young investor types (54 and 49 years on average respectively) and have a strikingly lower proportion of equity with only 7% and 8% on average. Compared to the other investor types, their behavior thus deviates from the recommended benchmark. Analyzing the share of equity for the different age groups within an investor type reveals a clear tendency for a decreasing share of equity in older age groups. Only the Limited-wealth Risk-groups do not follow this trend. Their general level of equity is relatively lower (which fits with this type’s risk appetite), but distribution by age is skewed, with age groups 4549 and 55-59 in particular not exploiting the potential for revenue enhancement through a higher risk-return profile. To shed more light on this issue, actual behavior is also analyzed from a different perspective, namely the percentage of equity held in their portfolios by individuals within each investor type. Table 6.37 displays the shares of individuals who hold a specific equity range. The results are evidently differently distributed for the different investor types. Table 6.37 Share of individuals holding a specific share of equity LimitedLimitedwealth Risk- wealth Selfemployed groups Retirees

Highpotential

Wealthy

All investor types

as % of total sample n=

238

53

55

83

66

495

0% 0 - 10% 10 - 25% 25 - 50 % 50 - 75%

39.3% 25.8% 25.5% 7.7% 1.7%

57.8% 15.9% 20.3% 6.0% 0.0%

38.4% 22.0% 22.4% 17.2% 0.0%

50.5% 21.8% 18.2% 8.6% 1.0%

11.4% 26.1% 49.1% 13.4% 0.0%

39.3% 23.7% 26.5% 9.5% 1.0%

Weighted average

9.8%

6.6%

11.5%

8.1%

14.9%

10.1%

Equity exposure – Share of equity PC_4 in total wealth portfolio

Remark:

Analysis based on questions H. 7 Attribute whose distribution between the five investor types is not significantly different based on a 10% significance level

270

6 Empirical analyses of individual retirement-specific FPB

Table 6.37 shows that interestingly, almost 40% of all individuals do not hold any form of equity, be it in direct holdings or in mutual funds. This effect is substantially influenced by the Limited-wealth Risk-groups and the High-potential, where over 50% are not investing in equity at all. Given that the individuals surveyed are affluent, having no equity at all shows some irrationality with regard to the normative behavioral benchmark and is a sign that these individuals could benefit from education about the basic capital market concepts. One point to be taken into account is that practitioners often dissuade individuals from investing in stocks if they have a lower risk appetite and e.g., feel uncomfortable and will stay up nights worrying about their investments. 443 The share of equity that most individuals hold ranges between 10 and 25% of their total wealth and is proof of a rather conservative investment strategy. This observation is consistent with the analysis of their risk appetite analyzed in sub-section 6.2.4.1 that revealed that only 21% of all interviewees are willing to accept a certain loss in exchange for an enhanced expected return. Management portfolio theory (MPT) states that individuals with a higher risk aversion, i.e., a steeper indifference curve, should assume a lower share of equity. Flat indifference curves on the other hand belong to a less risk averse investor and allow for a more aggressive portfolio. Following the logic of the MPT, the study investigates the connection between risk appetite, an indicator for the level of risk aversion, and the riskiness of the portfolio, in Table 6.38. Table 6.38 Average share of equity for different levels of risk appetite LimitedLimitedwealth Risk- wealth SelfRetirees groups employed

Highpotential

Wealthy

All investor types

Average share of equity for respective risk appetite n=

238

53

55

83

66

495

5.4% 12.8% 22.5% 29.0%

4.3% 6.8% 10.4% 26.4%

7.7% 12.4% 13.3% 20.5%

4.3% 6.3% 12.1% 36.1%

2.3% 13.7% 16.0% 22.8%

5.2% 11.2% 16.3% 25.8%

Equity exposure – Share of equity PC_4 in total wealth portfolio Completely risk averse Risk averse Somewhat comfortable with risk Comfortable with risk

Remark:

Analysis based on questions H. 7 and B. 3

The relationship between the share of equity and the level of risk aversion confirms that individuals behave as expected given their risk appetite: An increasing share of equity stands for a higher risk appetite. This can be 443

See SHIM/SIEGEL 1991, p. 93.

6.3 Analysis of investor type specific FP actions

271

seen on the overall level (all investor types) as well as for specific investor groups. Here, rational behavior is confirmed. Besides the discussed share of equity, the real estate leverage is an indicator of the risk-return profile of a portfolio. As such, benchmark behavior would be to reduce the relative value of the mortgage (measured in relation to the value of total property assets) as individuals age. Table 6.39 illustrates the relative value of the share of mortgages for different age groups. Table 6.39 Average value of mortgages relative to the total property value for different age groups (real estate leverage) LimitedLimitedwealth Risk- wealth Selfemployed groups Retirees

Highpotential

Wealthy

All investor types

Average share of mortgage relative to property value for respective age groups n=

164

36

44

54

57

355

N.m. N.m. N.m. 15% 11%

49% 21% 25% 17% N.m.

36% 30% 22% 28% N.m.

33% 34% N.m. N.a. N.a.

39% 38% 14% N.a. N.a.

37% 29% 16% 16% 11%

11%

29%

31%

32%

34%

22%

64

54

52

49

50

57

Real estate leverage – Share of mortgages relative to total PC_5 property value 45 - 49 50 - 54 55 - 59 60 - 64 65 - 70 Weighted average Average age

Remark: N.m. N.a.

Analysis based on questions H. 2, H. 3 and H. 12; Interviewees who did not indicate the value of their mortgage were excluded Not meaningful – value has been eliminated as the corresponding sample size is smaller than 5% of the weight of the respective type No data available for this age group

As with equity, the results for all investor types indicate that actual individual FP behavior with regard to the relative value of the mortgage corresponds to the behavioral benchmark: The relative share of mortgages is reduced from an average level of 37% for the youngest individuals (aged 4549) to a share of 11% for the oldest group (65 to 70 years old). The behavioral benchmark is also met with regard to the average share of mortgages in relation to the average age of each investor group: The Retirees as oldest investor type hold the lowest share of mortgages with 11% 444 while the two youngest types (High-potential and the Wealthy) hold 32 and 34% respectively. Looking at the investor types in more detail, 444

This reflects a key proposition of the behavioral life-cycle hypothesis, namely that drawdown of assets in the dissaving period is slower than predicted by the standard life-cycle hypothesis. See section 4.3.1/SHEFRIN/THALER 1988, p. 632.

272

6 Empirical analyses of individual retirement-specific FPB

the Wealthy and the Retirees exhibit behavior conforming to the principle. Within the Limited-wealth Risk-groups, the Limited-wealth Self-employed and the High-potential, the trend of a decreasing share of mortgages in older age is sometimes not met, even if the overall direction corresponds to the behavioral benchmark. Furthermore, the risk exposure of the Limitedwealth Self-employed needs to be considered in light of their high real estate holdings. Consequently, they have a very pronounced risk exposure even in absolute terms. To better understand individual behavior, the relative value of mortgages is also illustrated from the perspective of the share of individuals within each investor type who hold a specific range of real estate leverage (Table 6.40). The investor types display evident differences. Table 6.40 Share of individuals with a specific real estate leverage LimitedLimitedwealth Risk- wealth Selfemployed groups Retirees

Highpotential

Wealthy

All investor types

as % of total sample n=

164

36

44

54

57

355

64% 9% 20% 4% 0% 3%

49% 5% 16% 9% 0% 22%

19% 18% 34% 15% 5% 9%

24% 11% 26% 30% 2% 8%

14% 23% 34% 7% 11% 11%

43% 12% 24% 10% 3% 8%

11%

29%

31%

32%

34%

22%

Real estate leverage – Share of mortgages relative to total PC_5 property value 0% 0 - 20% 20 - 40% 40 - 60% 60 - 80% 80 - 100% Weighted average

Remark:

Analysis based on questions H. 2 and H. 3 Attributes whose distribution between the five investor types is not significantly different based on a 10% significance level

The results show that over 40% of the sample (those who disclosed the value of their mortgage) say that they have no mortgage on their property. This number is substantially influenced by the Retirees and the Limitedwealth Risk-groups, of whom only 36% and 51% respectively have a mortgage, usually with between 20 and 40% leverage. This leverage is substantially less than practitioners recommend (Credit Suisse, for example, suggests reducing the mortgage to 66% of the real estate value by the age of 60). 445 At the same time this also reflects the relative low overall risk appetite of the German population. However, it is surprising that 8% 445

See CS 2005a, p. 17 and CS 2005b, p. 5. Furthermore, SHIM/SIEGEL 1991 recommend that the ongoing costs for housing should be not more than 35% of take-home pay. See SHIM/SIEGEL 1991, p. 184.

6.3 Analysis of investor type specific FP actions

273

of all interviewees have a mortgage of between 80 and 100% of the value of their property, a value that must be considered very risky. The Limitedwealth Risk-groups show a particularly interesting and very polarized behavior in this regard: On the one hand, only 50% indicate to have mortgages, but on the other 22% are leveraged between 80-100%. This illustrates again that this investor type seems to behave rather irrationally and could potentially benefit from educational measures. 6.3.6 Comparative analysis: Risk mitigation Central to the financial optimization problem an individual faces with regard to retirement are regulatory, capital market and personal risks. The individual awareness about the specific risk types has been analyzed empirically in section 6.2.4 and is the base of this analysis. To adequately provide for a secure financial situation in retirement, this awareness of individual risks needs to be translated into mitigation measures. To analyze the extent to which risk awareness translates into the mitigation of the respective risks, this analysis focuses on the mitigation efforts of individuals who have shown a high awareness about specific risks. The observation sample has been limited in this case to separate the analysis of risk awareness – included in sub-section 6.2.4.2 of the FP perspectives – from the investigation of consequent mitigation actions: If not even the individuals who judge particular risks as important showed a high level of mitigation, the results obtained would be particularly telling. Based on different considerations the following recommended benchmark behavior with regard to risk mitigation was set up in section 4.4.6: Mitigate non market performance-related risks selectively, by attributing the highest priority to the inflation and longevity risks This explicitly relates to risks other than market-performance-related ones. Building on the behavioral benchmarks for diversification and the risk-return profile, this postulate assumes that capital market risks associated with negative performance effects are already mitigated if the individual adapts his behavior in accordance with the two principles. Nevertheless, the mitigation of the performance risk is investigated together with the other capital market related risks and shown in Table 6.41.

274

6 Empirical analyses of individual retirement-specific FPB

Table 6.41 Share of individuals assessing a specific capital market risk as somewhat, very or extremely important and at the same time mitigating the respective risk

Retirees

LimitedLimitedwealth Risk- wealth Selfgroups employed

Highpotential

Wealthy

All investor types

as % of those individuals who find the respective risk somewhat, very or extremely important Mitigation of capital market risks identified as rather, very or PC_6 extremely important n=

Inflation will erode the buying power of my retirement savings n=

My savings will be reduced due to unfavorable market developments (e.g., negative performance) n=

Income from my savings will be lower than expected (e.g., due to low interest rates, poor performance) n=

Surplus/profit participation of pension or life insurance will be lower than anticipated

Remark:

189

46

46

72

49

402

9%

9%

11%

15%

12%

11%

167

39

44

66

53

369

25%

15%

30%

26%

17%

23%

166

42

43

66

60

377

17%

19%

23%

20%

17%

19%

121

44

41

69

51

326

26%

9%

15%

22%

16%

20%

Analysis based on questions C. 11 and C. 12 Attribute whose distribution between the five investor types is different based on a 10% significance level Attributes whose distribution between the five investor types is not significantly different

In comparing the mitigation level of the various capital market risks with mitigation efforts focused specifically on the inflation risk, the results look alarming. Bearing in mind that this analysis reflects not the mitigation level of all individuals but only those who acknowledged inflation as a medium to highly important risk, this situation illustrates that there is a wide gap between the level of awareness and the translation of awareness into action. The low propensity to mitigate the inflation risk (with only about one in ten individual hedging this risk) represents – especially since products that allow mitigation are readily available – a real threat to individuals’ financial security in retirement. A new picture emerges when identifying the investor types that stick most to the behavioral benchmark. Here, the High-potentials show the highest mitigation level for the inflation risk (15%), followed by the Wealthy and the Limited-wealth Selfemployed with 12 and 11% respectively. From the Limited-wealth Riskgroups and the Retirees less than each tenth does something against he risk they acknowledge as relevant for them. The difference in the mitigation

6.3 Analysis of investor type specific FP actions

275

level is not statistically significant. But the overall level of mitigation of the inflation risk needs to be considered as dramatically low and points to a substantial gap. The other capital market related risks show a higher level of mitigation, even if less than a quarter of those judging them to be important also mitigate the respective risks. In accordance with the benchmark recommendations about diversification and a risk-return profile tailored to the age of the individual, both of which are analyzed above and are mostly reflected in individual FP actions, the capital market risk that has the highest mitigation level is the performance related risk. Within the personal risks shown in Table 6.42, the behavioral benchmark also recommends specifically mitigating the longevity risk. As before, the mitigation rates show the behavior of those individuals who have expressed a medium to very high awareness (assessed importance) of the respective personal risks. In comparing these mitigation levels with the behavioral benchmarks, it becomes obvious that the mitigation level for the longevity risk also ranks dangerously low even though it is almost double the mitigation level of the inflation risk. Only one in five who finds this risk very or fairly important does something to hedge its impact. Once again, this startling result indicates that individual FPB shows a substantial gap between recommended and actual FP actions in this area. Since the differences in mitigation between the various investor types are not statically significant, all investor types are likely to be equally bad at hedging this risk. Also, it is noteworthy that the Retirees show the highest mitigation level, perhaps because the risk is imminent and thus more real to them than to the pre-retirees, giving them the impetus to act. Their mitigation level is closely followed by the Limited-wealth Self-employed and the High-potential. The Wealthy on the other hand show the lowest level of mitigation of the longevity risk, but given their substantial financial cushion it can be assumed that the need to provide for this specific risk is less pronounced for them. The investor type that has the highest risk exposure and at the same time a very low mitigation rate of the longevity risk is the Limited-wealth Risk-groups.

276

6 Empirical analyses of individual retirement-specific FPB

Table 6.42 Share of individuals assessing a specific personal risk as somewhat, very or extremely important and at the same time mitigating the respective risk

Retirees

LimitedLimitedwealth Risk- wealth Selfgroups employed

Highpotential

Wealthy

All investor types

as % of those individuals who find the respective risk somewhat, very or extremely important Mitigation of personal risks identified as rather, very or PC_6 extremely important n=

I will outlive my wealth and financial assets before I die (i.e., the longevity risk) n=

Poor health and medical bills will run down my retirement assets n=

I will need to pay to live in a retirement or nursing home for an extended period n=

My money will be tied up and unavailable when I need it for specific expenses n=

I will not leave as valuable an estate behind after my death as I intended

Remark:

137

37

37

52

42

305

23%

14%

22%

19%

12%

20%

190

44

48

68

55

405

31%

16%

25%

21%

13%

24%

195

39

40

66

59

399

38%

15%

25%

17%

24%

29%

103

29

27

43

27

229

33%

28%

30%

23%

15%

28%

88

31

23

51

37

230

18%

16%

13%

20%

0%

15%

Analysis based on questions C. 11 and C. 12 Attributes whose distribution between the five investor types is different based on a 10% significance level Attributes whose distribution between the five investor types is not significantly different

With regard to the two personal risks with statistically significantly distributions (mitigation of the risk of medical bills and living in a retirement home), the investor type with the lowest tendency to hedge these risks is once again the Limited-wealth Risk-groups – precisely those individuals who are most at danger and in need of coverage. The risk of not being able to leave behind as valuable an estate as anticipated is evidently differently distributed with the High-potentials showing the highest mitigation level. But the detailed consideration and assessment of the mitigation level for these personal risks are not in the scope of this study. With regard to the regulatory risks, the above discussed principle of using different classical retirement saving products already contributes to the mitigation of changes in retirement legislation (i.e., taxation schemes for specific products) or to hedge against the risk of not having a source of

6.3 Analysis of investor type specific FP actions

277

guaranteed retirement income. Table 6.43 details the mitigation level for the regulatory risks. Table 6.43 Share of individuals assessing a specific regulatory risk as somewhat, very or extremely important and at the same time mitigating the respective risk LimitedLimitedwealth Risk- wealth SelfRetirees groups employed

Highpotential

Wealthy

All investor types

as % of those individuals who find the respective risk somewhat, very or extremely important Mitigation of regulatory risks identified as rather, very or PC_6 extremely important n=

I will not receive the state pension that I am currently expecting n=

An increase in tax rates will erode the buying power of my retirement savings n=

The value of the state pension will not increase in line with earnings n=

I will not have a source of guaranteed retirement income

Remark:

164

49

36

75

45

369

36%

47%

69%

61%

24%

44%

174

42

41

68

58

383

9%

2%

15%

13%

0%

8%

182

47

38

80

47

394

32%

28%

32%

38%

21%

31%

140

38

40

60

36

314

31%

26%

55%

38%

47%

37%

Analysis based on questions C. 11 and C. 12 Attributes whose distribution between the five investor types is different based on a 10% significance level Attributes whose distribution between the five investor types is not significantly different

The analysis confirms the finding from above, namely that the Limitedwealth Self-employed and the High-potential tend to show the highest propensity to mitigate risks they judge as being important. The Limitedwealth Risk-groups on the other hand show the lowest propensity. This illustrates that the latter investor type shows the lowest level of actionorientation or consequence in actions, resulting in the most pronounced shortcomings in financial planning for retirement.

6.4 Scenario analyses for adequate saving rates The amount individuals are saving has been identified as one of the key FP actions with regard to financially providing for retirement (PC_6). Due to the complex and very individual character of saving, this entire sub-

278

6 Empirical analyses of individual retirement-specific FPB

chapter is dedicated to this topic. It allows for a better understanding of how much the different investor types should be saving in order to secure their financial situation in retirement and live the life they are planning, how their required saving rate varies with changing assumptions, how long their assets will last and finally how their actual – indicated – saving rate compares with the recommended saving rate. As for most FP actions, it is difficult to find a universal statement about the recommended amount an individual should save to provide for a secure retirement. One point of reference for what the state deems appropriate is the value of state-subsidized savings in the form of Riester or Rürup Products: For the Riester Reform, this would be €2’100 per annum (from 2007 onwards), which amounts to around 6% of the average annual income of a German. 446 Another point of reference is a practitioner’s handbook that mentions 10%. 447 However, most universal indications ignore the highly individual character of people’s inter-temporal financial optimization problem and that individuals can save in various forms (e.g., financial investments or real estate assets). To avoid this shortcoming the required saving rates used as behavioral benchmarks in this study are derived from a simulation analysis for the different investor types analyzed. It is based on the financial situation in retirement to which they aspire, as well as the specific average characteristics of each investor type. 448 The idea is to estimate a potential retirement income gap based on the individual circumstances and regulatory and capital market conditions and then calculate the saving rate required to close this gap. This procedure also corresponds to the approach of major private banks and financial planners. 449 Indeed, supporting an individual in understanding and analyzing his own inter-temporal financial optimization problem and deriving the recommended saving rate accordingly is the core duty of any financial planner. 446

According to the STBA 2003b, Einkommen und Einnahmen sowie Ausgaben privater Haushalte in den Gebietsständen – Deutschland insgesamt, Table UB2, the average income for a German is €2,833 per month. 447 See KOBLINER 2000, p. 42. 448 The question of how much an individual should save depends on personal characteristics (such as risk capability, family commitments, health status), the financial endowment (i.e., actual income and financial wealth level, net value of real estate), the planning horizons (i.e., life-expectancy, duration of retirement and thus liquidation phase but also the time until e.g., an inheritance is received), duration of working phase as well as specific expectations about e.g., the capital market or the development of the taxation and retirement system. The detailed assumption of this simulation analysis are listed in Appendix 2. 449 ORGLAND 2006 for example stated that the individual tailoring is precisely the reason for why there is no general rule about the recommended saving rate.

6.4 Scenario analyses for adequate saving rates

279

To reflect this approach, the different conceptions of the retirement gap are presented in the first section. In section 6.4.2, the recommended saving rate for different investor types is derived analytically, based on the wealth-adjusted statutory state retirement income gap. In 6.4.3, ceteris paribus analyses are conducted to highlight the impact of changing certain individual assumptions or exogenous variables on the required saving rate. Building on this knowledge, section 6.4.4 analyzes the combined impact of the different levers on the situation of the Limited-wealth Risk-groups – the investor types with the lowest risk capability and the least secured financial situation in retirement. Section 6.4.5 addresses the question of the age at which the Limited-wealth Risk-groups would run out of money if various adverse events happen. Finally, section 6.4.6 compares the stated saving rates of the four pre-retired investor types with the recommended saving rates and so helps to assess the appropriateness of this specific FP action. This simulation analysis tests how much of their working income individuals are recommended to save, so it is only relevant for the preretired investor types. At the core of these simulation analyses is the population of the intertemporal financial optimization problem (Equation 2.3) with investor-typespecific parameters, the key elements of which are reported in Table 6.44. Building on this equation, investor-type-specific recommendations for the saving rate required to close a potential retirement gap are derived. The recommended saving rates relate to direct savings in financial assets. Real estate assets and corresponding savings are assumed to be reserved for bequest.

280

6 Empirical analyses of individual retirement-specific FPB

Table 6.44 Key assumptions about the four pre-retired investor types for the simulation analyses Limitedwealth Riskgroups

Limitedwealth Selfemployed

Highpotential

Wealthy

Investor type specific characteristics building on socio-demographic variables Average age in 2005

54

52

49

50

Years already in the work force

37

32

30

29

Average planned age of retirement

61

62

61

61

88.3

85.8

86.1

86.8

Average life expectancy Saving period (years) Retirement period (years) Share of women

7

10

12

11

28

25

26

27

60%

22%

30%

40%

702,000

Investor-types specific financial assumptions based on socio-economic variables and FP perspectives Average financial wealth today (€)

186,000

248,000

259,000

30%

30%

30%

30%

46,000

58,000

53,000

80,000

Share of individuals with a secondary education Share of individuals with an A-levels degree Share of individuals with a university degree

90% 6% 4%

46% 24% 30%

51% 25% 24%

31% 9% 60%

Expected yearly real increase in income in %

0.3%

0.6%

0.6%

0.8%

Percentage of income prior to retirement needed in retirement

86%

80%

85%

76%

Share of financial wealth intended to keep as a reserve Average net income today (€)

Remark:

Variables with no notation stem directly from the empirical survey and correspond to the average indication of all interviewees of the respective investor type Variables with an empty triangle ( ) mark values that have been calculated based on the information from the survey and external data sources

6.4.1 Different conceptions of the retirement gap The retirement gap is not only one of the main topics in the academic world but also in practical discussions about individuals’ financial situation in retirement. Generally, the term retirement gap means the difference between an individual’s income and expense streams in retirement. Since no commonly acknowledged definition of the retirement gap could be identified 450 this thesis has established three levels of retirement gap used

450

BÖRSCH-SUPAN et al. 2005 for example use the term “retirement gap” to compare the anticipated level of retirement income after the reforms with the historic level of retirement income analogous to Fig. 3.4. SCHNABEL 2003b denotes the

6.4 Scenario analyses for adequate saving rates

281

to identify the required saving rate. All the definitions build on Equation 2.3 but take different financial flows into consideration. Total retirement gap

The most comprehensive definition, termed total retirement gap, describes the retirement gap as the difference between what an individual expects to need in retirement to fulfill his financial and life aims and what funds this individual counts on having at his disposal in retirement. These funds can stem from state and private income sources, wealth increases during retirement as well as assets accumulated during work life and available for dissaving at the beginning of retirement. Thus, the total retirement gap captures all the elements of Equation 2.3 on the income and expense side. This broad definition of the retirement gap reflects the understanding of individual retirement-specific financial planning used in this thesis. As seen in sub-chapter 2.2, a financial plan should aim for a holistic examination of the perspectives an individual has on his financial situation in retirement, taking into account all the income and expense streams and consequently the total retirement gap. The outcome of such holistic advice is an indication for additional saving requirements (e.g., in the form of regular and irregular savings, ast and ost as denoted in Equation 2.3) to cover a potential retirement gap. The individually assessed importance of holistic advice analyzed in Table 6.31 sheds light on the individual’s understanding of the need to assume this broad perspective when considering retirement. Retirement income gap

A more narrow definition examines the retirement gap that would result if only “pure” income were taken into consideration. This includes statutory state pension, corporate pension or private pension income. If an individual had real estate or financial assets that yield regular income this would also be included. The difference that results relative to all the expense streams needed in retirement to fulfill life and financial aims is called the retirement income gap. This definition consciously does not consider the wealth stock accumulated during work life – both in the form of financial assets or real estate – as well as the increases in wealth during retirement difference between the pension income of a retired worker and the amount required to keep the actual standard of living as the pension gap.

282

6 Empirical analyses of individual retirement-specific FPB

through e.g., inheritances. The retirement income gap answers the question of whether the expense streams in retirement can be financed solely with the already anticipated and planned retirement income streams or if they need to be complemented with additional sources of wealth or to put it another way, the dissaving of the wealth stock. This definition of the retirement gap is used in this research to contrast an individual’s anticipation of how much he needs with how much he expects to receive in retirement. 451 The retirement income gap analyzed in sub-section 6.2.2.3 thus helps to understand if the German affluent segment is conscious about a retirement income gap. If this is the case, then it means that he needs to save (more) during work life or that he needs to dissave his financial or real estate wealth stock to finance his retirement. Thus, “continuing to save” (PL_4) as a possible financial aim in retirement is not reasonable if such a gap exists. Statutory state retirement income gap

The definition of the statutory state retirement income gap is even narrower than the one of the retirement income gap. As the name already indicates, the statutory retirement income gap examines the differences between the expenses an individual anticipates for retirement and the income from Pillar I, the statutory state retirement income. The reason for the detailed investigation of this statutory state retirement income gap lies in the fact that substantial changes and reforms are underway with regard to the SSP (Pillar I). Therefore, it is critical to understand what level of income the different investor types can expect from this pillar once they reach their retirement age. Furthermore, since statutory state income is the major income source for most Germans, this simulation analysis can provide insights on which levers an individual can pull to close his statutory state retirement income gap. In analogy to the above described definitions of the retirement income gap, the statutory state retirement income gap is defined as the difference 451

The retirement income gap is analyzed in the context of the FP perspectives and contrasts the income individuals expect to receive in absolute terms (variable FV_3) with the expenses they expect to have (variable FV_8). As it can be presumed that when individuals are asked about an absolute indication of the income they expect to get in retirement they would include the different income sources from statutory state pension, employer-based and private pension and perhaps also rental income but not consider their wealth pools as components of this income stream, this estimate is a good approximation of the income definition relevant for the retirement income gap.

6.4 Scenario analyses for adequate saving rates

283

between the income an individual can expect from the statutory state pension and the income needed in retirement, so all income sources except the state pension income (spt) are set to zero in Equation 6.1 (opt=0, wt=0). With regard to the expense side it is assumed that the individual does not plan any donations in retirement ( w = 0) and that he intends to leave his real estate assets as inheritance (wL) so they are not available for financing monetary needs in retirement. This is why property is disregarded in these considerations and thus set to zero (wL=0). Equation 6.1 illustrates the statutory state retirement income gap. L

⎛

CPI R

∑ ⎜⎜ e * CPI t =R

⎝

L

⎛

t

t

CPI R

∑ ⎜⎜ sp * CPI t=R

⎝

* (1 + rt ) −( t − R ) + 0 *

t

t

⎞ CPI R CPI R * (1 + rt ) −( t − R ) ⎟⎟ + 0 * * (1 + rt ) −( L− R ) = CPI CPI t L ⎠

* (1 + rt ) −(t − R ) + 0 *

⎞ CPI R CPI R * (1 + rt ) −( t − R ) + 0 * * (1 + rt ) −( t − R ) ⎟⎟ CPI t CPI t ⎠

(6.1)

R −1 ⎞ ⎛ CPI R CPI R CPI R * (1 + rt ) R−t + 0 * * (1 + rt ) R−t + wt * * (1 + rt ) R−t ⎟⎟ + ∑ ⎜⎜ as t * CPI t CPI t CPI t t =1 ⎝ ⎠

With t R L CPIt rt et ast wt spt

Year t Retirement age Expected life-time Consumer price index for year t Real discount rate or forecasting rate for year t Nominal expenses (ongoing or singular) for year t Annualized savings for year t (labor incomet – consumptiont) Wealth level in year t Nominal state pension income for year t

All variables whose influence is not examined are set to zero compared to the original Equation 2.3. It is important to note that to make the simulation as realistic as possible the actual wealth stock accumulated during work life (wt) is employed to close the statutory state retirement income gap. So the statutory state retirement income is first calculated based on the assumption that spt is the only source of income in retirement and wt is assumed to be zero. The resulting gap is termed the total statutory state retirement income gap. In a second step, the calculatory annuity, derived from the invested stock of wealth (wt (at R)) for the retirement period, is deducted from the statutory state retirement income gap to identify which share of the gap can be covered with the existing wealth stock through dissaving. This is then called the wealth-adjusted statutory state retirement

284

6 Empirical analyses of individual retirement-specific FPB

income gap. The recommended saving rate required for the different investor types is calculated to cover the wealth-adjusted statutory state retirement income gap. As it is the aim of this analysis to determine the amount of regular savings (ast ) – as opposed to one-time efforts (ost) – the latter are set to zero. 6.4.2 Analytical derivation of the saving rates required to cover the wealth-adjusted statutory state retirement income gap The saving rates required to cover the wealth-adjusted statutory state retirement income gap for the four pre-retired investor types is derived based on the simulation analysis using Equation 2.3. This simulation analysis takes into consideration the relevant socio-demographic and socioeconomic attributes of each investor type as well as their plans and expectations for retirement. Furthermore, it presumes that all of them have been subject to the SSP and are thus eligible for statutory state pension. 452 Further assumptions about the development of capital market as well as the retirement system and taxation were required. These assumptions and further explanations about the calculations can be found in Appendix 2. It is noteworthy that all calculations are based on a net basis (after taxes and social expenses) and in real terms, since behavioral finance research has shown that most individuals have trouble working with inflation (see sub-section 4.2.3.2 on money illusion). The calculation of the recommended saving rate is based on a five-step approach (illustrated in Fig. 6.1) which delivers the total statutory state retirement income gap as well as the wealth-adjusted statutory state retirement income gap, relevant for the derivation of the required saving rate.

452

For the Limited-wealth Self-employed this assumption might at first appear surprising, since they can apply for an exemption of the statutory state pension if they are insured differently. However, since the interviewees falling into that investor type have also indicated that a substantial share of their income stems from statutory state pension benefits (analyzed in the context of FP perspectives in sub-section 6.2.2.2), the extension of the scenario analyses to these individuals seems appropriate. The same analysis for the retired investor type is obsolete since they are already in a different phase of their life-cycle.

6.4 Scenario analyses for adequate saving rates 1. Income needed in retirement for all t >= R

2. Statutory state income received in retirement for all t >= R

Fig. 6.1

3. Total statutory state retirement income gap at R

4. Future value of existing disposable stock of financial assets (wealth) at R

285

Wealth-adjusted statutory state retirement income gap at R

5. Recommended amount of annual savings over the remaining work life in order to cover wealthadjusted statutory state retirement income gap

Five-step approach used for analytical derivation of the saving rate required to cover the wealth-adjusted statutory state retirement income gap

In the first step, the income needed in retirement is worked out based on individual socio-demographic attributes (i.e., age, gender and thus lifeexpectancy), the actual and future financial situation reflected in the socioeconomic attributes (i.e., income, education level and thus income growth) and PF perspectives on retirement (e.g., planned retirement age, share of income prior to retirement needed to live comfortably in retirement). A realistic development of these income needs is then calculated for the entire retirement period based on the anticipated lengths of the retirement period (defined by an individual’s age, his planned retirement age and his lifeexpectancy) and a real consumption growth rate assumed to be identical to the work-time salary growth rate. In a second step, the entitlement to statutory state pension is calculated building on a simulated earnings history and the German benefit formula (see Equation 3.1 in section 3.2.3). The individual entitlements for statutory state pension have been derived from the German benefit formula for the following two reasons: transparency of the analyses and avoidance of any perception bias stemming from the inability of the interviewees to correctly estimate their statutory state retirement income. 453 In the third step, the total statutory state retirement income gap is calculated as the difference between the needs and the statutory state income streams for the entire expected retirement period and then discounted back to the moment of retirement R. In the fourth step, the future value of the existing wealth stock at R is deducted from the total statutory state retirement income gap, resulting in the wealth-adjusted statutory state retirement income gap. This represents the income gap that an individual cannot cover with the existing wealth stock under the given 453

Sub-section 6.2.2.2 shed light on the question of which share of pre-retirement income individuals expect to receive from the statutory state retirement income. As the results show, these assumptions are clearly biased through deviations from rationality in perception (e.g., representativeness bias, conservatism) and should thus not be used in a financial model aiming at estimating a real situation.

286

6 Empirical analyses of individual retirement-specific FPB

assumptions. 454 In the fifth step, the wealth-adjusted statutory state retirement income gap is converted into the recommended saving rate during work life. Fig. 6.2 illustrates the size of the wealth-adjusted statutory state retirement income gap for the four pre-retired investor types. Limited-wealth Risk-groups

Limited-wealth Self-employed

€

€ Income needed in retirement

50,000

Income stream

40,000

Annuity from disposable financial wealth

20,000

Statutory state pension income

10,000

2010

2015

2020

2025

2030

2035

2040

2045

High-potential 60,000

40,000

Income stream

10,000

Fig. 6.2

2015

Annuity from disposable financial wealth

30,000 20,000

Statutory state pension income

10,000 ,0 2005

80,000

20,000

2010

40,000

Income needed in 100,000 retirement

30,000

,0 2005

Income stream

2010

2015

2020

2025

2030

2035

2040

2045

Wealthy

€

50,000

60,000 50,000

30,000

,0 2005

Income needed in retirement

70,000

2020

2025

2030

2035

2040

Annuity from disposable financial wealth

60,000

Statutory state pension income

20,000

2045

€

Income needed in retirement Income stream

Annuity from disposable financial wealth

40,000

,0 2005 2010

Statutory state pension income 2015 2020 2025 2030

2035 2040 2045

Graphical depiction of the wealth-adjusted statutory state retirement income gap for all pre-retired investor types

Fig. 6.2 shows the development of the net real income during work life and the income needed to live comfortably in retirement (solid lines). In order to display the total statutory state retirement income gap these investor types are facing, the net real income every sample individual can expected from statutory state retirement benefits is plotted (solid dotted line). 454

Due to the high popularity of wanting to leave an inheritance and keeping a reserve (chosen by 60% and 89% of all interviewees, PL_4), these financial objectives shown in sub-section 6.2.1.4 have been incorporated into these assumptions. As a consequence real estate assets are not taken into consideration for covering the retirement gap as they are assumed to be left as an inheritance. Furthermore, individuals are presumed to want to keep a reserve of their financial wealth even at the end of the expected life-time to provide for emergency situations or unforeseen expenses. This share is assumed to amount to 30%. Correspondingly, only 70% of the future value of today’s financial assets are disposable to cover the gap.

6.4 Scenario analyses for adequate saving rates

287

This highlights also the so-called “replacement rate”, the share of the last pre-retirement income that an individual can expect to get from statutory state benefits. 455 The areas between the black dotted line and the black solid line in the retirement phase show the total statutory state retirement income gap. It can be partially closed with the disposable financial assets. For this purpose, the future value of these financial assets (wt) is converted into an annuity upon retirement and raises the income in retirement to the thin black line. The resulting wealth-adjusted statutory state retirement income gap is the shared area above the thin and the solid black line. This area thus needs to be covered by additional savings during work life to ensure a financial situation that corresponds to the average life plans of the individual investor types. Fig. 6.3 depicts the same financial flows in absolute terms. Its elements correspond to the five steps of analysis defined in Fig. 6.1. Comparing the absolute size of the total with the wealth-adjusted statutory state retirement income gap allows conclusions to be drawn to the extent to which the different investor types are able to reduce the total gap with the future value of their currently available financial assets. Furthermore, it puts into perspective the resulting recommended annual savings, showing it as a percentage of the current level of income required to cover the wealthadjusted statutory state retirement income gap. The outcome of the analysis can be considered as a cautious assessment of the individual financial situation in retirement based on its conservative assumptions. As mentioned, they include a reduced share of the financial assets available for dissaving due to the creation of a reserve, the real estate assets being held back for inheritance, rather aggressive assumptions with regard to the transition of individuals into retirement (all investor types planning for early retirement and thus accepting a substantial reduction in statutory state pension benefit), combined with a rather optimistic

455

As these illustrations show, the replacement rate for net real income lies far beyond the net replacement rate of 55-60% for the years 2012 to 2016 indicated by DIA 2005a (see Fig. 3.4). This is due to the fact that the DIA calculated the replacement rate of the standard retiree with a much lower level of working income. Since these individuals all have income levels that are above the average income level and even above the contribution ceiling, their replacement rates amount to 35% for the Limited-wealth Risk-groups, 26% for the Limited-wealth Self-employed, 27% for the High-potential and 17% for the Wealthy. This confirms that the replacement rate is lower the higher the net income level of an individual is, and thus illustrates the digressive character of the German pension system (see also Fig. 3.5).

288

6 Empirical analyses of individual retirement-specific FPB

assumption about their life-expectancy. 456 The last two elements lead to a long duration of the dissaving time which again increases the financial needs in retirement. –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Value of income needed in retirement in € k, at R Limitedwealth Riskgroups

Value of income from statutory state pension in € k, at R

651

246

Total statutory state retirement income gap in € k, at R

405

Future value of existing disposable wealth in € k, at R

177

Wealthadjusted statutory state retirement income gap in € k, at R

Recommended saving rate in % of net income

228

62%

Limitedwealth Selfemployed

776

231

545

270

275

39%

Highpotential

772

226

546

307

239

29%

Wealthy

Fig. 6.3

1,115

223

892

797

95

9%

Quantification of the total and the wealth-adjusted statutory state retirement income gap

The Wealthy who expect the largest statutory state retirement income gap will be able to wipe it out almost entirely with their substantial level of financial wealth. As a consequence, these individuals have the lowest wealth-adjusted statutory state retirement income gap. Based on this assessment, and also visible in the lowest recommended saving rate of about 9% of their annual income, the analysis suggests that individuals with the characteristics of the average Wealthy investor type should not run into major problems in retirement if the assumptions are met, e.g., their expense and income streams correspond approximately to their expectations and their wealth develops as assumed (i.e., with 4.5% real return). The extent of the wealth-adjusted statutory state retirement income gap for the other three investor types shows that they might run into problems. A possible explanation for these results is the insufficient stock of accumu456

The calculation of the life-expectancy relies on the new DAV tables (see GDV 2004) used by pension insurances that estimate the life-expectancy as 2-3% higher than the life-expectancy tables of the German Statistical Federal Office. See STBA 2005c.

6.4 Scenario analyses for adequate saving rates

289

lated wealth. For example, the future value of the financial assets of the Limited-wealth Risk-groups and the Limited-wealth Self-employed does not even cover half of the total statutory state retirement income gap. Due to the younger age and thus the longer saving and investment period, the available financial assets of the High-potential allow more than half of the total statutory state retirement income gap to be covered. However, for all these three investor types, the recommended saving rate relative to their income level is very aggressive. While the High-potential, with an average net income of €53,000, would need to save 29% to meet their expectations, the Limited-wealth Self-employed would be recommended to save 39% of their €58,000, which of course is completely unrealistic, especially in light of their life plans and financial objectives. For the Limited-wealth Riskgroups, the situation looks bleakest: They would have to save 62% of their current net income of €46,000 up to retirement in order to cover the wealth-adjusted retirement income gap completely. Logically, the disposable income that would result with such a saving rate during work life would not be enough to live on. This illustrates that the Limited-wealth Risk-groups are most likely to run into financial problems in retirement, so they have the most urgent need to work on or re-think their financial plan for retirement. This implies that even among the affluent segment, a substantial share of individuals risks being confronted with a retirement gap. Considering that the situation for the retail segment of the population is probably even tighter, important sociological and political implications need to be examined. With regard to the extent of the recommended savings rate, a cautionary point needs to be made: All these investor types tend to have complemented their state pension income with other income sources such as private or corporate pensions (FV_4 and FV_5). This analysis has focused solely on the state pension income to illustrate the impact of this most prominent source that is subject to substantial reforms and because no realistic, generally valid quantitative information on the complementary income sources is available. As a consequence, the required saving rate also includes investments already made into these complementary income sources. Therefore, the burden through the saving requirements is slightly lessened because the indicated saving rates include existing savings. Nevertheless, the wide range of stated required saving rates is surprising given that all the individuals belong to the affluent segment. The above assumptions of the calculations and the different degree of endowment of the individuals with financial wealth as well as their current income level and the share of income needed in retirement are responsible for the wide

290

6 Empirical analyses of individual retirement-specific FPB

variation. This however also illustrates the sensitivity of the result to individual realities and expectations. With regard to the following comparison of the actually stated saving rate and these recommended saving rates (section 6.4.6) it is noteworthy that with the widely defined saving-concept described above this simulation analysis is applying the same definition as used in the interviews. 457 6.4.3 Scenario analyses for implications of different assumptions on the required saving rate The recommended saving rates derived from the calculations above are very ambitious and make it necessary to rethink individuals’ perspectives on retirement. To test how different concepts of retirement impact the saving requirements, this section illustrates the implications of different assumptions on these required saving rates. It focuses on specific levers that can be pulled, given the budget constraints used for this analysis, to improve the outlook on the financial situation in retirement. In doing so, it shows how altering the perspectives will change the situation for the various investor types. Four levers have been investigated in detail. On the personal assumption side, variations in the share of the last pre-retirement income needed to life comfortably in retirement as well as variations in the share of today’s financial assets that an individual intends to keep as a reserve are investigated. With regard to the regulatory environment, different scenarios are calculated for the nominal growth rate of state benefits to reflect considerations of the DIA and the Rentenversicherung Bund. Since different financial vehicles and various investment strategies also offer substantially different returns, scenario analyses have also been conducted for various real rates of return. Table 6.45 illustrates the recommended saving rates for the four preretired investor types under various assumptions for these four underlying levers. The analyses are conducted “ceteris paribus” (all else being equal). The recommended saving rate of the base case is at the top of the table. The base assumptions for each lever are highlighted at the top of each scenario analysis (in italics).

457

The respective question is C. 8: What is the maximum proportion of your net income that you would be prepared to invest (including any savings/investments you are already making) over the period to retirement to ensure financial security in retirement?

6.4 Scenario analyses for adequate saving rates

291

Table 6.45 Scenario analyses for the saving rates required to cover the wealthadjusted statutory state retirement income gap Limitedwealth Riskgroups

Limitedwealth Selfemployed

Highpotential

Wealthy

Base case

62%

39%

29%

9%

Share of income prior to retirement needed in retirement Base case (direct indications from interviewees) if 60% if 70% if 80% if 90%

86% 8% 29% 50% 70%

80% 11% 25% 39% 52%

85% 1% 13% 24% 35%

76% -13% 1% 14% 27%

if 0% if 25% if 50%

30% 41% 58% 76%

30% 23% 36% 50%

30% 13% 26% 40%

30% -22% 3% 29%

if 0% if 1% if 2%

1.5% 75% 67% 56%

1.5% 46% 41% 36%

1.5% 33% 31% 28%

1.5% 13% 10% 7%

if 3% if 4% if 5% if 6%

4.5% 92% 71% 53% 38%

4.5% 62% 46% 32% 20%

4.5% 52% 36% 23% 11%

4.5% 38% 18% 0% -15%

Required savings as % of actual income after deduction of wealth level available for financing retirement

Share of actual wealth intended to keep as reserve Base case (assumption)

Nominal growth rate of state benefits Base case (assumption)

Real capital market return/discount rate Base case (assumption)

If, for example, an individual from the Limited-wealth Risk-groups were to live on only 70% of his last pre-retirement income (instead of the 86% in the base scenario), he could more than halve his annual saving requirements from 62% to 29% of his income. This illustrates the importance of the coping strategies analyzed in sub-section 6.2.1.3. If the same individual could alternatively enhance his portfolio return and increase the real return rate from 4.5 to 6%, he could reduce his recommended saving rate to 38%. Since the expected real rate of return is significantly influenced by the choices an individual takes with regard to his portfolio mix (e.g., share of equity, level of diversification), an optimal portfolio strategy shown in the fourth and the fifth behavioral benchmarks (see sub-chapter 4.4 and section 6.3.4 and 6.3.5) is key to prepare for a solid financial situation in retirement. Furthermore, if a member of the Limited-wealth Risk-groups was prepared to renounce the idea of keeping a reserve, then the saving rate would fall to 41%. Even if this is still an unrealistically high saving rate for individuals with an annual net income of €46,000, it reveals the potential impact that slight variations in the underlying assumptions can have. Furthermore, this lever highlights the size of the financial cushion resulting

292

6 Empirical analyses of individual retirement-specific FPB

from the conservative assumptions of the base case. Considering the low share of individuals aware of a retirement gap (FV_9), with 66% expecting no gap and 15% even expecting surplus income, and that 68% of all interviewees feel well prepared and a further 27% feel neutral about the issue (FV_10), a conservative approach seems appropriate to convince individuals about the urgency and severity of their situation. 458 With regard to the regulatory environment and the capital market related assumptions, the scenario analyses reveal that the nominal growth rate of state pension benefits has a smaller impact than changes in the real rate of return. Since the latter can be influenced more easily by the individual than the development of the value of state benefits (i.e., cRVt), this is a good sign. For the Wealthy investor type for example, who is supposed to save 9% during his work life in order to cover his statutory state retirement income gap in the base scenario, an improvement of the real rate of return of 0.5% to 5.0% would make further savings unnecessary. If he were to earn a real rate of return of 6% on his financial wealth, his current wealth level of €702,000 could grow so much that he could even spend a higher share of the last pre-retirement income in retirement or make additional savings during retirement. Bearing in mind that the Limited-wealth Self-employed have a high share of their total assets in real estate, a possibility for them would be to set aside the property assets not just for inheritance but also as a reserve for their financial situation in retirement. On that basis they could reduce the share of their financial assets needed as reserve to zero and so would only have to save 23% of their income, an amount that looks more feasible than the original 39%. The High-potential could reach a similar recommended saving rate of around 25% if they tried to cope with only 80% of their pre-retirement income for their life in retirement or if they would be prepared to reduce the level of their reserves to 25% of their actual financial assets. A specific point needs to be made for this investor type. As High-potential, it can be expected that their income will grow substantially above average in the near future. Since consumption is habit forming, it is very probably that the expense streams of this investor type will increase in parallel with the income streams going forward and that this increase should be higher than subsumed by the model. However, as the savings are indicated as percent of the income, this change would be mirrored in the relative recommended

458

This statement builds on the finding of conservatism (sub-section 4.2.2.1). Accordingly, information needs to be provided in a repetitive, vivid and memorable way to be perceived and retained.

6.4 Scenario analyses for adequate saving rates

293

saving rate. If however, the expenses were to increase even more, then higher savings would be required. Overall, these scenario analyses reveal that the individuals who are most at risk (demonstrated by the highest recommended saving rate required to close the gap) are the Limited-wealth Risk-groups. Therefore, the economic situation of these individuals is examined in detail below. 6.4.4 Scenario analysis combining impact of different levers on the financial situation of the Limited-wealth Risk-groups In the base case, individuals from the Limited-wealth Risk-groups would need to save 62% of their working income until retirement in order to close the wealth-adjusted statutory state retirement income gap. Given the current net income level of €46,000, this would mean that the average individual would only have around €18,000 left at his disposal. This is in clear contrast to the amount the sample individual estimated as needed to live comfortably in retirement (about €40,000 in today’s purchasing power equivalent) which can be assumed to be slightly lower or equal to the actual living expenses during work life. This illustrates the difficulty that this sample individual is confronted with in putting aside the required saving amount. As a consequence, this investor type will probably not be able to live life in retirement as planned under the given assumptions. But as the ceteris paribus scenario analyses have demonstrated, there are different options that can substantially improve this bleak outlook and therefore should be considered in an individual’s financial plan. This section describes several levers an individual can influence himself and derives the new financial situation of the Limited-wealth Risk-groups based on the combined effect of these levers. Besides the levers investigated above, the individual could, for example, delay his transition into retirement. If an individual of the Limited-wealth Risk-groups decides not to retire early (i.e., at the age of 61) but delays until the age of 65 (still below what will be the then official retirement age of 65 years plus 5 months), this would have a very beneficial impact on the statutory state retirement income. On the one hand, the adjustment factor (AF) in the German benefit formula (Equation 3.1) would increase from 0.84 to 0.985. On the other hand, working several years more allows for collecting more EPs and at the same time extends the saving period for investments during work life. As a consequence, the net statutory state retirement income would increase for the year 2016 from a level of €15,960 under the old scenario to a level of €19,945 (both measured in today’s purchasing power, i.e., in real terms). This thus corresponds to an increase in

294

6 Empirical analyses of individual retirement-specific FPB

statutory state retirement income of around 6% per additional working year, as per BORGMANN 2005. If in addition, the individual could reduce the share of current financial wealth needed as reserve from 30 to 20% and at the same time assume a leaner retirement lifestyle with a share of only 80% of the last income needed (instead of the 86% indicated by the interviewed individuals) the situation looks even better. If all these levers are pulled simultaneously, the projected result is both startling and extremely encouraging. The savings necessary to cover the retirement income gap amount to only 7% of actual net working income (instead of 62% in the base case). Fig. 6.4 contrasts the base scenario with this adapted scenario. Limited-wealth Risk-groups – Base scenario

50,000

€

Limited-wealth Risk-groups – Proactively adapted scenario

Income stream Income needed in retirement

40,000

Annuity from disposable financial wealth Statutory state pension income

30,000 20,000 10,000

Income after savings during work life

€

Income stream Income needed in retirement Annuity from disposable financial wealth

40,000 30,000 20,000 10,000

Statutory state pension income

Income after savings during work life

,0

,0 2005

50,000

2015

2025

2035

2045

2005

2015

2025

2035

2045

Base scenario assumptions:

Proactively adapted scenario assumptions:

• Early retirement at the age of 61 • 86% of last income needed to live

• Early retirement at the age of 65 • 80% of last income needed to live comfortably

comfortably in retirement

• 30% of current financial wealth intended as a reserve

Fig. 6.4

in retirement

• 20% of current financial wealth intended as a reserve

Contrasting of saving requirements for the Limited-wealth Riskgroups under the base scenario and the proactively adapted scenario

As the comparison of the shaded area above the thin line and the solid line in the retirement period – the wealth-adjusted statutory state retirement income gap – indicates, the gap is substantially smaller for an individual who is prepared to make some compromises in his perspectives on retirement. This analysis has revealed three important findings. First, it has shown that the saving rate required to cover the statutory state pension income gap (62% of net working income), resulting from the individual’s overly optimistic expectations as to his life in retirement and the assumptions inherent in the model, is too high and unrealistic. As saving this amount would leave the individual with a substantially lower disposable income

6.4 Scenario analyses for adequate saving rates

295

than what they consider as the minimum to live comfortably in retirement, this example illustrates that it will be very difficult both to realize the set life goals and to meet the expectations about life in retirement. Therefore, it is essential to understand the different assumptions and expectations an individual has for his financial situation in retirement in order to identify, quantify and close a possible gap. Second, the analysis has revealed that if such a gap exists, different levers can be pulled to remarkable effect on the financial situation in retirement and the required saving rate. These can relate to the timing of the transition into retirement, the expectations about consumption in retirement or the financial objectives in terms of the share of financial assets intended as a reserve. Furthermore, even the conservative assumption about the treatment of real estate assets could be lessened. If an average representative of the Limited-wealth Risk-groups has net real estate assets (after deduction of mortgage) of €114,000, these assets could, for example, be (partially) used to finance retirement through reverse mortgage facilities or through direct sale and the consumption of the proceeds, instead of being left as inheritance for the next generation. Third, given that the sample individuals belong to the privileged 2.6% of individuals who get a statutory state pension income of over €1,650 per month 459 and also dispose of a relatively high wealth level, the already substantial retirement gap for these affluent individuals can be seen as an indicator for the dramatic dimension of the German retirement problem as a whole. 6.4.5 The longevity risk or the investigation of the duration of a secured retirement financing The longevity risk focuses on the danger of running out of financial means in old age. This situation could happen if not enough savings were accumulated earlier in life to finance the share of retirement consumption that cannot be covered through other income sources (such as statutory state retirement income or proceeds from investments). Therefore, the question of saving is closely linked to the estimation of the duration of the dissaving period in retirement. If, for example, an individual underestimates his lifeexpectancy and plans for too short a dissaving period, he is in danger of running down his financial assets before he dies. The determination of the age at which the individual would run out of money is the focus of this section. 459

See BMAS 2006b, p. 97.

296

6 Empirical analyses of individual retirement-specific FPB

In a situation where individual financial assets are getting tight, an individual must tap into those wealth pots that were initially intended as a reserve or bequest. Therefore, this analysis investigates not only the age at which individuals have run down their disposable assets and when they need to tap into these initially reserved wealth pots, but also the point at which all the financial and finally even the real estate assets are used up. (It could also be assumed that an individual would dramatically reduce his expenses the closer he gets to extinguish his assets. This effect has not been taken into consideration in the simulation but represents another security buffer for the individual financial situation in retirement). Since the Limited-wealth Risk-groups have been identified as those individuals with the most urgent need for action and the most critical situation, the different scenarios are calculated for this investor type. The scenarios are based on the assumption that the sample individual retires at the age of 65 and needs 80% of his last pre-retirement income to live comfortably (i.e., the parameters of the adapted perspective on retirement as shown in the previous section). As in the previous section, underlying assumptions are modified to explore the effect on the duration of a secured financial position or the age at which the money runs out. The results are displayed in Fig. 6.5. Baseline

Scenario

Example individual from Limited-wealth Risk-groups born in 1951 and retiring in 2016 at the age of 65 with a life expectancy of 88

Remaining saving period from 2005 on amounts to 11 years, retirement period of 24 years

In 2016, statutory state income amounts to €19,945 and income needs to €37,829 (in real terms)

Wealth in 2005 consists of €186,000 financial assets and €114,000 net real estate assets (all these assets are worth €430,000 in real terms at retirement)

Fig. 6.5

Age when reserve of 20% of financial assets is reached

Age when total financial assets are used up

Age when real estate assets are also used up

Normal scenario without further saving

82 years old

89 years old

97 years old

3 years of a bear market (á la 2000– 02 Dax performance) in 2017

77 years old

81 years old

88 years old

Inflation of 4% for 4 years after one year retirement

81 years old

84 years old

91 years old

Special care from 70 to 74 (€3,000 per month)

73 years old

76 years old

83 years old

Scenario calculations for the determination of the age at which the Limited-wealth Risk-groups individuals are running out of assets

6.4 Scenario analyses for adequate saving rates

297

In the base case, a typical member of the Limited-wealth risk-groups would reach the threshold level of 20% of financial assets at the age of 82. This confirms that – assuming the individual wants to keep a reserve of 20% of the currently available financial assets and does not undertake any additional savings – the individual would run out of “disposable” money before reaching the statistical life-expectancy of 88 years. As the duration of the available funds is not as long as the expected life-time (82 versus 88 years), the individual needs to save 7% of working income until retirement to cover this retirement gap as pointed out in section 6.4.4. The second analysis focuses on when individuals would run out of all financial assets, including the 20% reserve. If the individual were also prepared to run down this reserve, then the financial means would last until he were 89 years old, or one year later than the expected end of his life. From this point on, the individual would need to start using the real estate assets which have grown from €114,000 in 2005 by 1% p.a. in real terms 460 to a real value of around €160,000 by 2040. If the individual were prepared to use his complete asset pool, he could live until he is 97 without running out of money. This means that his total financial wealth could last for 9 years longer than his expected life-time, but he would not be able to leave an inheritance or keep a reserve. If he just reached his statistical lifeexpectancy, he would have used up some of his reserve but still be able to leave the entire real estate asset pool and the remaining share of the reserve as a bequest. The perspective looks bleaker if different adverse events are taken into consideration: Presuming that the equity stock markets would be hit by a slump similar to the one suffered by the German DAX in 2001 to 2004, the share of the financial assets that are invested in equity (assumed to be 30% of the financial wealth portfolio) would drop significantly in value. Even assuming a slight value increase in the remainder of the portfolio, such a stock market slump would lead to the threshold level of 20% reserve being reached at the age of 77 while all financial assets would be used up at 81 years. The real estate assets could then further finance retirement until the age of 88. If on the other hand, a relatively high inflation rate of 4% (which Germany had to face between 1992 and 1994) 461 would hit for four years at the beginning of retirement and the state pension income would not be adapted 460

The nominal growth rate derived from the German real-estate property index (DEIX: Deutscher Eigentums-Immobilien-Index) amounts to 2.5% minus the inflation in the measurement period that amounted to 1.5%. See GEWOS 2005 and STBA 2006. 461 See indications from the German Statistical Federal Office, STBA 2006.

298

6 Empirical analyses of individual retirement-specific FPB

equally – meaning that the income needs would even further outgrow the income received from the SSP – then all the financial assets would run out at the age of 84, with the total wealth being used up by the age of 91. This highlights how sensitive the situation is, specifically with regard to the inflation risk and the risk-return profile of an asset portfolio, and illustrates how essential it is to mitigate these risks. Another adverse scenario is based on the fact that the health care costs or the effects of having to live in a retirement home rate the highest risk awareness with 81% and 82% respectively (RP_4). It assumes the individual requires special care at the age of 70 for 5 years (costing an extra €3,000 per month). 462 At only 73 he would have to begin drawing down the 20% reserve, while the run down of the real estate assets would start at the age of 76 and all assets would be gone by the age of 83. Allowing for tweaking of the detailed underlying assumptions, the analysis as a whole reveals the vulnerability of the individual financial position in retirement, and consequently the extraordinary importance of thoughtful financial planning and dedicated risk and asset management. In addition to the remarks made earlier regarding the levers an individual can use to reduce the required saving rate during work life, these calculations offer insights into the extension of secured financing in retirement. If no major risks appear and if the individual adapts his perspectives and is prepared to renounce holding a reserve and leaving an inheritance, he should not run into a major financial crisis, even if financial resources might get tight at the end (normal scenario). However, if certain risks strike, then even the financial cushion will be quickly used up and the danger of old-age poverty is more imminent. Therefore, if the individual does not proactively save or mitigate the risks, he might run out of money before he has reached his statistical life-expectancy and then have to rely on state funding with the corresponding restrictions on the standard of living. 6.4.6 Comparative analysis with stated saving rates To close this discussion on the saving rate, the recommendations for the required saving rate for various investor types derived in section 6.4.2 are now contrasted with the stated saving rate (in effect, the actual FP actions). Table 6.46 illustrates the distribution of the answers from the different interviewees regarding the “maximal proportion of their income that they would be prepared to invest (including any savings already made) over the period to retirement to ensure financial security in retirement (as percent of 462

See GEIS/BÄHR 2006, p. 28.

6.4 Scenario analyses for adequate saving rates

299

net earnings from employment)”. This question was asked only of preretired individuals, so an intergenerational comparison to the Retirees is not possible. In the interview, the saving rate explicitly includes savings in the form of private or corporate pension provisions. This ties neatly into the definition of the wealth-adjusted statutory state retirement income gap which has been used as the basis to calculate the required saving rate and which also does not take these income sources into consideration, thus leaving them to make up the recommended saving rate. Therefore the recommended and stated saving rates are comparable. Table 6.46 Share of individuals planning to save a specific share of their income LimitedLimitedwealth Risk- wealth SelfRetirees groups employed

Highpotential

Wealthy

All investor types

as % of total sample n=

53

55

83

66

257

23% 68% 9% 0%

11% 84% 5% 0%

16% 80% 5% 0%

0% 66% 34% 0%

12% 74% 14% 0%

18%

19%

19%

27%

21%

Recommended rate (Base scenario)

62%

39%

29%

9%

Recommended rate (Without keeping a share of the financial assets as reserve)

41%

23%

13%

-22%

Recommended rate 29% (With being content to live on 70% of last pre-retirement income)

25%

13%

1%

PC_7 Readiness to save – Saving rate 0 - <10% 10 - <30% 30 - >50% >= 50% Weighted average

Remark:

N.a

Analysis based on question C. 8 Attribute whose distribution between the five investor types is not significantly different

The distribution of the answers illustrates several points. First, the weighted average of all investor types’ intended saving rate at 21% is relatively high. Compared to an official level of around 10.4% in 2004 463 or a 463

According to the DIA 2005b the official saving rate of the German population has decreased significantly since 1975 when the rate was over 15% but is on the rise again. Compared to the UK with only 5.2% saving rate, the 10.4% of Germany seems quite high. See PEAPE 2004, p. 5. An interesting point in this regard is that the consumption mentality in Germany can be considered as less pronounced than in other countries such as e.g., the US or UK where the saving rate is much lower and households are accepting a higher indebtedness. See BERNET 2005b, p. 64. However, the comfort from a relatively high saving rate is reduced if the investment strategy is taken into consideration. For example, individuals

300

6 Empirical analyses of individual retirement-specific FPB

median saving rate in Germany of 12% 464 this result shows that the individuals in the target group of this study intend to save substantially more than the average German. This reflects the second point which is the fact that the saving rate is rising in line with increasing wealth or earnings. This has already been documented by BANKS/BLUNDELL/TANNER 1998, SHEFRIN/THALER 1988 as well as by SCHNABEL 2003a for Germany. The effect of a positive correlation between wealth or earnings and the saving rate can be seen in the results of the total sample (affluent population versus entire population) as well in comparing the Wealthy with the other investor types. However, looking at the weighted average of the Limitedwealth Risk-groups (18%) and comparing it to the weighted average of the Limited-wealth Self-employed and the High-potential (with a level of 19% for both), the difference does not seem to reflect the total wealth distribution and income variations to the extent one could expect given the research cited above. Moreover, these results also reflect the findings from CHOI et al. 2002 that the willingness to save increases with higher education, even though only marginally. Furthermore, since another survey about the attitudes of the German generation of pre-retirees also attests to the high level of happiness of these individuals, 465 the data also seem to follow the positive correlation researched by MITCHELL/MOORE/PHILIPPS 2000 between happiness and willingness to save. Lastly, the high saving rate also confirms the higher complexity of pension arrangements of these individuals (i.e., through private pensions or corporate pensions, FV_6). With regard to the distribution of the saving rate, it needs to be emphasized that no individual is prepared to save more than 50%. This illustrates that the Limited-wealth Risk-groups, who would have to save 62% of their income in order to fulfill all their expectations in the base case, will not be able to realize their financial situation in retirement as planned but need to make other compromises as shown in section 6.4.4. Indeed, it is alarming that the Limited-wealth Risk-groups not only have the lowest overall saving rate in spite of their riskier position, but also that they have the highest in both countries, the US and the UK, tend to assume a higher share of equity and thus invest more aggressively, resulting in an increased potential for higher returns. 464 This means that 50% of all German households have a saving rate below 12%. Numbers relate to 2002. See BÖRSCH-SUPAN/ESSIG 2002, p. 49. 465 The Generation Gold study focuses on individuals aged 40 to 80 living in Germany in spring 2005. Contrary to this study’s target group, the individuals surveyed in the GDI study were not required to belong to the affluent segment. See FRICK 2005, p. 66.

6.4 Scenario analyses for adequate saving rates

301

share of individuals (around a quarter of interviewees) saving only between 0 and 10%, which is even below the level of 10% recommended by a practitioner’s handbook. 466 The fact that a large share of these individuals does not save more might be simply because they cannot, hindered as they are by their low total income, something other surveys have revealed, especially for women. 467 Furthermore, since this investor type also encompasses the Health-risk Employees, the results might also be influenced by the findings from MITCHELL/MOORE/PHILIPPS 2000, showing that individuals with poor health save less. 468 This investor type thus also has the largest differential to their recommended saving rate and should be considered as acting sub-optimally with regard to saving. The Wealthy investors are at the other end of the spectrum and save the most, primarily because of a higher income and wealth level. Furthermore, their higher saving rate also supports the statement established in the scenario analysis of the inter-temporal financial optimization problem, namely that this investor type is looking at a relatively secure financial position in retirement. Their high preparedness to save illustrates very cautions behavior but also reflects that for this investor type saving is just much easier. The Limited-wealth Self-employed as well as the High-potential indicated saving 19% of their income. As the Limited-wealth Self-employed have a higher than average income of €58,000 (versus €53,000) their absolute amount of saving is slightly higher. This confirms a rational hedging strategy, according to which individuals with a higher career risk tend to save more. This very strategy has been described by BÖRSCHSUPAN/ESSIG 2002. The High-potential are the youngest investor type, and their behavior mirrors – to a certain extent – the finding from the SAVE study, according to which the youngest have a tendency to save most. 469 Overall, the analysis has revealed that the indicated saving rates are – with the exception of the Wealthy – substantially below the recommended 466

See KOBLINER 2000, p. 42. See for example HÖLLGER/SOBULL 2001, p. 29ff or DEHM et al. 2000, p. 40ff. 468 Also BÖRSCH-SUPAN/ESSIG 2002 have found that individuals with poor health show a very pronounced risk aversion with regard to health risk. See BÖRSCHSUPAN/ESSIG 2002, p. 85ff. As a consequence, they would be expected to invest a lot of their assets into the mitigation of the health risk. So if it can be confirmed that these individuals show a high level of health risk mitigation (which indeed can be seen with a mitigation level of the health care risk of 31% versus an average mitigation of only 24%, see Table 6.42), it could well be that these mitigation costs are too high and leave no room for traditional saving. 469 See BÖRSCH-SUPAN/ESSIG 2002, p. 13. Since these authors are looking at a wider range of the population, they find that the groups that save most are individuals aged between 30 and 39 years. 467

302

6 Empirical analyses of individual retirement-specific FPB

saving rates derived in the base cases (section 6.4.2). However, relaxing the rather aggressive assumptions of the base cases dramatically changes the picture. By allowing all the financial assets to cover the statutory state retirement income gap or by reducing the amount of income needed to live comfortable to 70% of the last pre-retired income, the High-potentials also save more than required to cover the statutory state retirement income gap. But even for the Limited-wealth Self-employed and the Limited-wealth Risk-groups, whose stated saving rates do not meet the rates required in these cases, the outlook is brighter if these assumptions are relaxed and further compromises permit complete closure of the gap. Bearing in mind that the individuals might have additional income sources in retirement (e.g., inheritance) and showing some flexibility with regard to the transition into retirement and the life plans for retirement, the required saving rate could be further reduced. Therefore, given this relativization and the fact that the overall preparedness to save is quite high in this target group compared to other countries and the overall German population, the FP behavior with regard to saving is quite consistent with the recommendation. Finally, a point needs to be made about the mental discounting of the indicated saving rates: THALER/BENARTZI 2004 and REIFNER/TIFFE/TURNER 2003 have shown that there is a large difference between the amount people intend to save and the amount they actually end up saving. As a consequence, the effective average saving rate of this target group might be well below the indicated 21%. Nevertheless, even applying a mental discount to the weighted average saving rate still leaves a good margin, especially for the Wealthy and the High-potential.

6.5 Summary of the empirical analyses of individual retirement-specific FPB As the core of the empirical work, this chapter describes the observable individual retirement-specific FPB in the light of previously defined FP perspectives and FP actions. The main findings are: • Based on comparable socio-demographic and socio-economic attributes, the eight investor groups can be merged into five investor types: To start with, the “Retirees” are analyzed separately to highlight intergenerational differences. Among the other investor groups with a below average risk capability, the Health-risk Employees, the Typical Employees and the Single Mothers are pooled into the “Limited-wealth Risk-

6.5 Summary of empirical analyses of individual retirement-specific FPB

303

groups” investor type. All its constituents share an increased risk factor without enjoying the comfort of a substantial financial cushion. The “Limited-wealth Self-employed” show a profile that is so distinct from these three investor groups that they warrant their own investigation. Among the investor groups with an above average risk capability, the Highly-educated and the Well-off Middle-aged are pooled to the “Highpotential”. Despite their different educational backgrounds, all have the potential for a significant wealth increase due to their education or previous work experience. Finally, the “Wealthy” are analyzed separately as their financial profile is very different from the two investor groups with an above average risk capability. • FP perspectives on life and financial decision-making identify the target group within the German affluent segment as “OPALS” (Older People with Active Lifestyles). They have a high level of self-determination and are very confident about their own financial sophistication. Their FP perspectives express an overly optimistic attitude with regard to their financial flows as well as a pronounced feeling of financial preparedness for retirement. This optimism is mainly caused by a representativeness bias and conservatism relative to the sound financial situation of today’s retirees. Surprisingly, this good feeling is also perceivable with many individuals whose income and expense expectations suggest a retirement gap, which illustrates a rather unthinking approach towards financial planning. • FP actions are dominated by low-risk behavior, also demonstrating limitations in consequent implementation, passivity or procrastination: The share of equity in individuals’ financial assets averages only 10%. Furthermore, cautious behavior is revealed in the high stated saving rate of 21% and the high share of classical pension savings products. A lack of consequent implementation on the other hand is observable in the difference between objective and subjective diversification and in a risk mitigation level that is very low, despite these individuals’ high awareness of risks. But the largest gap relative to the established behavioral benchmark is the late start of financial planning activity, which is another sign of procrastination. Overall, these identified human limitations are indicators of a rather low actual sophistication with regard to financial planning for retirement. • A simulation of different investor types’ financial situation in retirement has identified a retirement gap for the Limited-wealth Risk-groups, the Limited-wealth Self-employed and the High-potential – even considering their relatively high stated saving rate. These retirement gaps are in

304

6 Empirical analyses of individual retirement-specific FPB

marked contrast to the feeling of being financially prepared for retirement and highlight the optimism that reigns among today’s pre-retirees. While the High-potential can close a large part of the gap with flexibility on the expense side (i.e., by applying coping strategies), the Limitedwealth Self-employed would need to draw substantially on their real estate assets to safeguard their well-being in retirement. For the Limitedwealth Risk-groups the simulation shows that their retirement expectations are unrealistic and that this investor type needs to be flexible in several areas. With flexibility in the timing of retirement and their financial needs and objectives, their situation can substantially be improved. But even so, they face an increased probability of running out of assets if adverse events such as a stay in a retirement home, a market crash or an inflation hike happen.

7 Review of empirical research and identification of suggestions for policy-makers, financial planners and the individual

“The goal of learning about cognitive illusions and decision-making is to develop the skill of recognizing situations, in which a particular error is likely. […] An ability to recognize situations in which one is likely to make large errors is a useful skill for any decision maker.” KAHNEMAN/RIEPE 1998, p. 53 The previous chapter described the socio-demographic and socioeconomic attributes of the five investor types, shed light on the FP perspectives and finally compared the actual FP actions to the behavioral benchmarks derived in the normative part of this study. It is the objective of the first two sub-chapters to review the surveyed retirement-specific FPB and shed light on the most important findings from FP perspectives and FP actions. The third sub-chapter presents a profile of each investor type that summarizes their key characteristics and peculiarities with regard to retirement-specific FPB. The fourth sub-chapter starts by identifying those areas where individuals’ retirement-specific FPB shows the most adequate behavior but also where the most pronounced limitations can be perceived and where the gap between actual FP actions and the behavioral benchmarks is most striking. Then it introduces guiding principles to develop specific measures for the improvement of individual FPB. Building on these most prominent limitations and guiding principles, the chapter closes with an illustration of different levers that policymakers, financial planners and the individual have to enhance individual retirement-specific FPB.

306

7 Review of research and suggestions for improving individual FPB

7.1 Review of identified FP perspectives The key findings of the four constructs of FP perspectives presented in sub-chapter 6.2 are summarized below. Additional investor-type-specific characteristics will be illustrated in sub-chapter 7.3. 7.1.1 Planned life in retirement The planned life in retirement takes a qualitative look at how individuals see their life in retirement and determines primarily the expense side of the individuals. Its first element is the planned transition into retirement (i.e., the retirement age). The study shows that the current generation of preretirees plans a slightly older retirement age than the current generation of Retirees (retiring at 61 compared to the Retirees’ actual 59 years). Examined in more detail, 29% of all interviewees still plan for an early retirement (before the age of 60), 67% aim to retire between 60 and 65 and only 4% are counting on continuing to work after 65. The analysis of the life plans in retirement reveals why this generation is termed “OPALS – Older People with Active Lifestyles” in relevant trend research: 470 A majority of the individuals visualize their retirement as a life of activity, self-determination and pleasurable consumption. This is reflected in extensive travel plans (66%) and a strong preference for hobbies, whether indoor or outdoor (68 and 70% of all interviewees planning this activity). Since the latter is directly linked to good health, the popularity of outdoor activities highlights the importance that health plays for this “Generation Gold” 471 Besides these self-focused activities, an increasing importance is put on social relationships (i.e., friends and family) with many interviewees planning to spend more time with their family and performing charitable activities (55 and 17%). Lastly, new life-concepts such as parallel life modules and the reinvention of the self can be deduced from the plans to study or the willingness to continue working in retirement (14 and 19%). Interestingly, today’s Retirees are less active than the preretirees plan to be. This could be a hint of inter-generational changes or the fact that once in retirement, energy levels and desire for activity decrease, which could be a result of overconfidence and optimism before retirement.

470 471

See FRICK 2005, p. 16. Term used in FRICK 2005 and BERNET 2005a to describe a generation that has “the time, money and energy needed to make old and new dreams come true.” FRICK 2005, p. 16.

7.1 Review of identified FP perspectives

307

Even taking into account the concentration of wealth in the hands of the older generation and the affluent characteristics of the target group, the question arises which coping strategies individuals are prepared to assume in order to cut their expenses and so avoid financial shortfalls. Fortunately, the high degree of planned activity is also accompanied by a high level of preparedness to assume coping strategies. Financial measures seem to be most popular (78% are willing to release financial investments and 70% would sell an investment property), but many individuals are also ready to restrict their lifestyle (65%) or continue to work (57%). These elements throw a different light on consumption-intensive life plans and planned early retirement and illustrate the idealistic character of individuals’ notions of retirement (i.e., travel plans become “nice-to-haves”). Interestingly, the values of self-determination and autonomy can also be perceived in these coping strategies, for example in a high reluctance to move in with the family. One point of caution needs to be considered however with regard to these coping strategies: Since the empirical survey has shown that individuals do mostly not count with a financial shortfall in retirement, they might also not consider being in need of coping strategies. Under these circumstances they might be more inclined to indicate a preparedness for assuming coping strategies than if the risk of financial shortfalls was more conscious and thus the need for coping strategies more realistic. Besides the day-to-day expense streams that are driven by life-plans and coping strategies, the expense side also depends on the overall financial objectives individuals envisage with their assets. Keeping a reserve to provide for unexpected future events has the highest importance for all interviewees (89%) and illustrates that individuals are very concerned about risks and want to provide accordingly. Furthermore, they also care about their dependents since – with a 60% agreement rate – leaving an inheritance is the second strongest motive. Interestingly, 31% of all interviewees want to continue to save in retirement, which implies that they expect their total income to surpass their expenses. The realization of this plan however seems questionable, given the existence of retirement income gaps or income streams that just equal the expense streams (as detailed below). A new phenomenon within the financial objectives is that 36% of all individuals are prepared to spend their assets as they do not need to leave an inheritance. This represents a shift away from the historical German reality of Retirees still saving in retirement. 472 On the other side, this identified 472

BÖRSCH-SUPAN/ESSIG 2002 analyze the saving behavior of Germans and find that the impact of age on the saving rate does not display the characteristics predicted by the classical economic theory: The life-cycle hypothesis predicts individuals to dissave in retirement. Rather, the results indicate that in Germany in-

308

7 Review of research and suggestions for improving individual FPB

trend for dissaving in retirement corresponds to one of the key predictions of the life-cycle theory. At the same time, it highlights that from a sociological perspective, the “family clan concept” is decreasing in importance and partially explains why the “Generation Gold” might be followed by the “Lost Generation”. 473 7.1.2 Financial view on life in retirement As a complement to the qualitative perspective described above, the financial view on life in retirement investigates individuals’ expected income and expense streams for retirement from a quantitative angle. The results reveal that individuals have trouble assessing future monetary values and flows in relative as well as in absolute terms: They assume their last-preretirement income will be lower than their actual income or expect a replacement rate from state pension income of 46% compared to an analytically derived 26%. This confirms that – although the affluent segment in Germany qualitatively understands the dimensions of retirement income sources (with overall state pension as most important contributor, followed by private pensions and employer-based pensions) – typical human limitations such as money illusion or optimism constrain its financial astuteness. Even in light of these estimation difficulties, one can test whether individuals risk facing a retirement income gap by comparing the anticipated absolute income and expense streams. The expected nominal income streams amount to €48.0k on average, compared to a substantially higher actual income of €53.5k. The target group’s expense streams seem to reflect more active and consumption-intensive life plans with on average €48.4k needed to live comfortably (90% of today’s income). The comparison of individual income and expense indications shows that two thirds of all interviewees expect their income streams to be sufficient to cover their expenses. Of the remaining individuals, 18% presume their expenses to be higher than their income leading to a negative retirement gap while 15% still think that their consumption will be lower than their income, which will allow them to save. These results hint at a rather thoughtless approach towards retirement financial planning where individuals have not taken an in-depth look at the economics of their financial situation in retirement nor reached a solid understanding of the mechanisms associated with their flows. As a further complication, interviewees tend to be optimistic with dividuals keep saving even in their old days. See BÖRSCH-SUPAN/ESSIG 2002, p. 12ff. 473 As termed in BERNET 2005a, p. 27.

7.1 Review of identified FP perspectives

309

regard to their financial situation in retirement – 68% of them feel well prepared and another 27% feel neutral about their financial preparedness for retirement. It is quite striking that only 5% of all interviewees feel financially unprepared for retirement. This means that over half of those individuals who expect a negative income gap based on their anticipated income and expense streams (18% of all individuals) still believe that they are well prepared. This illustrates that some individuals have a clear lack of realism or cognitive dissonance relative to retirement financial planning. 7.1.3 Transaction preferences The interviews confirmed the high importance of self-determination, reflected in the majority of the individuals (57%) preferring self-directed information collection and decision-making. The increased importance of friends and family 474 and associated changes in the sociological structures of households can be perceived in the willingness of more than half of all individuals (53%) to take financial decisions together with their partner. 7.1.4 Risk profile The objective risk capability is the first element of an individual’s risk profile and reflects his socio-demographic and socio-economic characteristics. This logic was the basis for the attribution of interviewees to various investor groups with a below or above average risk capability. Therefore the summary of the respective findings needs to differentiate between the five investor types. The Wealthy have clearly the highest risk capability, given their age, solid education and a very comfortable financial cushion. The individuals with the second highest risk capability are the High-potential who are younger and substantially less well-off than the Wealthy but can expect to be financially successful in the future due to their education and past work experiences. Both these investor types have an above average risk capability. The Limited-wealth Risk-groups, the Retirees and the Limited-wealth Self-employed on the other hand have below average risk capabilities. The Limited-wealth Self-employed have a substantial financial cushion (with a high share of real estate holdings) but are exposed to the self-employment risk. The Retirees have a below average risk capability because of their retirement status and a shorter time horizon. Lastly, the Limited-wealth 474

As pointed out in the life-plans above (PL_2), 55% of all individuals plan to spend more time with their family in retirement.

310

7 Review of research and suggestions for improving individual FPB

Risk-groups are most exposed to risk due to their high age compared to the other pre-retirees, a lower education level, a small financial cushion and subjective risk elements like bad health or family responsibilities. The self-assessed willingness to take on risk in order to enhance an expected return is the second element of an individual’s risk profile. It demonstrates the low level of risk appetite among the German affluent segment, where 79% of all interviewees are (completely) risk averse. The comparison of this self-assessed risk appetite with the risk capability described above reveals an unexpectedly high willingness to take on risk for the Limited-wealth Self-employed (ending up with the second highest risk appetite) while the High-potential show a more pronounced riskaverseness than could be expected given their risk capability. The third element of the risk profile is the risk sophistication, which is driven by the self-assessed financial sophistication, the risk awareness and the translation of this awareness into an interest for financial products to hedge the respective risks. The self-assessed financial sophistication confirms the behavioral finance finding of overconfidence: A higher share of individuals (31%) assess themselves as having an above average level of financial knowledge compared to 22% who feel they have a below average sophistication level. Combined with the expressed preference for making decisions on their own (self-directed behavior), this conceitedness (overestimation of one’s own capabilities) makes for to a dangerous mix. Another striking insight is related to the awareness of different risks: Even if individuals are mostly feeling well prepared for retirement, they still are very worried (expressing awareness of 9.2 out of 14 possible risks). This high level of concern reflects to a large extent the type-specific self-assessed risk appetite: With the exception of the Retirees, who are the least worried about risks, individuals with the lowest risk appetite show the highest risk awareness. The awareness is most pronounced for the risk of exploding health care costs, having to live in a retirement home and the impact of inflation. The generally high risk awareness illustrates that individuals are very conscious about the different uncertainties that await them, and represents a solid foundation for an enhanced individual retirement-specific financial planning. This good base for improving individual FPB is also confirmed by the fact that the high risk awareness translates into a heightened interest for financial products that hedge the risks. Fig. 7.1 summarizes the key positions within all four constructs and illustrates the positioning of each investor type relative to the average of all interviewees.

7.2 Review of gaps identified in individual retirement-specific FP actions 1 Retirees

2 Limited-wealth Risk-groups

Transaction preferences

Financial view on life in retirement

Planned life in retirement

Planning late retirement (PL_1)

Risk profile

4 High-potential

3 Limited-wealth Self-employed

Low 4

Planning to continue to work part-time (PL_2)

1

Planning to travel extensively (PL_2)

1

Prepared to restrict life style (PL_3)

3

Planning to continue to save (PL_4)

2

Absolute income needed to live in retirement (FV_3)

2

Probability to have state pension as main income (FV_4)

3

Complexity of pension arrangements (FV_6)

1

Absolute income expected in retirement (FV_8)

2

Share of individuals with no retirement income gap (FV_9) Share of individuals with a negative gap relative to share of individuals with a positive gap (FV_9)

5

1

Share of individuals who felt/feel well prepared (FV_10)

2 4

1

3

4

4

1

6

1

1

5 1

5

4

3

5 5

3

3

4

2

2

3 1

3

5

2 5 2

1

3

2 2 4

1

3

5

4

3

2

5

2

2

Awareness about longevity risk (RP_4)

2 4

1

Interest for product protecting from longevity risk (RP_5)

1

3

1

5

5 5

3 1

1

2

3

2

1

5 4

4 4

4

4 5

3

5

Fig. 7.1

2

1

1

3

Awareness about inflation risk (RP_4)

5

1 4

3

Interest for product protecting from inflation risk (RP_5)

3 4

5

Share of individuals with delegating behavior (TP_1)

Interest for financial products protecting from risks (RP_5)

5

5

Share of individuals taking decisions with the partner (TP_2) Share of individuals who feel (somewhat) comfortable with risk (RP_1) Share of individuals assessing themselves an above average financial sophistication level (RP_2) Worry-indicator (RP_3)

2

2

3

2

High 3

5 4

3

5

Share of individuals with self-directed behavior (TP_1)

5 Wealthy

Average 2

4

311

2 4

4

4

5 4 3

3

4

2 5

Comparison of average investor type specific agreement rates and attributes for selected elements of the FP perspectives

7.2 Review of gaps identified in individual retirementspecific FP actions Sub-chapter 4.4 introduced six behavioral benchmarks to guide individual retirement-specific FPB. Along these principles, sub-chapter 6.3 described the actual individual FP actions and demonstrated where individual FP actions deviate from the benchmarks. Sub-chapter 6.4 performed a detailed simulation analysis for the seventh element of FP actions, the required saving rate, and so contributed to the identification of the seventh benchmark against which the stated saving rate was compared. Fig. 7.2 provides a summary perspective on the congruence between the seven normative principles and the respective FP actions. It represents a qualitative assessment of the deviations and offers insights into where the largest gaps and thus the most urgent needs for improvement exist.

312

7 Review of research and suggestions for improving individual FPB

No gap between actual FP actions and behavioral benchmark Substantial gap between actual FP actions and behavioral benchmark

1

Start of financial planning for retirement

2

Understanding of personal financial situation in retirement

Retirees

Limitedwealth Riskgroups

Limitedwealth Selfemployed

Highpotential

Wealthy

All investor types

• Using an expert advisor • Showing interest in holistic advice

• Consulting information sources 3 4

Holding classical pension saving products Diversification

• Self-assessed level of diversification

• Objective level of 5

6

diversification Risk-return profile of the portfolio • Share of equity • Real-estate leverage Mitigation of risks

• Inflation risk • Longevity risk 7

Indicated saving rate

Fig. 7.2

Identification of gaps in individual retirement-specific FP actions based on the comparison between actual FP actions and the corresponding behavioral benchmarks

The most striking gap between actual FP actions and the behavioral benchmarks is with regard to the age at which individuals start to think about their financial situation in retirement and the mitigation of the inflation and longevity risks. These limitations are very important for all investor types. Furthermore, many investors’ risk-return profile with its share of equity and real-estate leverage as well as their objective measure of diversification indicate that their portfolios would benefit from a more sophisticated financial planning approach. While these key limitations in FP actions will be taken up again in section 7.4.1., other elements, such as the expected retirement gap of the Limited-wealth Risk-groups are addressed in the type-specific findings of the next sub-chapter. With regard to the different investor types, the results reveal that the Wealthy and the Limited-wealth Self-employed show the most active and most sophisticated financial planning behavior. For example, they show a better understanding of their financial situation in retirement (more frequent use of advisors, more focused consultation of investment magazines and the Internet) and a higher comprehension and concrete realization of basic financial concepts (e.g., diversification, share of equity). The High-potential display certain awareness about their financial situation in retirement in that they show a high propensity for having classical

7.3 Summary of individual retirement-specific FPB profiles for all types

313

pension savings products and a readiness to mitigate inflation risk. At the same time they are underserved by advisors and lack consequence in the implementation of basic financial concepts (e.g., low objective diversification and much lower share of equity than their risk capability would induce). The Retirees are well covered by retirement advisors and show a sober approach relative to the risk-return profile of their portfolio but could benefit from a better mitigation of risks. Finally, the Limited-wealth Risk-groups not only demonstrate a lower level of interest and awareness but also less sophistication and resultant actions (e.g., very low risk mitigation level, low objective diversification level, lowest share of equity). Furthermore, they indicate the lowest saving rate, while being likely to have the most pronounced wealth-adjusted statutory state retirement income gap. Therefore they are the investor type most at risk with regard to a secure financial retirement and thus the one for whom adequate retirement-specific FPB is most important.

7.3 Summary of individual retirement-specific FPB profiles for the five investor types In this sub-chapter the FPB profiles for each investor type are summarized. The profiles delineate the investor types’ key socio-demographic and socio-economic characteristics, highlight their most important FP perspectives and FP actions and offer a broad assessments of each investor type’s retirement-specific FPB. 7.3.1 Key findings about the Retirees As mentioned earlier, the analysis of this group was done mainly to highlight inter-generational differences relative to pre-retirees. Retirees are on average 64 years old, with an even gender distribution and a rather weak health position. As can be expected from such a broadly defined group, its educational backgrounds are rather heterogeneous. However, many Retirees held quite senior job positions at the end of their careers, a fact that is in line with their affluent characteristics. Consistent with the notion of reduced earnings in retirement, they have a rather low annual income (€~47k) but dispose of the third largest wealth level (€~465k), mostly held in financial assets. Due to their retirement status they have been attributed a below average risk capability.

314

7 Review of research and suggestions for improving individual FPB

The Retirees’ life plans are less active and more indoor and family oriented than those of the pre-retirees. In addition, their willingness to continue working is much lower than the statements of pre-retirees about their retirement plans would imply. State pension dominates the income of Retirees and if an employer pension is available, it tends to be DB based. Given that the income and expense streams of most Retirees are similar, it is questionable whether they can realize their financial objective of continuing to save in retirement, which was mentioned by 32% of them. While almost three quarters of the Retirees attribute to themselves a below average or average financial sophistication level, most seem to be happy with their monetary situation and indicate they were financially well prepared (73% state to have been well prepared, 22% are neutral and only 5% mention having been badly prepared). The Retirees have the lowest risk appetite but at the same time show the least pronounced anxiety about risks, in contrast to the high risk awareness observable for the pre-retirees with a low risk appetite. This attitude of the Retirees could be triggered by an underestimated life-expectancy (resulting in the perception that risks will not be relevant for them anymore), an unbounded optimism or by a rather low financial sophistication. Despite their low anxiety level, Retirees apply some of the identified behavioral principles for FP actions: Corresponding to their advanced age, they have a rather low share of equity and mortgage leverage, which could be a result of the high advisor coverage of this group. With regard to the classical pension savings products, the Retirees show the lowest, but still a very high penetration (83% of the Retirees own at least one of these products). This result could be explained by the fact that their respective products have already matured and that new retirement saving products are geared towards a customer group that is still working (e.g., Riester supported unit-linked or classical private pension insurance). As an additional shortcoming, Retirees show the lowest mitigation level of the inflation risk (9% of Retirees considering this risk as important have undertaken something against it). On the other hand, their mitigation of the longevity risk ranks highest but with 23% there is still substantial improvement potential. The Retirees’ good feeling about their own financial situation is dangerous for two reasons. First, due to the time-orientation of the German retirement system, Retirees – just like anyone else – will also be negatively affected by an unfavorable development of the statutory state pension income (i.e., the cRVt). Therefore, even if they are doing fine at the moment, this situation is not guaranteed to persist. Also, there is some leeway for improvement in their risk management approach. First, their risk awareness and the effective mitigation of risks could ideally be improved through their preferred information source, the newspaper, or directly

7.3 Summary of individual retirement-specific FPB profiles for all types

315

through their advisors. Second, the Retirees’ optimistic self assessment of their financial situation is treacherous for the pre-retirees. Since the latter have demonstrated a representativeness bias and conservatism, they might infer their own retirement situation from the actual situation of Retirees and so end up with a too optimistic view about their future. 7.3.2 Key findings about the Limited-wealth Risk-groups The Limited-wealth Risk-groups combine Single Mothers, Typical Employees and Health-risk Employees. As a consequence, it is the oldest preretired investor type (on average 54 years old) with the largest share of women (60%), the lowest education level and the most pronounced propensity to work part-time. Individuals of this type also have the lowest income (€~46k) and wealth level (€~320k). Based on this assessment and their above average risk exposure due to family responsibilities and poor health, the Limited-wealth Risk-groups have the lowest risk capability of all the individuals analyzed in this study. Nevertheless, it is noteworthy that compared to the typical retail segment of the entire German population, this investor type should still be considered as “affluent” based on the value of their financial assets, even if they undoubtedly are at the lower end of the affluent scale. The life plans of this investor type are comparable to those of the Retirees (family focus, preferring indoor activities) which reflect their older age, social situation and relevant risk factors. Their income sources are also comparable to those of the Retirees, with a dominating share from state pension, DB rather than DC based employer pensions and only limited complementary earnings. According to their statements 77% of the Limited-wealth Risk-groups believe their income streams will equal their expenses in retirement. This is the highest share of individuals who believe they have comparable in- and outflows, from which a rather unthinking and passive approach towards retirement financial planning can be inferred. They have the highest risk aversion among the pre-retirees but in contrast to the Retirees they display the highest level of anxiety. This concern translates into the most pronounced feeling of unpreparedness but not into a similarly strong interest for the corresponding risk-hedging products. This missing mental link between risk awareness and product interest hints at a low actual financial sophistication level. The Limited-wealth Risk-groups show various forms of inadequate behavior: Latest start of retirement-specific FP activities among the preretirees (at 46 years), low diversification of income sources and assets, low share of classical pension savings products, limited mitigation of risks.

316

7 Review of research and suggestions for improving individual FPB

Furthermore, the simulation analysis has revealed that their plan for retirement (with an early retirement and a substantial share of income needed to live comfortably) is unrealistic: An intended saving rate of 19% of their income will not suffice if they cannot count on additional income sources such as private pensions, employer-based pensions, or an inheritance. These considerations re-emphasize their low actual financial sophistication. With regard to the risk-return characteristics, they hold a low share of 7% of their assets in equity, and 58% of this investor type neither hold shares nor mutual funds. Furthermore, 22% have a mortgage leverage of between 80% and 100%. Combined with the most substantial retirement income gap, the Limited-wealth Risk-groups display the highest retirement-specific risk profile. A possible explanation for their sub-optimal behavior could be the investor type’s comparatively lowest take-up of advisors (68% compared with an average coverage of 73%). Moreover, their inability to actually take any actions could be an expression of financial constraints or the feeling of being overwhelmed by the task. Judging from their only average interest in holistic advice and the substantially below average readiness to collect information, general passivity and disinterest could be another explanation: The Limited-wealth Risk-groups simply do not display enough commitment for individual FPB, do not judge financial planning to be appropriate for them 475 and lack the personal drive to conduct adequate retirement financial planning. These results also reflect a finding from behavioral finance, namely that it gets more difficult to execute willpower and that the lack of self-control is more pronounced for individuals with lower income. Fortunately, the Limited-wealth Risk-groups’ high level of anxiety could serve as a platform to improve their retirement financial planning. They could be awoken from their passivity with a message of hope, educating them about existing retirement provision options and about the fact that – especially for them – financial planning for retirement is appropriate and necessary. This could be achieved by increasing the investor type’s financial sophistication through, for example, mandatory retirement seminars or sessions with independent advisors. In an ideal world, such an effort would be supported by the right kind of advice coming from friends and family as this investor type attributes a lot of importance to that channel.

475

This point is specifically relevant for women. See DEHM et al. 2000, p. 24ff and HÖLLGER/SOBULL 2001, p. 5ff.

7.3 Summary of individual retirement-specific FPB profiles for all types

317

7.3.3 Key findings about the Limited-wealth Self-employed The Limited-wealth Self-employed are the second oldest pre-retired investor type (52 years on average) and are mostly male (78%). They have enjoyed a very good education and dispose of the second highest income (€~60k) and wealth level (€~520k, mainly invested in real estate). In spite of this solid financial situation, this investor type is assumed to have a below average risk capability because of his self-employment status. Many of the Limited-wealth Self-employed plan to continue working after the age of 65 and at the same time strive for a very active and outdoor focused lifestyle. As these investors have the choice to opt out of the statutory state pension, their income in retirement is dominated by private pensions, proceeds from investments, and income from second property or work. Their SSP income plays only a minor role. Astonishingly, even though one out of five in this group expects a negative retirement gap, the Limited-wealth Self-employed feel overall best prepared for retirement (79% compared to an average of 68%). This can partially be explained by their pronounced readiness to dissave, but could also be a sign of overconfidence and unbounded optimism. Surprisingly, the risk appetite of this investor type is second highest, 476 which also hints at an optimistic overall financial perspective. They show the highest self-assessed financial sophistication and their retirement-specific FPB is characterized by a strong sense of self-direction. Correspondingly, they assume self-responsibility about planning for their financial situation in retirement. The Limited-wealth Self-employed also show a good actual (rather than just self-assessed) financial sophistication. For example, they express a strong interest for products that protect them from retirement-specific risks, and for a holistic financial plan (agreement rate of 71% compared to an average of 63%). They are prepared to leverage an advisor and consult information sources in a focused way. Furthermore, they show a strong penetration with classical pension savings products and their investments display a risk-return profile that is consistent with their risk appetite. Nevertheless, the analysis of their financial plans features a gap that cannot be covered by the indicated savings alone (in the base case of the simulation they should save 39% but are only intending to save 19%). This is in clear contrast to their feeling of being well prepared for retirement. In order to reduce this gap, a decrease of the share of assets kept as reserve, a reduc-

476

This is in contrast to BÖRSCH-SUPAN/ESSIG 2002 who found that individuals with a riskier job situation tend to assume less risk with their investments and save more. See BÖRSCH-SUPAN/ESSIG 2002, p. 89f.

318

7 Review of research and suggestions for improving individual FPB

tion of their needs in retirement or the liquidation of some of the real estate assets (all assumptions of the scenario analyses) could be envisioned. Since the Limited-wealth Self-employed display a strong activism, sense of self-responsibility and a good grasp of financial concepts, it seems justified to delegate to them a considerable share of the responsibility for their own situation in retirement. Therefore the current system that allows them to opt out of the SSP seems adequate for this investor type. However, the Limited-wealth Self-employed are facing an important retirement gap, mainly caused by aggressive life plans for retirement, and seem to suffer from overconfidence. Given their substantial share of wealth kept in real estate, home equity release products could serve this investor type as a flexible solution to generate additional income in retirement. Furthermore, the overconfidence of this investor type could be addressed through advisors or with corresponding articles in financial media in order to protect them from a too optimistic assessment of their financial situation in retirement. 7.3.4 Key findings about the High-potential With an average of 49 years, the High-potential is the youngest investor type. This type encompasses individuals who either have already demonstrated financial success and were able to accumulate financial wealth between €150k and €400k – the so-called Well-off Middle-aged – or who have at least an A-level education and therefore the potential for substantial wealth increases going forward (Highly-educated). They earn on average €53k and hold about €~380k of total assets, mostly in financial investments. The High-potential are considered to have an above average risk capability due to their young age, education level or their past financial success. This investor type intends to lead an active life in retirement with a comparatively stronger desire to continue to study and spend time with their family. At the same time it also shows the most pronounced preparedness for coping strategies: 71% compared with an average of 65% are prepared to restrict their lifestyles in retirement. They have rather complex pension arrangements and complement their state income sources with private and DC based employer pensions. Such a diversified portfolio of retirement income sources can be considered as a progressive retirement FPB. Nevertheless, the High-potential show the highest probability for a negative retirement gap based on their indicated income and expense streams (21% expect their income to be lower than their expenses). However this gap is likely to be reduced if their pronounced preparedness for

7.3 Summary of individual retirement-specific FPB profiles for all types

319

coping strategies is taken into consideration. In spite of their above average risk capability, the High-potential have a rather low risk appetite. This low risk appetite also translates into high anxiety, a strong interest for risklimiting products and an overall feeling of unpreparedness. What is positive about the FP actions of this investor type is that they are the youngest to have started to plan financially for retirement that almost all hold classical pension savings products and that they are interested in screening sophisticated information sources. Provided the Highpotential show some flexibility regarding their retirement age, the intended saving rate of 19% should be sufficient to cover an existing wealthadjusted statutory state retirement income gap. However, their low objective diversification and a sub-optimal share of equity (50% without stocks or mutual funds and an average of 8% equity holdings) point in the direction of a limited actual financial sophistication. This behavior might be driven by a lack of self-confidence in financial matters, a limited knowledge and lastly the fact that they have the lowest advisor penetration (66% coverage compared with an average of 73%). The High-potential’s FPB can best be improved by a better diversification of their assets and a closer alignment of their risk appetite and risk capability. Their pronounced willingness to plan financially and to save makes them receptive to retirement seminars and recommendations from advisors. Given that the frequency of advisor interactions is less pronounced than the propensity to discuss financial matters with friends and family, the latter channel also represents a good way to influence the Highpotentials’ FPB. 7.3.5 Key findings about the Wealthy The Wealthy are at the young end of the study’s age range (50 years on average), have the highest education level and almost half of them are selfemployed. A high income level of around €80k and an average wealth level of €~910k, which surpasses the one of the other investor types by at least a factor of 1.8, characterize their financial situation. Correspondingly, they have the highest risk capability of all investor types. The Wealthy plan an active and expensive life in retirement (i.e., traveling extensively). While a fifth of the Wealthy intends to retire early, about 10% envision continuing to work after the age of 65. They are financially sophisticated as shown by their highly complex pension arrangements and their high preparedness to release home equity – a coping strategy that seems not to be wide spread. Building on its solid financial position, it is the only investor type where more individuals expect to have a positive

320

7 Review of research and suggestions for improving individual FPB

rather than a negative retirement gap (26% expect their income to be larger than their expenses and only 20% expect a surplus of expenses). 477 This is also reflected in their feeling of being financially well prepared for retirement. Furthermore, they show the highest risk appetite and the highest actual financial sophistication. This financial sophistication and a very responsible financial planning approach is reflected in an early start to retirement financial planning activities, the most sophisticated use of information, a very high penetration with classical retirement saving products, the best objective diversification and the most appropriate share of equity. Furthermore, they are in such a comfortable situation that they intend to save 27% of their income. Given the simulation analysis, this amount will be sufficient to provide for their expected expenses in retirement and so prevents them from facing a retirement gap. This investor group has the highest penetration with advisors, which of course is also driven by the attractive size of their available assets. The Wealthy’s high level of self-assumed responsibility, their highest penetration with advisors and the fact that they can be considered “at home in financial matters” are an ideal starting point for further enhancing their retirement-specific FPB. The core message to them should be that they are well on track. But even these individuals suffer from typical human limitations such as overconfidence and a reduced awareness of longevity and inflation risk. They would benefit too from a focused discussion about these topics, be it in specialized financial media, the Internet or in a direct interaction with their advisor. 7.3.6 Comparative positioning of all five investor types Building on these key findings for each investor type, this section presents a graphical overview showing the comparative position of each investor type. Two dimensions have been identified that capture the key characteristics of the different investor types. First, the feeling of financial preparedness is a key differentiator that also determines the overall tone that should be used in addressing the different investor types. Second, the five investor types have shown very distinct behavior with regard to the sophistication 477

The retirement gap was calculated based on absolute Euro indications. Since individuals were asked how much they expect to receive in retirement, it can be assumed that not only the different pension incomes but all revenue sources such as yields from savings and investments, rental income from second properties, etc. are included in the estimate.

7.3 Summary of individual retirement-specific FPB profiles for all types

321

of their retirement provision. These dimensions together give an indication of the average overall positioning of each investor type with regard to FP perspectives and FP actions. Fig. 7.3 shows the relative position of each investor type as well as the percentage of individuals in each type. Almost half of all individuals in this sample are already retired. Of the remainder, High-potentials make up the largest proportion, which is a positive situation given that this type has the most potential to improve his retirement-specific FPB. The investor type with the probable best financial situation in retirement are the Wealthy which make up 13% of the overall sample and almost 25% of all pre-retirees. Finally, it is the Limited-wealth Risk-groups and – to a much lesser extent the Limited-wealth Self-employed – who represent over 20% of all pre-retired each, who are in the least comfortable situation and need most support.

Feeling unprepared

Investor types with a below average risk capability

Limited-wealth Riskgroups

• Lowest risk capability and most pronounced retirement gap • Highest anxiety level

• Low financial sophistication and very passive FP approach

• Need motivational and content-specific support 11%

Investor types with an above average risk capability X% Share of total sample

High-potential

• Very worried but strong awareness of the need to plan (e.g., early start) • Financial sophistication in certain areas

• Need encouragement (advice) and education

• “Best candidates” for improving FPB 17%

Retirees

• Send out positive message of their “second life” Wealthy

• Dangerous due to time-orientation of German system and conservatism/availability bias 48%

• Substantial financial cushion leading to actual financial sophistication Limited-wealth Selfemployed

• Self-directed with Overall, the German affluent segment displays the profile of OPALS with the following values: activity, self-determination, health, pleasurable consumption and parallel life modules

Feeling well prepared

very active and sophisticated FP behavior • Prone to be overconfident 11%

Least sophisticated retirement provision

Fig. 7.3

Conceptual positioning of all five investor types

• Considered sophisticated selves who could benefit from discussion of human tendencies 13%

Most sophisticated retirement provision

322

7 Review of research and suggestions for improving individual FPB

7.4 Suggestions for policy-makers, financial planners and the individual The analysis of individual retirement-specific FP perspectives and FP actions of the German affluent segment has revealed several areas where individuals showed an adequate approach towards ensuring a secure financial situation in retirement. Among the FP perspectives, the objective to keep a financial reserve for unexpected needs or the preparedness to engage in coping strategies address today’s retirement challenges in an appropriate and practical way. Furthermore, the high awareness of different retirement related risks and the extent to which this awareness translates into an interest for specific products that hedge these risks is a good starting position for financial planning for retirement. Among the FP actions, the high level of self-assessed asset diversification corroborates the understanding of the need to diversify investments. Also the strong advisor penetration and the heavy use of classical pension savings products represent a solid base on which an improved individual FPB can be built. Other research reveals that in international comparison, the Germans are considered as very informed with regard to their future pension income 478 and additionally have an average saving rate that ranks among the higher ones in Europe. 479 An above average saving rate specifically holds true for the target group of this study which is prepared to save on average 21% of its income. Nevertheless, many limitations could still be identified in the FP perspectives and actions of the target group. This once more reflects that “retirement saving decisions are, at least an order of magnitude, more complex than other economic decisions, [and therefore] people need help.”480 A too positive assessment of one’s own financial situation in retirement 478

According to the DIA 2005c 44% of the Germans know their future pension income, but only 22% of the Americans, 21% of the British, 16% of the Japanese, 12% of the French and the Italian and 9% of the Spanish. Another supporting evidence for this advanced level of understanding was surveyed by BOERI et al. 2001 who find that in Germany 54% of all interviewees know that the income from contributions falls short of the amount required to finance the sum of all pensions. See BOERI et al. 2001, p. 24. 479 In a forecast for the household saving rates in Europe for 2006, Germany ranks third behind Italy (~12%) and France (~11.5%) with ~10.5%. It is closely followed by Belgium, Sweden, Austria and Switzerland, all of which have saving rates above 8%. The Netherlands and Spain are expected to save between 6 and 7% and in the UK, the saving rate is anticipated to amount to just over 5%. See N.N. 2006b, p. 89. or refer to PEAPE 2004, p. 5 for a comparison of 2002 data. 480 MITCHELL/UTKUS 2004a, p. 35.

7.4 Suggestions for policy-makers, financial planners and the individual

323

combined with a passive or inappropriate retirement provision approach may make it impossible for many individuals to live life in retirement as they had planned. The retirement gap simulation analysis in sub-chapter 6.4 confirms this threat. This leads to the last part of this study’s knowledge aim, namely the identification of levers for policy-makers, financial planners and the individual to improve individual FPB. Building on the elements of recommended retirement-specific FPB, the proposed measures will focus on the most pronounced gaps and limitations identified. As a consequence, section 7.4.1 highlights the five areas where the largest gaps relative to adequate financial planning and the behavioral benchmarks of sub-chapter 4.4 exist and where change is most urgently needed. The subsequent section defines guiding principles to improve individual FPB. The portrayal of the measures for policy-makers, financial planners and the individual is then the topic of the last section. 7.4.1 Key limitations in individual retirement-specific FPB Developing the analysis of FP perspectives and FP actions in Chapter 6, five areas can be identified where individual limitations cause major gaps between actual and recommended FPB. The first two of these limitations are driven by FP perspectives linked to the overall attitude and financial planning sophistication of individuals. The remaining three lie in areas that are closely related to FP actions. 7.4.1.1 Limitation #1: Over-optimistic perception of one’s own financial reality

The first limitation is driven by perception biases of the individual. They relate to the way individuals perceive their financial reality in retirement and to their attitude towards their own financial capabilities. Individuals’ perception of their own financial reality in retirement is blurred by different behavioral tendencies such as the representativeness bias, anchoring, conservatism, unbounded optimism and the saliency bias. The representativeness bias becomes manifest in the planned average retirement age of 61 years. It is anchored in the average retirement age of today’s retirees (60 years) 481 and reflects neither the higher official German retirement age (65 years) nor the anticipated further increase to 67 years. The insufficient adaptation to the official and rising retirement age also is a 481

See BÖRSCH-SUPAN et al. 2005, p. 19. Indication relates to the years 1999 and 2001.

324

7 Review of research and suggestions for improving individual FPB

sign of conservatism, meaning that individuals update their beliefs in the right direction, but only to an insufficient extent. This phenomenon also becomes manifest in the amount individuals expect to receive from statutory state pension. With an expected average of 46% of their last preretirement income, it is much lower than the official replacement rate and takes into consideration the digressive character of the German state retirement system. However, these expectations still substantially surpass the target group’s actual eligibility for statutory state income (weighted average for the target group’s pre-retirees based on the simulation analysis: 26%). This overestimation of future income streams contributes to optimism, inducing 68% of all individuals to feel financially well prepared for and a further 27% to feel neutral about retirement. As an additional perception bias, increased risk awareness can be perceived for frequently discussed topics or much feared situations (e.g., explosion of health care costs borne by the individual, spending time in a retirement home), an attitude which can best be described by a saliency bias. With regard to the perception of the self, overconfidence reigns: More individuals assess themselves as having an above average rather than a below average level of financial sophistication (31% versus 22%). Also the difference between the self-assessed diversification and the objectively measured use of different asset classes in an individual’s portfolio points in that direction. The overly optimistic assessment of one’s financial situation in retirement and an overconfident attitude towards one’s own financial capabilities is a dangerous mix for individual retirement financial planning. It is especially threatening as it comes for most individuals with a high level of self-direction in making financial decisions: 57% of all individuals want to collect information from various sources and take decisions themselves. This attitude is a confirmation of the trend towards self-determination and carries the risk that individuals do not pay enough attention to experts and so take sub-optimal decisions. 7.4.1.2 Limitation #2: Unsophisticated planning of retirement cashflows

The second major limitation relates to the restricted quality of individuals’ predictions about their future income and expense streams and thus the value of their financial plan for retirement. The first point of criticism relates to the wide-spread unthinking approach towards planning income and expense streams. Based on the comparison between estimated income and expense streams, less than one person in five in the German affluent segment is expecting a negative

7.4 Suggestions for policy-makers, financial planners and the individual

325

retirement gap. Two thirds of all individuals estimate their income streams to just equal their expense streams. This is even more surprising since a public discussion about how to close the retirement gap has been going on for years in Germany. 482 A possible explanation for this finding is a lack of scrutiny of or a serious debate about one’s own financial flows in retirement: If people have not spent time thinking about their income and expense streams, chances are high that they assume both streams to be identical. Therefore, if the majority of individuals expects about the same income as they anticipate spending in retirement, this can be interpreted as a rather careless approach towards financial planning. Explanations for such a behavior can be found in procrastination, the tendency to postpone unpleasant tasks such as thinking about one’s retirement and implicitly death, inertia or the lack of self-control. Besides the lack of a conscious approach, the research also revealed individuals’ difficulties in estimating future cash flows, leading to an unsophisticated and unrealistic financial plan. Partially due to money illusion, hyperbolic discounting and a projection bias, partially influenced by optimism, people are not able to realistically project their financial flows in retirement. The fact that people estimate their last pre-retirement income to be lower than their current income level is a striking example for this strong limitation in the assessment of future realities. As a consequence, individuals’ plans for retirement lack an appropriate sense of realism. Given their limited savings (net of planned reserves and bequest), they will not be able to live the retirement life they anticipate. Moreover, individuals’ bounded rationality and unbounded optimism appears also in the cognitive dissonance between expecting financial flows leading to a negative retirement gap and still feeling well prepared for retirement: Of all interviewees, 18% anticipate their retirement income to be lower than their expenses but only 5% feel financially unprepared for their old days. The readiness to dissave, mentioned by 36% of all interviewees, could – at least to a certain extent – provide an explanation for this lack of mental consequence. However, it is still striking that 56% of those individuals who expect a negative retirement gap still feel well prepared. In addition to the explanations above, this unsophisticated planning of retirement cash flows points at a lack of consciousness about the risk inherent in not planning adequately for retirement or doing it in a cursory way. Since “the costs of taking action are immediate and concrete, and the benefits are distant and abstract”, 483 pure cost-benefit considerations will not induce people to engage in regular and sound financial planning. Also, 482 483

See for example SCHNABEL 2003b and BÖRSCH-SUPAN et al. 2005. WEBER 2004, p. 64.

326

7 Review of research and suggestions for improving individual FPB

given the solid penetration with advisors, this observed unsophisticated approach towards financial planning is surprising. One possible explanation for this result is that advisors do not focus enough on the elaboration of a holistic picture and on overall financial flows in retirement but rather recommend the use of specific products. Another explanation is more in line with the observation made earlier that having an advisor is actually beneficial to one‘s own financial knowledge (e.g., higher interest in holistic advice, higher subjective and objective level of diversification): Advisors actually do discuss topics like future cash flows with their clients but – due to the above mentioned perception biases and specifically the human tendency of absorbing only information that is consistent with one’s world view – individuals are just pushing away the sometimes unpleasant truth. 7.4.1.3 Limitation #3: Late start of financial planning for retirement

The third major limitation relates to one of the process related aspects of FP actions. The moment when financial planning activities for retirement are initiated showed the most significant difference between the behavioral benchmark and the actual FP actions. While the benchmark states that an individual should start planning for retirement the very day he enters work life, only a minority of 22% of the interviewees indicate having done so before their 40th birthday. Even at an older age, the awareness about the need to provide individually for retirement only gradually filtrates through to people, with most individuals starting the mental planning process between their 50th and 60th birthdays. While the High-potential are the youngest to start thinking about retirement (at 41 years – which is still much too late compared to the benchmark), results look worst for the Limited-wealth Risk-groups: Overall, they start at the age of 46 – only two years before today’s generation of Retirees did. Such a late start is typically provoked by procrastination, inertia and the lack of self-control, and does not leave enough room for corrective measures once an inadequate preparation for retirement is identified. 7.4.1.4 Limitation #4: Low risk mitigation despite high risk awareness

The German affluent segment has shown a high awareness of the different retirement risks, since they are worried about 9.2 out of 14 possible risks (66%). This elevated risk awareness translates into a high level of interest for financial products that hedge the respective risks (on average 73% of all interviewees are interested) and thus represents a solid base for improving individual FPB. On the other hand, only a minority of all individuals

7.4 Suggestions for policy-makers, financial planners and the individual

327

who have identified a risk as important to them (8% to 44%, depending on the kind of risk) also takes specific actions to mitigate these risks. This phenomenon illustrates a lack of self-control or bounded willingness. The behavioral benchmark for risk mitigation puts the focus on inflation and the longevity risk. But even for these two predominant retirement risks, the mitigation level of the target group shows substantial shortcomings. While 20% of all interviewees that assessed the longevity risk to be important for them claim to have also mitigated it, a mere 11% addressed the inflation risk – and this despite the fact that the awareness about the inflation risk is higher (81% versus 62%). The Retirees show the highest level of longevity risk mitigation, closely followed by the Limited-wealth Self-employed and the High-potential (1923%). The Wealthy show the lowest level of mitigation of the risk of outliving one’s assets. However, in light of their substantial financial cushion, such behavior might be justifiable. This argument however does not apply to the Limited-wealth Risk-groups whose mitigation only amounts to 14%. Given that inflation risk awareness ranks third after those of exploding health care costs and having to spend time in a retirement home, the observed low mitigation level is surprising. The investor type with the highest level of mitigation (15%), are the High-potentials. As they are the youngest investor group, the impact of inflation is most important for them. The Wealthy and the Limited-wealth Self-employed surprise with mitigation rates of 12% and 11% respectively, while the Limited-wealth Risk-groups show a rate of only 9%. A possible explanation for this behavior is that individuals lack the awareness about the existence of products to hedge the respective risk or that they cannot establish the mental link between individual products and their potential to hedge specific risks. Furthermore, typical human limitations in decision making such as procrastination, inertia or lack of selfcontrol could also explain the results. Lastly, also perception biases such as money illusion pointed out above could lead to this low mitigation level. 7.4.1.5 Limitation #5: Sub-optimal portfolio choices

The last major limitation is that the target group’s asset portfolios often feature sub-optimal characteristics with regard to the opportunities offered by capital markets. These sub-optimal portfolio choices can be grouped in three categories. First, the level of objective diversification is much lower than the subjective level (54% versus 90%). This observation is an indication of overconfidence but also reflects the actual sophistication of specific investor types with regard to financial planning for retirement: At one end of the

328

7 Review of research and suggestions for improving individual FPB

spectrum are the Wealthy who prove their sophistication in financial matters by a consistently high level of diversification, measured both subjectively and objectively. At the other end are the Limited-wealth Risk-groups with the lowest subjective and objective level of diversification: With only 42% of all portfolios fulfilling the criteria of objective diversification, their position has significant improvement potential. The same conclusion applies to the High-potential with only 45% of objective diversification. This again proves that – even if individuals are aware of the benefits of diversification – they are subject to a perception bias with regard to their own level of diversification, caused by overconfidence and unbounded optimism. At the same time, this behavior points to a consequential lack of actions, caused by a lack of self-control and inertia. This highlights that especially the individuals with a lower actual financial sophistication require additional support for the realization of an appropriate diversification strategy. The share of equity is the second portfolio choice where shortcomings have been identified. As discussed earlier, the share of equity should reflect the risk profile of an investor type and is recommended to decrease with age. Even if the overall reported share of equity decreases as individuals age, it does not always correspond to the risk profile of the individual investor types: As an example, the High-potential with 8% own a (too) low share of equity. Furthermore, the analysis has revealed that 39% of all individuals and more than half of the Limited-wealth Risk-groups and the High-potential hold no equity at all, be it in the form of direct holdings or mutual funds. They thus forgo substantial long-term return enhancement opportunities through equity but also benefits such as diversification. Chances are high that these allocation decisions are not the consequence of careful evaluations and assessments but that they are a proof of a rather unsophisticated and thoughtless financial planning approach. Moreover, they might be influenced by human limitations in the implementation of decisions (i.e., lack of self-control or passivity). The third portfolio choice that shows certain limitations is the mortgage leverage. Overall, the level of real estate leverage seems rational as the relative value of the mortgage (and hence the corresponding risk) decreases with individuals’ age. However, this observation does not hold true for the Limited-wealth Risk-groups, the Limited-wealth Self-employed and the High-potential. Also surprising is that 8% of individuals indicate having between 80-100% of their real estate value leveraged with a mortgage. Since 22% of the Limited-wealth Risk-groups show this risky behavior, a substantial gap between actual and recommended behavior becomes manifest.

7.4 Suggestions for policy-makers, financial planners and the individual

329

Possible explanations for all the above shortcomings are a limited knowledge about capital markets, insecurity about the existence and selection of appropriate products and a lack of resultant actions, which might be driven by inertia and bounded willpower. Specifically for the real estate leverage, a limited awareness about the risks associated with debt but also simple greed – be it of the individual borrower (aspiring for housing beyond his financial means) or even the creditor (maximizing the mortgage volume sold) – could be a reason. Finally, these outcomes might also be influenced by the second limitation described above, the restricted ability of individuals to estimate their financial flows and assets in retirement. 7.4.2 Guiding principles to enhance individual retirementspecific FPB The guiding principles developed in this section serve as the conceptual base for the derivation of suggestions to enhance individual retirementspecific FPB at the level of the different stakeholders. As such, they also represent rules against which the suggestions can be evaluated. The improvement of retirement-specific individual FPB is closely linked to the concept of shared responsibility, which means that all three stakeholders, policy-makers, financial planners and the individual need to accept and act upon their share of responsibility for securing the individual financial situation in retirement. This concept can be illustrated with an analogy. When the first firms changed their corporate pension schemes from a DB to a DC system, the question arose whether an employee was fully responsible for his pension outcome or whether it should partially be borne by his employer and how the latter was to support the employee in this switch of responsibility. To limit any potential liability after having switched the system, employers initially provided their employees with educational material. But the material often was very generic, difficult to understand and hard to apply to the individual situation. Also the provision of advice or the selection of advisors was done with reluctance by the companies, since they feared being held liable for any recommendation made by these advisors. Since then the situation has changed and “many plan sponsors now believe that offering advisory services actually […][reduces] their legal liability.” 484 This example, where employers have shifted retirement provision responsibility to their employees but still remained accountable for providing them an appropriate decision-making support, can be applied to the situa484

SCOTT/STEIN 2004, p. 207.

330

7 Review of research and suggestions for improving individual FPB

tion of the policy-makers: Despite policy-makers switching responsibility and risk for individual retirement provision to the individual, they remain liable for ensuring that individuals receive the right kind of support for adequate retirement-specific FPB (e.g., through provision of information or access to qualified independent advisors). This concept can be broadened further and the question of responsibility expanded to other stakeholders. Since the provision of financial security in retirement is one of the key value propositions of financial planners, they also need to accept their share of responsibility for a client’s financial situation in retirement. And lastly, of course the individual himself has to bear his share of responsibility for his own financial situation in retirement too. In providing assistance for an adequate retirement-specific FPB, a libertarian paternalistic decision support is recommended. This approach can be described as “institutional efforts to affect individuals’ behavior while respecting their freedom of choice.” 485 Especially if the individual preferences are ill-informed and the decisions outcomes are influenced by behavioral tendencies such as framing, inertia and passive decision-making, an institution can – and should – steer choices in a welfare-promoting direction without eliminating the freedom of choice: “Thoughtful regulations can influence passive decision makers without encroaching on the freedom of active decision makers to opt out of the defaults and choose in their own (perceived) best interest.” 486 An effective way to implement this libertarian paternalism builds on the human tendency for passive decision-making and accepting default options as well as inertia. These tendencies explain, for example, why menu design of a plan is more powerful in influencing participants’ choices than the risk-return characteristics of the different investment options offered. The idea of the libertarian paternalism is to find a balance between encouragement and compulsion. The focus should clearly lie on creating the right incentives, but sanction mechanisms are required too. The aversion to a fully liberalized system can be seen in the fact that a large part of the population would welcome the choice to opt out partially from the public pension system and be mandated to save the corresponding amount rather than just having the option to opt out but without any conditional savings. 487 This preference may be explained by savers’ lack of confidence in their ability to exercise the discipline needed to build up additional old-age provisions (i.e., lack of self-control). Another expla-

485

SETHI-JYENGAR et al. 2004, p. 88. CHOI et al. 2002, p. 104. 487 See BOERI et al. 2002, p. 397f.

486

7.4 Suggestions for policy-makers, financial planners and the individual

331

nation is the fiscal externality imposed by those counting on social assistance rather than saving themselves (so-called “state-reliant free riders”). 488 When evaluating the different choices available for improving an individual’s retirement-specific financial situation, one needs to take into consideration the incremental cost impact for the different stakeholders. This means that the impact of each intervention should lead to pareto-optimal solutions (i.e., overall no one should be worse off but at least one stakeholder should be better off). For example, the improvement of retirement provision default options (e.g., by investing into life-cycle funds if no active choice is made) would imply an enhancement for everyone, while still allowing alternatives for the more sophisticated individuals. When evaluating such measures, strict cost-benefit considerations must be applied. Such an analysis should, for example, assess the trade-off between direct costs of state subsidies and indirect effects such as the reduction of welfare cases, leading to a decrease of state expenses. Non-monetary considerations such as an increase in social peace or a decrease of the poverty slope should also be taken into consideration. An example is the comparison of incremental controlling expenses of the government associated with an improved cost transparency for specific retirement saving products with the benefits of a fairer cost allocation structure, better product performance and the associated reduction in public safety net outlays. Another aspect to bear in mind is that since the different institutions associated with retirement financial planning are dispersed across the society, measures also need to be considered under the aspects of feasibility and data protection issues. Since even the best of measures only shows results if it is understood and accepted by the target audience, a substantial focus needs to be on communication. If the individual responsibility stands at the center of the discussion, a sense of urgency needs to be instilled in the individual. This sense of urgency must evoke a motivation to accept responsibility and adapt perspectives and actions correspondingly. A HIV-fighting society that sees the evidence of AIDS all around is a ready audience for the message to assume more individual responsibility and adapt its behavior. 489 The desire to act to secure the financial situation in retirement however 488

See BÖRSCH-SUPAN/WILKE 2004, p. 41f. Similarly to this idea of the “statereliant free rider”, HURD/PANIS 2006 are concerned regarding the high cash-out rates of individuals with small plan values and low wealth holdings. The authors fear that the ability to cash out pension rights results in greater public safety net outlays, such as Supplemental Security Income later in life. See HURD/PANIS 2006, p. 2226. 489 See SELNOW 2004, p. 44f.

332

7 Review of research and suggestions for improving individual FPB

needs to be awoken first, especially since the focus of today’s society lies more on the present rather than on the future. Such an awakening is best achieved if messages of caution and hope are used as a communication tactics. This means that the retirement system’s lack of sustainability needs to be made transparent (message of caution). But at the same time, individuals need to be shown that there exist feasible ways out of the problem (message of hope). The illustration of different choices is important since, if individuals do not see options and therefore feel coerced, they will not be motivated to act. Such communication tactics should not only target the individual but also the democratic society as a whole, since a survey conducted by BOERI/BOERSCH-SUPAN/TABELLINI 2001 found that “betterinformed voters are more likely to favor reforms.” 490 In this context it is important to create transparency about what individuals will lose (message of caution), but also about what they can gain (message of hope) with their vote. 491 This principle for communication also reflects that all measures need to consider that financial planning for retirement is mostly also an emotional act. It entails “every emotional drive associated with money[…]: the longing for security, the guilt engendered by greed, the quest for power and self-esteem, the fear of being abandoned, the search for love, the dream of omnipotence.” 492 Furthermore, planning financially for retirement is quite often associated with topics that have a high emotional association such as aging and death. Moreover, many catalysts of starting to financially plan for retirement, such as familial transitions (e.g., marriage, divorce, children) are events that are charged with emotions. 493 Lastly, a tiered approach is required, distinguishing available design options and corresponding support measures according to the financial soundness and motivation of the individual. This allows leveraging an individual’s knowledge and motivation while responding to the human sensitivity to choice overload. Very knowledgeable, active and self-directed individuals need less support and require more options than an individual who shows a passive approach towards retirement FPB. The latter might need hands-on education that is simple, short and explicit and focuses on the present day benefits. Especially for individuals not wanting to exercise full control of their retirement financial planning, the program should be 490

BOERI et al. 2001, p. 10. See BOERI et al. 2002, p. 400f. 492 SCHOTT/ARBEITER 1998, p. 56. 493 KEMP et al. 2005, for example, find that different financial, personal or familial circumstances can act as catalysts or also constraints of individual financial planning for later life. See KEMP et al. 2005, p. 273ff. 491

7.4 Suggestions for policy-makers, financial planners and the individual

333

directive (e.g., provision of explicit saving and investment allocation advice) and only contain a limited set of options. The more sophisticated individuals have a greater interest in exploiting the different possibilities the system offers. Therefore they need access to a larger set of decision options. A qualification test could verify whether individuals requesting more options actually are sophisticated enough to use them for their own good. Alternatively, to avert potential legal actions against the provider of additional retirement options, the signature of a waiver, certifying that the undersigned is aware of the additional risks associated to the broader choice of options could be envisioned. Another approach, building on the assumption that wealthier individuals are more sophisticated, is to allow only basic options for the ground stock of pension provision while for higher incomes more choices are offered (similar to the new regulation for corporate pensions in Switzerland 494 or the pension system in Singapore 495). The option with the least administrative effort would be to present all individuals with the same basic choices but always offer them a selection possibility called “other options”. This solution however would have to be combined with warning signs for the riskier options. Following these guiding principles, different levers have been identified to enhance individual retirement-specific FPB. Fig. 7.4 provides an overview of selected levers for policy-makers, financial planners and the individual. Building on the knowledge of behavioral finance, the aim of these measures is two-fold. On the one hand, they should create awareness (i.e., of the pension system, human limitations and the individual financial outlook on retirement) and thus influence a person’s perspectives. On the other hand, these measures aim to improve the actual FP actions. More specifically, the focus of policy-makers should lie in providing a favorable background and the right incentives for an adequate retirementspecific FPB. Financial planners have to demonstrate individual limitations and highlight optimal FP solutions. But at the end of the day, only the in-

494

The regulation for the execution of the corporate pension provision in Switzerland states that a free choice of the allocation strategy of the pension assets is only approved for amounts that lie above CHF~120,000 for 2007. See BVG §8 and BVV 2 §1e. 495 According to WALTER 1993 the Singaporean Central Provident Fund (CPF), the administrator of Singapore’s compulsory savings and social insurance scheme has a two tiered structure. In the Basic Investment scheme, 80% of all gross savings above S$34,600 can be allocated to the investment vehicles selected by the CPF. In the Enhanced Investment scheme, individuals with larger savings may place 80% of them (above the minimum of S$50,000) in the same vehicles. See WALTER 1993, p. 95f.

334

7 Review of research and suggestions for improving individual FPB

dividual himself can change his behavior and take concrete measures to improve his financial situation in retirement.

Provide a favorable background and the right incentives

Demonstrate limitations and optimal solutions

Change behavior and act

Policy-makers

Financial planners

Individual

• Adaptation of regulations • Mandatory retirement seminars • Compulsory individual

• Systematic consideration of

• Improvement of personal

"retirement sanity checks"

•

typical human limitations Professionalization of financial planning advice

knowledge

• Conscious financial planning approach

• Flexible approach towards life in retirement

Enhanced individual retirement-specific FPB

Fig. 7.4

Suggested levers for policy-makers, financial planners and the individual to enhance individual retirement-specific FPB

7.4.3 Suggestions for policy-makers seeking to improve individual FPB Policy-makers can influence individual retirement-specific FPB with three levers. The question of which levers will most probably be used depends also on the agenda of the political economy as well as the constraints imposed by politicians through the democratic process (i.e., public choice theory). 496 Adaptation of regulations

By changing the regulatory environment in which individual retirementspecific FPB occurs, policy-makers can influence both the type and quality 496

Public choice theory studies the behavior of voters, politicians and government officials in their role as mostly self-interested agents as well as in their interactions in the social system. Specifically in the light of the demographic shifts underway (see sub-chapter 3.1) changing majorities will substantially impact these interactions in the social system and influence the kind of levers policy-makers wish to pull to increase popularity and chances for re-election.

7.4 Suggestions for policy-makers, financial planners and the individual

335

of products and services that individuals purchase. The Riester reforms and the proposals of the Rürup Commission discussed in section 3.2.2 represent examples of such regulation adaptations. Three ideas have been identified within this area. The first idea focuses on improving the quality of financial planning. Despite the fact that many individuals have an advisor with whom they can discuss financial aspects of their retirement, many of them seem to lack a clear perspective about their financial future as well as a solid financial plan. To overcome this observation, described above as limitations #1 and #2, the policy-maker could introduce a standard for retirement-specific financial planning advice. Such a standard would prescribe the main components of an individual financial plan and so contribute to advisors providing holistic advice instead of only focusing on the sale of certain products. Simultaneously, policy-makers would need to ensure a monitoring of the quality of advice provided. 497 Ideally, financial planners would participate in the establishment of these quality standards in order to ensure best practice individual financial planning. An example of an area where such a standard could be particularly helpful is the compensation structure. A way to overcome the problem of favoring products that offer the highest retrocessions 498 would be to implement hourly fees or menu-based costing for this new standard of financial planning advice. This means that a complete financial plan including product recommendations could be bought for a fixed amount, while the financial plan alone would be charged at a lower, pre-arranged rate. In order to foster the use of this improved financial planning support, fiscal incentives are recommended as subsidies for developing a financial plan with a certified advisor. In order to overcome limitation #3, the fact that individuals start to financially plan for retirement much later than the behavioral benchmark recommends, these incentives should vary with the age of the individual. The younger someone is, the higher the contribution for performing a standardized financial plan should be. To ensure that plans are updated regularly and thus overcome the human tendency to inertia and procrastination, the age dependency could be complemented with a factor reflecting the frequency with which a plan gets updated (i.e., contri497

Examples of financial advisors supervised by an organization mandated by the government can, for example, be found in the UK with the FSA. See FSA 2002. 498 Most advisers in the real world have a clear incentive to push certain products and therefore convince an individual to buy them. See KLÖCKNER 1995, p. 236ff for different tactics used by financial advisors. However, regulations like MiFID should contribute to an increased transparency on retrocession arrangements and could ultimately lead to more competition and less incentive-biased advice.

336

7 Review of research and suggestions for improving individual FPB

bution decreases less with age if the individual takes out a new financial plan every 5 years). The second idea is about product improvements. In the first place, it addresses criticism related to product pricing. For example, many traditional savings products, like endowment life-insurances, are not transparent with regard to their pricing and tend to provide the wrong incentives for advisors. Furthermore, some reporting guidelines (e.g., embedded distribution costs) negatively influence the performance of these products. For these products, policy-makers could define pricing and cost allocation guidelines similar to the certification of Riester contracts. As an example, such a certification requires surrender values not to be too miserly during the first five years of the product life. 499 Further topics regarding pricing transparency are rules for cost allocations along the value chain. 500 If it is the purpose of the system that everyone should have a specific retirement saving product, it could even be argued that all additional sales charges (e.g., marketing fee, load fee) should be eliminated or total fees should be reduced to an industry standard amount, thus resulting in a higher efficiency of the product. 501 If it is the purpose of the system that everyone should have a specific retirement saving product, it could even be argued that all additional sales charges (e.g., marketing fee, load fee) are to be eliminated, thus resulting in a higher efficiency of the product. Another thrust for product improvements would help individuals to overcome their limited mitigation of inflation or longevity risks (see limitation #4 above): For ex499

This measure addresses the problem of “Zillmerung”. “Zillmerung§” stands for a mathematical approach to calculate the (actuarial) reserves for traditional life and health insurances. It is relevant from a corporate law consideration, not for the contract between insurance and insurance holder. However, commonly, “Zillmerung” has been held responsible for the low surrender value during the first few years of a life-insurance resulting from offsetting acquisition and distribution costs against the first premium contributions. 500 An example of such regulations for an increased product pricing transparency has been proposed by the Swiss fund association in collaboration with the EBK. According to these transparency regulations total fees need to be split into the fees for asset management, distribution (marketing and sales fees) and administration (publication, account keeping). See ZULAUF 2006, p. 64. In order to align regulations in Switzerland with European laws these regulations will be put into effect when transparency is given about the European laws. 501 The curbs on the administrative costs in the Swedish private accounts system (e.g., administrative fee of maximal 30bp) or the recommendation of the Pensions Commission in the UK to provide retirement saving products with low costs (i.e., a total expense ratio of 30bp at the maximum) point in this direction. See CRONQVIST/THALER 2004, p. 424ff and PC 2005, p. 396.

7.4 Suggestions for policy-makers, financial planners and the individual

337

ample, it would make sense to stipulate that a certain share of each pension product be inflation-protected and that not all payouts can be taken as a lump sum to overcome the respective human limitation (i.e., hyperbolic discounting, loss aversion, framing and overconfidence). 502 In order to increase the mitigation of the longevity and inflation risk, another option could be to pay specific incentives for these protections. With regard to another major shortcoming, the sub-optimal portfolio choices (limitation #5), policy-makers could foster new retirement-specific products that contain an optimal share of equity given an individual’s risk profile and his position in the life-cycle and leverage the benefits of diversification. Since these so-called life-cycle products or age-based balanced portfolios automatically adjust their equity allocation as the individual approaches retirement, they ensure an optimized asset allocation while at the same time leveraging the human tendency to inertia. 503 The third idea centers on the system and default options. With regard to the entire pension set-up, policy-makers should strive for a substantial simplification of the system. This postulate builds on the complexity aversion and specifically the sensitivity to choice overload identified within retirement-specific behavioral finance research and described in sub-section 4.2.3.4. In Germany, simplification seems to be a very important lever specifically with regard to products, where a host of bureaucracy and complexity have made people shy away from dedicated retirement saving solu-

502

“Overvaluing the near term and undervaluing the future increases people’s probability of taking their pension accruals as a lump sum instead of buying a life annuity, and may explain why some argue that ‘locking up’ one’s assets in annuities boosts rather than reduces risk. To meet such concerns, as well as to reduce the fear of ‘losing it all’ due to premature death, some insurers have begun to combine annuity offerings with [term] life-insurance, long-term care or disability benefits.” MITCHELL/UTKUS 2006, p. 91. Since annuitization is an irreversible decision, individuals might also favor products allowing them to maintain the option of starting an annuity income stream later. With such a product, they would only decide on part of their pension value to be paid out as a lump sum today and defer the decision about the use of the remainder. 503 Examples for products that assume such a strategy are the target funds from Fidelity or the life-cycle funds from Swisscanto. See FIDELITY 2006b and SWISSCANTO 2006. Since they take the view of a balanced portfolio however, assuming such a strategy would imply investing all financial assets into this product and correspondingly not have additional fixed income or equity funds. An explanation for the low penetration of customers with these funds is the fear of advisors to become obsolete and thus the lack of pushing these products to the end-customers.

338

7 Review of research and suggestions for improving individual FPB

tions. 504 Furthermore, simplification is essential in communications: Since people use heuristics anyway to solve complicated problems to overcome their bounded rationality, communication specialists should educate individuals about a limited number of core options. Furthermore, policymakers should build on the human tendency for passive decision making by using their influence on menu design to set defaults that best correspond to ideal retirement-specific FPB. If, for example, a voluntary Germanywide private savings plan were introduced, it should start with an automatic enrollment but allow opting out. Another idea is to automatically sign up every employee in a corporate pension plan and to automatically allocate a share of each salary increase to this plan – similar to the idea of the SMarT plan and always with the opt-out alternative. 505 Such concepts could then ideally be combined with the above mentioned products as default choices, e.g., life-cycle products including an inflation protection, and allow a tiered-solution for more sophisticated investors. Mandatory retirement seminars

Limitation #1 describes why individuals generally feel well prepared for retirement: They have a blurred perception of reality and see their position in retirement more optimistically than can objectively be expected. These findings are not surprising, given the complexity of the retirement topic and typical human bounded rationality. Furthermore, inertia, procrastination and a lack of self control, as well as the emotional aversion to thinking about getting old, makes people reluctant to look seriously into the subject of their retirement. As a consequence, they lack a good enough information base and are therefore prone to take sub-optimal FP actions. To overcome this situation, individuals need a better grasp of reality. But since – for the reasons mentioned above – people are not motivated to educate themselves about the important topic of retirement, some compulsory measures are required.

504

A survey by BORTZ 2005 found out that many individuals seem to be repelled from closing Riester contracts due to the high level of complexity and bureaucracy. Even after the latest simplification effort, a quarter of individuals surveyed think that the Riester system is still too complicated, and about 30% did not perceive any difference after the changes. See BORTZ 2005, p. 625. 505 This specific measure would leverage the human money illusion and the fact that income is perceived in nominal terms. Thus, the individual would not perceive this as a loss if (part of) the salary increase was dedicated to savings. See section 4.2.3.2.

7.4 Suggestions for policy-makers, financial planners and the individual

339

The policy-maker (i.e., the state) as the “pension provider of last resort” should be in a position to impose a retirement debate on individuals. The objective of such a debate would be to prevent people from taking suboptimal retirement-specific decisions that harm their situation in retirement and – ultimately – also become a burden for the society as a whole. Similar to other mandatory trainings by the state in areas where limited skills can jeopardize public safety or well being (e.g., compulsory school attendance, theoretical driving lessons or dog owner training courses 506), compulsory retirement seminars could be introduced. 507 One reasoning for proposing retirement seminars is that they represent a measure to overcome or at least reduce bounded rationality. An other stems from the research results of LUSARDI 2004 according to whom the active use of financial training programs has a more pronounced effect than just making information available. Furthermore, CLARK et al. 2004 found that “seminars were the most effective type of communications.” 508 Also the OECD 2005 report on financial literacy confirms this finding. Another striking argument for retirement seminars is that women, who – as shown by DEHM/KILBERTH/PSYCHONOMICS 2000 and HÖLLGER/SOBULL 2001 – demonstrate a strong shortcoming with regard to providing for their financial situation in retirement, 509 “seem more responsive to financial education programs than men” 510 partially because they are more dutiful. 511 506

The city of Cologne for example describes in N.N. 2006d that the law requires holders of very dangerous or big dogs as well as dogs from certain races to acquire a certificate of handling the dog (Sachkundenachweis). Even if an inappropriate handling of individual retirement financial planning decisions does not represent a direct threat to other members of society (such as an uncontrollable dog or a dangerous car driver), it threatens society indirectly due to the increased expenses for social security. 507 As opposed to driving a car or owning a dog, where individuals have a choice whether they want it or not, every individual who reaches a certain age will be facing retirement. Thus, everyone needs to be aware of the realities of retirement in order to provide accordingly. 508 CLARK et al. 2004, p. 188. 509 According to DEHM et al. 2000 a majority of women acknowledge that state pension provision will probably not be enough to cover the expenses during retirement, but only a minority also acts on this knowledge. However, this impression does not reflect the female potential in financial matters, since the study also revealed that women are mostly handling the day to day operational banking tasks (e.g., transfers, withdrawal of money, account overviews, etc). See also HÖLLGER/SOBULL 2001, p. 77f. The results of these studies need to be considered with caution since they investigate the behavior of women without taking into consideration the age and wealth bracket chosen for this study. This is even more relevant as the studies

340

7 Review of research and suggestions for improving individual FPB

The focus of these retirement seminars should be twofold: First, the lack of sustainability of the current retirement system and the incomparability of the situation of today’s retirees with the one future retirees will be facing should be made transparent. This should help to overcome the prevailing representativeness bias and conservatism (limitation #1) while increasing individuals’ sense of urgency (message of caution). As research has shown that individuals are more “loss averse” than “risk averse”, illustrating the lack of a secured financing in retirement as a loss question could prove effective here. Second, the seminars should illustrate the different levers individuals have within the context of the existing regulation to optimize their situation in retirement (message of hope). Applied to the specific lever of the retirement age, the seminars should explicitly point out – detached of any political dispositions – the trade-off between a lower retirement income and an increasing retirement age. This information strategy should be successful, since BÖRSCH-SUPAN/WILKE 2004 showed that individuals are receptive to the logic of substitution: If individuals are offered a transparent demonstration of available trade-offs and face actuarially fair and understandable choices between e.g., retiring early at a reduced rate or retiring at the official retirement age at the standard retirement income, they are in a position to make conscious and rational FP decisions. 512 Another lever to be discussed are financial market mechanism such as the risk-return profile of investments. As shown above, many portfolios’ characteristics do not correspond to the investor’s risk capability. While the retirement seminars must not advocate that everyone invests in equity, they should provide a fact base for individuals to use a more conscious and educated approach towards equity investments. Furthermore, they should also foresee a discussion of risks associated with a

have also shown that the behavior of women who tend to have more responsibility in their work-life, who are dealing with financial matters on their job and can also have a higher propensity to be affluent show a more educated and active behavior. 510 CLARK et al. 2004, p. 201. 511 In this context it is noteworthy that GLASS/KILPATRICK 1998 emphasize specifically the need to adapt educational programs to the specific life circumstances and „psychosocial and attitudinal composition“ of women. GLASS/KILPATRICK 1998, p. 611. 512 BOERI et al. 2002 also showed that such information logic contributes to the acceptance rate of reforms. See BOERI et al. 2002, p. 52. Building on the research by BORGMANN 2005 who identified the German adjustment factor for early retirement not to be actuarially fair, the reforms would ideally also be accompanied by an revision of the adjustment factor.

7.4 Suggestions for policy-makers, financial planners and the individual

341

heightened level of real estate leverage as well as the benefits of diversification to overcome limitation #5. It needs to be recalled here that changing perspectives and behavior is a long-term process. Due to conservatism individuals are persistently slow in adapting their behavior: “It takes anywhere from two to five observations to do one observation’s worth of work in inducing a subject to change his opinions.” 513 However, as sub-section 4.2.2.1 on conservatism has shown, information is much more easily retained if it is presented in an active and lively way. Therefore, retirement seminars should be designed in a very pragmatic and present-focused way and not promote abstract information, emphasize statistical figures or focus on distant future consequences. Additionally, there are differences with regard to the cognitive and emotional aspects of information processing that need to be taken into consideration. While “the cognitive aspects concern the way people organize their information, […] the emotional aspects deal with the way people feel as they register the information.” 514 “Because cognitive biases stem from faulty reasoning, better information and advice can often correct them. Conversely, because emotional biases originate from impulsive feelings or intuition – rather than conscious reasoning – they are difficult to correct.” 515 Due to the lack of direct interaction, the focus of retirement seminars should be more on cognitive aspects, while financial planners, discussed below, need to consider more the emotional side (while still leveraging cognitive aspects). In order to ensure the motivation of individuals to paying attention in these seminars, it is recommended to offer different levels of seminars according to the sophistication of the attendees. While, for example, a lot of care needs to be applied to the understanding of the basic system and the most common saving products for individuals who are very unfamiliar with the retirement topic, the seminar for financially sophisticated individuals could focus on more advanced product choices while also ensuring coverage of the basics. This would thus also correspond to the proposition of tailoring the measures according to a tiered approach. 516 Finally, as CHOI et al. 2002 have shown that individuals tend to change behavior im-

513

SHLEIFER 2000, p. 128. SHEFRIN 2002, p. 29. 515 POMPIAN/LONGO 2005, p. 59. 516 In terms of feasibility, an option could be to implement these seminars as part of the curriculum at the university, in apprenticeship and unemployment programs or in adult learning centers. Enforcement could be reached, for example, through tax breaks for seminar attendance. 514

342

7 Review of research and suggestions for improving individual FPB

mediately after a seminar or not at all, a feedback loop would have to be conducted shortly after a seminar. Similarly, the German state has recently launched the so called “Altersvorsorge macht Schule”-initative. The responsibility for this initiative is borne by several federal organizations and it provides individuals access to information about the retirement system. 517 In contrast to the solution proposed above, this seminar is not compulsory and does not seem to differentiate based on the level of sophistication of the attendees. Applied to the findings of this study, 518 this approach could reveal two dangers. On the one hand, those individuals who need this information most urgently might not attend because they show a rather passive behavior and might not feel worthy of financial planning or attending such a seminar. On the other hand, those individuals who typically display a very active information gathering behavior and can thus be assumed to attend such a seminar might be bored and discouraged by a too generic content. Compulsory individual “retirement sanity checks”

Besides the retirement seminars that provide more general information, individuals also need to be confronted with their specific retirement situation. Limitation #2 highlighted that individuals have only a very vague understanding of the asset levels and the income and expense streams they can expect in retirement.

517

The initiators of this project are the BMAS (Bundesministerium für Arbeit und Soziales), the Bundesministerium für Ernährung, Landwirtschaft und Verbraucherschutz, the Bundesministerium der Finanzen, the Bundespresseamt, the Deutsche Rentenversicherung, the German association of the adult learning centers (Volkshochschulen), the Verbraucherzentrale Bundesverband, the Deutscher Gewerkschaftsbund and the Bundesvereinigung der Deutschen Arbeitgeberverbände. The seminar is organized over 12 hours and taught by experts from the Rentenversicherung Bund. All attendees have to contribute towards the expenses with a token €20 per person. The curriculum of the seminar is similar to the process described by this study, starting with a vision of life in retirement followed by an identification of the different elements to provide individually through personal and corporate pension arrangements. However, the monitoring of the decisions and the update according to new challenges lie in the responsibility of the individual. See BMAS 2007a. 518 More sophisticated individuals tend to show a more active information gathering behavior, while those individuals who are in the least secure position (i.e., the Limited-wealth Risk-groups) show a rather passive information collection behavior.

7.4 Suggestions for policy-makers, financial planners and the individual

343

The idea of confronting people with personalized information about their expected retirement income builds on the concept of the “Renteninformation”. 519 This annual statement provides individuals with an estimate of their state pension income in retirement based on their individual eligibility criteria. Since the “Renteninformation” is limited to the state pension and thus only covers part of the retirement income, and since such a statement runs the risk of being ignored, the concept could be expanded along two dimensions. First, to provide a more holistic picture, the individual could receive additional statements about his retirement income eligibility from corporate and private pensions. Here, the state would need to define an individual’s right to receive these statements 520 and supervise the execution. Second, the individual could be obliged to include and sum up the respective pension statements in a specific section of his tax declaration. This would prod him into facing up to his prospective income in retirement and so to perform a personal “retirement sanity check” every year. However, especially with regard to this proposal, the practicability would need to be closely examined with regard to data protection issues. 7.4.4 Suggestions for financial planners seeking to improve individual FPB “Financial planning is a prescriptive activity whose main objective should be to guide investors to make decisions that are in their best interest. […] Providing timely warnings about the pitfalls of intuition should be one of the responsibilities of financial advisors.” Kahneman/Riepe 1998, p. 52f.

519

Based on the Riester Reform, pension insurance carriers (Rentenversicherungsträger) are requested to provide a so-called “Renteninformation” for all individuals aged 27 years and over stating their yearly pension entitlements and the corresponding amount of pension income. This has been done in order to inform individuals better about the retirement income they can expect and about the required level of savings. In 2006 three scenarios for the development of the cRV (Rentenwert) are calculated: first, with no increase of the cRV, second with an increase of 1% and third with an increase of 2% nominally. See DIA 2006b. 520 Similarly to the UK where members of a Personal Pension or Stakeholder Pension Scheme must be provided with an annual benefit statement showing their contributions paid and the current value of the fund. Furthermore, government regulations require that the pension provider includes an illustration of the pension income they can expect in retirement. See PAS 2007.

344

7 Review of research and suggestions for improving individual FPB

Two levers were identified for how the financial planners can enhance individual FPB. Systematic consideration of typical human limitations

Chapter 4 highlighted different human tendencies in terms of perceiving reality, making decisions and implementing actions. The description of the most prominent limitations of individual FPB in section 7.4.1 has confirmed that most of these human limitations are inherent in individual retirement-specific FPB. As shown above, policy-makers can improve individual FPB by optimizing regulations or product specifications in light of typical human tendencies such as inertia or taking the path of least resistance. Another way to improve individual FPB is to increase individuals’ awareness about one’s own human limitations and to illustrate ways to overcome them. However, it must be acknowledged that it remains very difficult to raise awareness about one‘s own tendencies through general information campaigns or retirement seminars. Also, it represents a weak bet to build on individuals’ own efforts to become aware of typical human limitations. Therefore, the ideal channel to raise awareness about human tendencies and thus turn individuals into “sophisticated selves” is the financial planner with his personal contact and his position as an expert. If a financial planner is aware of typical human tendencies, he can deal with them in the financial planning process and in the interaction with the individual. This means that the financial planner could highlight typical human limitations in the counseling conversation (message of caution) and at the same time illustrate ways to overcome them (message of hope). Therefore, “from a client’s and planner’s perspective, the study of behavioral finance is the logical companion to comprehensive financial planning.” 521 For example, the financial planner should make hyperbolic discounting transparent and show to what extent committing devices such as an automatic saving plan can be leveraged to avoid it. Furthermore, he could design the investment options provided to the individual in such a way that the default settings are most adequate given the individual’s situation (e.g., life-cycle products building on inertia). Another area for financial planners to leverage their knowledge of human tendencies is communication: Instead of suggesting to sell the loss making stock and buy the new ones recommended, a financial planner who is familiar with the human tendency for loss aversion would recommend the client to transfer the value of his wealth to another 521

OPIELA 2005, p. 42.

7.4 Suggestions for policy-makers, financial planners and the individual

345

account. 522 Finally a financial planner could also help individuals to face up to their optimism or overconfidence by comparing their feeling of preparedness with the actual financial situation they can expect in retirement. Professionalization of financial planning advice

The professionalization of financial planning advice has two elements. On the one hand, process related aspects need to be considered. On the other hand, the investment management approach should be improved. Overall, these measures should lead to a completely new type of customer experience in financial planning for retirement. The process related aspect revolves around ensuring easy accessibility and periodicity of financial planning advice and so addresses limitation #2. With regard to the accessibility, research from SCOTT/STEIN 2004 has shown that the propensity of performing financial planning activities increases if the access to information is easy. 523 Furthermore, the financial advisor should ensure that each interaction with the individual is consciously evaluated with regard to its particular implications on retirement financial planning. Apart from ensuring easy access, a professionalization of a financial plan relies on the completeness of the different steps of a financial advisory process as described by MAGINN/TUTTLE 1990. This highlights the importance of periodically monitoring, reviewing and adapting financial plans for retirement. In these reviews the portfolio can be adapted to changing conditions of the individual (e.g., new marital status) through the investment management approach described below. Such an approach also seems recommendable in light of the proposed incentivization of the new standard for financial planning services that is to be provided by policy-makers with the support from financial planners. Besides practitioners’ knowledge also behavioral finance offers further arguments for the establishment of periodic financial plans: The creation of habits helps to overcome inertia and procrastination and represents a mechanism to overcome the self-control problem. Furthermore, the creation of habits is important as individuals tend to stick to habits in order to avoid regret 522 523

See SHEFRIN 2002, p. 26f. SCOTT/STEIN 2004 show that sending an email with a link to an online tool is one of the most effective ways to encourage individuals to utilize support for individual financial planning. Due to the concept of taking the path of least resistance and the fact that individuals tend not to devote a lot of time to retirement financial planning, they already perceive it as too much of a hassle to type an URL from a printed letter into their Internet browser. See SCOTT/STEIN 2004, p. 211ff.

346

7 Review of research and suggestions for improving individual FPB

from commission. 524 A similar argument can be drawn from individual loss aversion: If losing something they already have is worth more than what they had to invest to get it, the existence of a financial plan will increase its value for them. With regard to the investment management approach, financial planners can also help overcome the limitations concerning the understanding of one’s financial situation in retirement, risk mitigation and sub-optimal portfolio characteristics (limitations #2, 4 and 5 mentioned in section 7.4.1). To increase the overall understanding of an individual’s financial situation in retirement, the financial planner should support the individual in estimating his expense streams in retirement, by taking in consideration the projection bias and leveraging the expense side to make the problem of money illusion transparent. Then he should contrast these expense streams with the expected income streams and so derive a possible retirement income gap. This point needs to be seen in the context of the postulate for a conscious financial planning approach formulated for the individual and described below. Also to be recommended is the application of best practices used by pension fund managers. An example for such an approach is provided by Financial Engines. 525 The company is a provider of advisory services to sponsored retirement plans, works through an online tool and applies practices such as fund style and performance attribution, Monte Carlo simulation and mean-variance optimization to individual retirement problems. Following these analyses, the individual gets an estimate about his retirement income if his investments perform well, average or poorly. Furthermore he can also receive specific recommendations for saving and fund allocation. Similarly, the financial advisor could use these techniques to calculate different scenarios for his client’s financial income in retirement (that would then also offer different scenarios for the retirement gap analysis) and provide recommendations on how to optimize the equity, mortgage 524

Regret of commission is stronger than regret of omission. See KAHNEMAN/RIEPE 1998, p. 63 and sub-section 4.2.4.4. 525 Financial Engines is a company co-founded by William Sharpe. It gives 401(k) investors access to the same mean-variance algorithms that Sharpe developed for institutional money managers. But it is not the mean or variance that is interesting for the people, rather the chance by which they can reach their aspiration level. By adjusting risk, contribution level and retirement age, a user can see how different combinations affect the chance of succeeding to reach his retirement goal. See SHEFRIN 2002, p. 126f and SCOTT/STEIN 2004, p. 209.

7.4 Suggestions for policy-makers, financial planners and the individual

347

and diversification characteristics of the portfolio (addressing limitation #5). 526 The advantage of an advisor using such an online tool is that he can leverage the personal contact to explain the logic behind different capital market mechanisms or the reasons why e.g., an early start to financial planning activities makes sense. The latter would thereby address limitation #3. Another point is noteworthy with regard to the segregation of the portfolio. Building on the idea of a layered portfolio as described by the Behavioral Portfolio Theory (section 4.3.2), it is important that the financial planner helps the individual to not only see the different layers influenced by narrow framing and myopia, but also to consider the overall portfolio characteristics by taking into consideration diversification and correlations between the different layers. In addition, the financial planner should support the individual in a consequent risk management approach and thus help to overcome limitation #4. This means that he should explain the most relevant risks to the individual, highlight the impact they could have on his financial situation and so raise his awareness of them. Here, careful communication is essential. A risk can, for example, best be described by the absolute downside potential (Value at Risk) and not by indicating a volatility value. This builds on the fact that even if risk is measured in terms of volatility (as positive or negative deviations from an expected value) it is the negative deviations that concerns investors. To improve the low level of risk mitigation, it is essential that the advisor helps to identify products that hedge the respective risks and prioritizes the product selection with the individual. An example of a service that covers both the process related aspects and improvement of the investment management is Fidelity’s “retirement income advantage” concept. 527 Besides these very specific aspects, giving financial planning advice should reflect a new type of customer experience. As addressed above in 526

With regard to the changes in the share of equity and the required saving rate, the financial planer needs to consider the effect that framing and anchoring have on the individual. Correspondingly, adaptations need to be made relative to an individual’s reference point. Furthermore, the financial planner should also leverage his interaction with the individual to overcome the phenomenon of home bias that has been observed often in retirement savings in other research efforts (e.g., MITCHELL/UTKUS 2006, p. 88 or FRENCH/POTERBA 1991, p. 223ff; see also sub-section 4.2.4.3.). 527 The idea behind this concept is to link services and products in order to support the individual with the financial planning and the financial realization of his retirement. It encompasses education, tools and advice and allows management of the retirement economics from one integrated platform (e.g., including the possibility to calculate amounts of monthly withdrawals). See FIDELITY 2007.

348

7 Review of research and suggestions for improving individual FPB

the mandatory retirement seminars, it is key to consider both emotional and cognitive aspects in retirement-specific financial planning. Especially the financial planner should leverage the direct interaction with individuals to ensure the best possible tailoring of information and options to the individual and thus an improvement of decision-outcomes. Therefore retirement financial planning should not be considered as just one set of products or services, but rather as a professional and personalized relationship built on trust that aims at a life-long accompaniment through the different phases of the financial life-cycle. 528 In all this, the buying experience needs to respect the values such as self-determination, autonomy and pleasurable consumption illustrated in section 7.1.1. One specific requirement that arises because financial advice should also be targeted to consumers that are aging is the necessity to adapt the offer to the reduced cognitive capabilities and slower information processing capabilities of this generation. 529 Aside from some physical adaptations such as using a larger font size, this reinforces again the need to reduce complexity – as stated above in the recommendation for policymakers to simplify the system. Due to the human complexity aversion, simplification is a key success factor in enabling individuals to take better decisions. 530 At the same time however, the offer also needs to be tailored to the sophistication and motivation level of the individual. As a consequence, it can be concluded that these financial advisors who manage to simplify without trivializing while at the same time offering a tiered approach adapted to the respective client’s sophistication and motivation will deliver the highest utility experienced by the customer. 7.4.5 Suggestions for the individual seeking to improve individual FPB It will not come as a surprise that at the center of improving individual retirement-specific FPB is the individual himself. Even if the policy-makers provide an ideal background and the right incentives and financial planners demonstrate individual limitations and propose optimized solutions, it is the individual who needs to develop adequate perspectives and act accordingly. Since this means that the individual needs to assume most of the re528

See BERNET 2005a, p. 28, who states that the positioning of financial institutions will depend more on emotional factors and social competences of the advisors than just product characteristics. 529 See STAIB 2005, p. 5. 530 MADRIAN/SHEA 2001, for example, highlight the fact that simplifications help individuals to take the right kind of asset allocation and saving decisions.

7.4 Suggestions for policy-makers, financial planners and the individual

349

sponsibility for his financial situation in retirement, it is essential for him to understand his own accountability and to correspondingly accept it. This acceptance of personal responsibility is linked to the need to dedicate more time to retirement financial planning, since the lack of time has been mentioned as “the single largest barrier” 531 to individual financial planning. This time shall be spent for improving one’s own knowledge level and thus getting more realistic perspectives and undertaking conscious financial planning activities as mentioned below. Building on loss aversion and the fact that individuals feel more regret if they have changed a habit and things go wrong, this would mean making a habit out of retirement financial planning, similar to the duty of doing the taxes yearly. Such a habit could also represent a committing device that would help to overcome the respective human limitations (i.e., procrastination, inertia, lack of selfcontrol). But the individual does not only need to assume responsibility for himself – it is also his duty to support others. The idea behind this statement is that many individuals have mentioned friends and family as one of their most frequently used information sources for personalized financial information about retirement. The interaction with friends and family thus represents an ideal channel for reaching those individuals who have historically lacked a high penetration with retirement advisors and demonstrated strong limitations in their FPB (i.e., the Limited-wealth Riskgroups and the High-potential). In this context, individuals should strive to convince their friends and family members to understand and assume their own share of responsibility. That such an approach can be successful is proven by DUFLO/SAEZ 2004 who state that (company) peer pressure has a positive impact on retirement financial planning. Based on these considerations, three main improvement levers have been identified for the individual.

531

SCOTT/STEIN 2004 examined the reasons why individuals do not use employerprovided advice services for corporate pensions. They found that a lack of time is the reason most often cited: “Between one quarter and one half of the nonadopters surveyed indicated they did not know the benefit existed. An additional one-third to one half indicated they just had not found the time to try the advisor. Averaging across all surveys, lack of time is reported as the single largest barrier. Interestingly, fewer than 5 percent listed the reason as not needing financial advice and a small similar number indicated they were unwilling to use the internet”. SCOTT/STEIN 2004, p. 213.

350

7 Review of research and suggestions for improving individual FPB

Improvement of personal knowledge

A lever that the individual can pull to improve his financial planning behavior is to enhance his understanding of the overall retirement system and the basic functioning of capital markets. This would substantially increase his knowledge about the more objective elements of retirement-specific financial planning. Furthermore, a better comprehension of his personal financial situation in retirement and typical human limitations is recommended which would enhance the subjective knowledge. Through providing a better knowledge level, the individual ensures a more realistic perception of reality (addressing limitation #1) and lays the basis for a realistic financial plan and adequate actions (limitation #2-5). An understanding of the relevant retirement system and capital market mechanisms will be improved by consciously attending the mandatory retirement seminars mentioned above. The knowledge acquired there would improve an individual’s grasp about the retirement system and his own situation, thus laying the basis to develop the understanding of the personal financial situation and thus addressing limitation #1 and #2. Furthermore, it would improve an attendees’ risk and investment management capabilities required in the process of financial planning (e.g., starting earlier, choosing the right products to ensure adequate equity coverage or selecting appropriate risk mitigation – limitations # 3, 4 and 5). As highlighted above, the actually offered seminars “Altersvorsorge macht Schule” represent a good starting point here. Chapter 4 has shown the different typical human limitations in decisionmaking and has illustrated how these tendencies lead to an adaptation of the life-cycle theory or the modern portfolio theory. The reason to improve the personal knowledge with regard to an enhanced understanding of typical human shortcomings builds on the distinction between sophisticated and naïve selves. While sophisticated selves comprehend their human tendencies and act in order to overcome them (e.g., by accepting selfcommitting devices), naïve selves wrongly believe that in the future they will carry out the wishes of the current self and do what is right in the long run. 532 Building on these findings, individuals should strive to become sophisticated selves in order to act more responsibly with regard to their financial situation in retirement. Consequently, they should be open to understand how their emotions intrude on their ability to act rationally. As financial planners should be in a position to identify typical human tendencies of clients and thereby help to increase the awareness about them, indi532

See ANGELETOS et al. 2001, p. 52.

7.4 Suggestions for policy-makers, financial planners and the individual

351

viduals should get the chance to learn about their human limitations and ways to overcome them in interactions with these financial advisors. This highlights the link between cognitive and emotional aspects in the relationship between financial planner and individuals pointed out above. As a consequence of an enriched personal knowledge about typical human tendencies, individuals should leverage self-regulating actions or commitment devices (e.g., a periodic review of the financial plan, the “pay-yourself-first” approach that deducts the savings upfront from the payroll or even leveraging the different propensities to consume lump sum payments such as the Christmas bonus by dedicating it directly to the corporate pension provision through “Entgeltumwandlung”). Furthermore, knowing typical human tendencies such as the differences in the propensity of consuming assets, they should try to influence their financial streams in an optimal way. For example, if they can choose to have their bonus paid out once yearly or every month, they should opt for the first alternative. If they can choose to receive an inheritance now or in a few years, they should opt for the delay. On the other hand, this form of mental accounting can represent a good argument for investing in classical retirement saving products. Besides this element of subjective knowledge, the individual also needs to reach a better comprehension of his personal financial situation. This is best achieved through a thought-out financial plan, which is described in the next paragraph. Conscious financial planning approach

Limitation #2 described in sub-section 7.4.1.2 has shown that most individuals assess their retirement income and expense streams as equal. Most likely, this finding is a sign that individuals do not consciously think about their financial situation in retirement and have not well understood the prospects of their financial situation in retirement. To complement the above described lever of improving the subjective angle of the personal knowledge, this lever aims specifically at developing the understanding of the one’s personal financial situation in retirement and furthermore encouraging the individual to actually start planning for retirement in a careful way. To this aim, it is essential that individuals start to consciously think about their retirement and translate this life-view into financial streams. As described in sub-chapter 2.2, an optimal financial plan starts with the identification of the life plans and financial objectives but also contains appropriate coping strategies. This means that individuals should try to envision

352

7 Review of research and suggestions for improving individual FPB

their life in their 60s, 70s and 80s. A good starting point for translating these plans into monetary amounts is to get an overview of how expensive their actual lifestyle is. Here, the fact that Germans are a nation of very thorough household book-keepers could come in handy. 533 Another approach would be to collect in a shoebox the necessary data to get a rough estimate of personal expenses. An experienced financial advisor could then evaluate the data and reconstitute them into an estimate of the expense side. According to EISENBERG 2006 such a collection would include the receipts for a year’s worth of expenses together with an estimate of the pocket change someone fritters “away day to day, all brokerage and cash management statements; a comprehensive net-worth statement; documents relating to how you plan to dispose of your assets upon your death; all durable powers of attorney, health care proxies; a complete file of insurance policies, including life, health, long-term-care, and liability.”534 With regard to the income side, the above suggested expansion of the concept of the “Renteninformation” to the corporate and private pension would be helpful. This could be a good starting point to cover the pension income side. Even if due to data security issues no overall solution can be found with regard to this expanded overview of entitlements, it would still be up to the individual to try and collect this kind of information from the respective parties (e.g., insurance provider sending updates about the prospective amount of pension). To give a complete picture of the income side in retirement, this information would also need to be complemented with additional income sources from e.g., a second property. To ensure that all the different information sources are brought together correctly and to overcome typical human limitations such as bounded rationality, hyperbolic discounting, money illusion, and projection bias on the one hand and overconfidence and optimism on the other hand, the contact with an independent financial advisor is recommended. This again highlights the changed quality of an individual’s relationship with his financial planner. Building on the suggestions of a professionalization of the financial planning process as described above, it would be the duty of the individual to periodically review his financial plan and adapt the investment strategy accordingly.

533

BÖRSCH-SUPAN/ESSIG 2002 for example state that more than every sixth households keeps a household-book (Haushaltsbuch). See BÖRSCH-SUPAN/ESSIG 2002, p. 80. 534 EISENBERG 2006, p. 250.

7.4 Suggestions for policy-makers, financial planners and the individual

353

Flexible approach towards life in retirement

Another key finding arising from individual retirement-specific FPB is that the individual needs to show a certain degree of flexibility towards his life in retirement and be prepared to adapt his assumptions and life visions accordingly in order to ensure a financially secure retirement. The simulation analysis in sub-chapter 6.4 has shown that the variation of underlying assumptions can substantially impact the perspective of an individual financial situation in retirement. Therefore it is very important that based on a conscious financial plan, the individual tests different options to close a potential retirement gap and also evaluates various choices of life plans. The most important levers identified in this respect are changes in retirement age, in the share of pre-retirement income needed or in the value of assets to be held in reserve. Also the question of whether all of the real estate assets should be left for inheritance or how new products (such as equity release products) could contribute to the individual financial situation in retirement need to be asked and answered. With regard to the increase of the retirement age, the efforts of the German BMAS under the idea of “Generation Arbeit – Initiative 50plus” are a positive step. 535 Its efforts aiming at a longer and deeper utilization of the knowledge of older employees, allowing them to continue work until the official retirement age, should provide the political, social and corporate environment that allows the pre-retirees more flexibility with regard to their chosen retirement age. Overall, the analysis shows that it is essential to explore different opportunities and to remain flexible when planning for one’s own (financial) situation in retirement.

535

See BMAS 2006a. This initiative’s aim is to enable individuals to work longer, ideally until their regular retirement age, by providing them with support for educational measures or by according different incentives to their employers (e.g., through subsidizing part of the salary or allowing specific projects). This effort is supported by cutting back on options that employers had previously to send their employees into early retirement.

354

Review of research and suggestions for improving individual FPB

7.5 Summary of the review of empirical research and identification of suggestions for policy-makers, financial planners and the individual This chapter synthesizes the findings from the empirical investigation in Chapter 6. It summarizes the most important FP perspectives and discusses the most pronounced gaps between recommended and actual FP actions in order to derive levers for key stakeholders to enhance individual retirement-specific FPB. • The results by investor types show distinct FPB profiles. The Retirees feel well prepared but should rein in their confidence and start considering how their situation will be affected by future changes in the retirement system. Due to a substantial financial cushion as well as a very sophisticated and active FPB, the Wealthy have been identified as the best positioned investor type that do not require interventions. The Highpotential show a very imbalanced profile in that they display certain recommended behaviors but at the same time have a very pronounced anxiety level, a high risk aversion and some irrational portfolio characteristics (e.g., low share of equity). They need encouragement and support in their retirement-specific FPB. The Limited-wealth Selfemployed show a very self-directed and sophisticated FPB. However, they suffer from overconfidence and should also keep their selfemployment risk in mind. Finally, the Limited-wealth Risk-groups represent the pre-retired individuals who are most at risk. They show a strong level of passivity and lack of sophistication while at the same time disposing of the lowest financial means and the most pronounced retirement gap. These investors need to learn about the necessity to plan financially for their retirement and thus receive motivational encouragement. Furthermore, they need educational support and very specific recommendations for their FPB. • The analysis of individual retirement-specific FPB has shown adequate behavior in only a few areas (e.g., willingness to keep a reserve, preparedness for coping strategies, high risk awareness and product interest, understanding of the need to diversify investments, high penetration with advisors and an overall intensive use of classical pension savings products). However five key limitations were identified that need to be addressed: Over-optimistic perception of personal financial reality; unsophisticated planning of retirement cash-flows; late start of financial planning for retirement; low risk mitigation despite high risk awareness

7.5 Summary of research review and identification of suggestions

355

and sub-optimal portfolio choices with regard to diversification across asset classes, the share of equity and the real estate leverage. • To address these key limitations, measures are proposed for policymakers, financial planners and the individual that focus on creating awareness and thus influencing the perspectives as well as enabling adequate FP actions by leveraging the findings from behavioral finance. Conceptually they are developed and evaluated along the lines of a shared responsibility between the different stakeholders, a libertarian paternalistic decision support, pareto-optimal solutions that withstand cost-benefit considerations, the reflection of the associated emotionality and a tiered approach. While policy-makers should aim at providing an advantageous regulatory background with the right (fiscal) incentives for retirement-specific saving (e.g., through mandatory retirement seminars and compulsory individual retirement “sanity checks”), financial planners need to demonstrate individual limitations and propose optimal solutions to their clients. In this, they should focus on an enriched client relationship (not on the incentives different products or solutions provide for themselves) and ensure a professionalization of the financial planning process and the investment management. However, only the individual himself can change his behavior and take concrete measures to improve his financial situation in retirement. Therefore, the most important lever for the individual is to understand and assume responsibility for his retirement-specific financial planning, adapt his perspectives accordingly and undertake the respective actions (e.g., conscious financial planning approach and flexible adaptation of retirement life vision to the needs and circumstances).

8 Conclusion

“In a sense, saving for retirement requires behavior similar to that enjoined by other behavior modification programs such as exercising, dieting, quitting smoking, or following through on New Year’s resolutions.” Mitchell/Utkus 2006, p. 83. The knowledge aim of this thesis was to gain an understanding of individual retirement-specific financial planning behavior (FPB) with its two elements FP perspectives and FP actions. While FP perspectives comprise the mental constructs, plans and expectations individuals have for retirement, FP actions describe the process decisions and portfolio choices that express how individuals actually carry out their financial planning for retirement. With regard to the FP actions, the thesis specifically aimed to compare actual behavior with principles for FP actions derived from behavioral finance, modern portfolio theory and practitioners’ advice. Based on the identification of areas where individual retirement-specific FPB showed the most pronounced limitations, levers were identified by which policymakers, financial planners and the individual can improve individual FPB. These recommendations reflect in particular the new retirement reality with a reduced pension contribution stemming from the state, a shift of responsibility to the individual and a related general insecurity with regard to individual financial situations in retirement. Compared with existing academic research, this study takes a broader look at the topic of retirement financial planning. Building on over 500 interviews, this work represents a comprehensive analysis of the retirementprovision behavior of affluent individuals in Germany. By explicitly including FP perspectives, it considers elements such as the general attitude individuals have towards life in retirement, their financial objectives for old age, their awareness of different risks as well as their readiness to bear them, and lastly, their level of knowledge about the pension system and financial markets. Through the inclusion of these perspectives, the thesis acknowledges that individual retirement-specific behavior cannot be evaluated only on the basis of quantitative dimensions such as the saving rate,

358

8 Conclusion

the equity share or the holding of classical retirement products. Indeed, the study advocates that FP perspectives need to be considered as an integral part of an individual’s financial planning behavior for retirement and often serve as the root cause of individual FP actions. This chapter represents a summary of the results, provides a critique of the study and gives an outlook on further research questions.

8.1 Summary of results The most characteristic findings for the different investor-types, the most important limitations with regard to retirement-specific FPB and the key improvement levers identified for policy-makers, financial planners and the individual are described below. 8.1.1 Investor-type specific findings In order to get a more detailed picture of the impact of different sociodemographic and socio-economic characteristics on the individual retirement-specific FPB, analyses have been conducted for five investor types with distinct profiles. Apart from having substantially different objective risk capabilities (captured in various socio-demographic and socioeconomic attributes), the investor types showed varying levels of anxiety about retirement, different degrees of retirement-specific financial planning activity and a distinct level of financial sophistication (expressed both in the self-assessment and in the more objectively measurable portfolio characteristics). A simulation analysis has confirmed the results from the comparison of the financial income and expense streams the individuals themselves expect for retirement, namely that – apart from the Wealthy – all pre-retired investor types will have a retirement gap. However, with some flexibility regarding the timing of the transition into retirement, their needs during old age, the assets they want to keep as a reserve or leave as an inheritance, the complementation of state income with other income sources as well as with a consequent realization of the indicated saving rate, this gap can be closed for most individuals. Retirees were analyzed to illustrate inter-generational differences. They seem to be doing quite well in retirement and thus send out a positive notion of their “second life”. This can be dangerous for themselves (because of the time-orientation of the German retirement system) and for others (because of the human tendency to see the current situation of Retirees as representative and thus to feel too confident about their own future).

8.1 Summary of results

359

The Limited-wealth Risk-groups are the individuals with the lowest risk capability and the most pronounced retirement gap, which is reflected in the highest anxiety level. Since the financial sophistication of this type is quite limited too, and as they show a rather passive FP approach, it becomes clear that this investor type needs support most urgently among all individuals analyzed. The Limited-wealth Self-employed have a below average risk capability because of their self-employment status. They are very self-directed and show a sophisticated and active FP approach. Therefore, it seems justified to delegate to them a considerable share of the responsibility for their own situation in retirement through their option to opt out of the SSP. However, they are prone to be overconfident, which could lead to a significant retirement gap. The best way to combat this trait would be to educate them about the dangers associated with overconfidence. Their substantial real estate holdings can also be employed as leverage in reducing the retirement gap. The High-potential have an above average risk capability but are at the same time very worried and seem to lack the confidence to undertake adequate FP activities in all areas (specifically equity investments and diversification). Given their strong awareness of the need to provide individually – deduced from having started earliest to think about financial planning as well as rather active information gathering – and their rather low take-up of advisors’ services, these individuals would benefit greatly from encouragement and education. As they also have the means to undertake additional savings or investments, they represent the best candidates for individual FPB improvement. The behavior of the Wealthy is strongly influenced by their substantial financial cushion. It provides them with an above average risk capability as well as the base on which they have developed their financial sophistication and an active FP approach. These individuals face by far the best financial situation in retirement. However, especially since the Wealthy can be considered as sophisticated selves, they could benefit from a constructive discussion of typical human tendencies that stand in the way of an optimal retirement-specific FPB. To sum up, the Wealthy and the Limited-wealth Self-employed are responding quite well to the shift of responsibility onto them and showing an adequate retirement FPB. The Retirees are doing fine but the optimistic message they send out about retirement needs to be put into perspective for the welfare of the pre-retirees and their own welfare. It is the Limitedwealth Risk-groups and the High-potential who represent the investor types most at risk and who have the greatest need to improve their individual retirement-specific FPB.

360

8 Conclusion

8.1.2 Most substantial limitations The individual retirement-specific FPB of the German affluent segment meets only some of today’s retirement challenges (e.g., there is a strong willingness to keep a financial reserve to provide for unexpected expenses, a pronounced preparedness to make compromises on the expense side, an understanding of the need to diversify investments with a relatively high penetration with classical retirement saving products, and a high risk awareness and product interest). On the other hand, five areas have been identified within FP perspectives and FP actions where individual retirement-specific FPB shows the most substantial limitations across the different investor types. The first point of caution has to do with individuals’ over-optimistic perception of their own financial reality. The majority of individuals have indicated that they want to screen different kinds of information sources and then make decisions themselves, which is an ideal way to encourage individual responsibility for the financial situation in retirement. The problem with this is that at the same time many individuals have a perception of reality that is positively skewed because of a prevailing representativeness bias, conservatism and optimism. A further complication is that all investor types overestimate their financial astuteness. The second limitation is related to the unsophisticated planning of retirement cash-flows. The research has revealed that most individuals have a rather unconsidered approach towards conducting a financial plan for retirement. Furthermore, the estimation of the expense and income streams and the identification of a potential retirement gap are not based on solid reasoning and are influenced by optimism. Confronting the feeling of financial preparedness for retirement with the estimate of the income and expense streams (and correspondingly the income gap) also reveals substantial cognitive dissonance. Thirdly, a large difference has been detected between the ideal age at which individuals should start to plan for retirement, namely the day they enter work life, and the age at which they do indeed start to think about it (at 46 years on average). The fourth reservation results from a low risk mitigation despite a high risk awareness. Despite the fact that the interviewees have shown a quite high risk awareness that translates into almost as high an interest for products to hedge these risks, they do not translate this risk awareness into the purchase of the suitable products and thus the mitigation of the respective risks. The last major shortcoming in individual retirement-specific financial planning, sub-optimal portfolio choices, has been found among different

8.1 Summary of results

361

investors. First, the objective level of diversification is substantially lower than the subjective awareness of the diversification benefit. Second, the share of equity for certain investor types does not reflect their risk capability. Finally, the amount of mortgage leverage sometimes does not correspond to the risk-return principles defined as behavioral benchmarks. 8.1.3 Improvement levers for policy-makers, financial planners and the individual To address the behavioral limitations summarized above and improve individual retirement-specific FPB, different levers are identified for the key stakeholders. On the one hand, these levers aim to create awareness about the overall retirement system, the individual financial situation and typical human shortcomings, thus changing the perspectives of an individual on his financial situation in retirement. On the other hand, these measures are targeted at enabling adequate individual retirement-specific FP actions. As a conceptual basis for developing and evaluating these measures, the following guiding principles were set up: shared responsibility between the different stakeholders; libertarian paternalistic decision support; pareto-optimal solutions that withstand cost-benefit considerations; reflection of the associated emotionality; a tiered approach according to the financial sophistication; financial soundness or motivation of individuals and a careful communication strategy. The focus of the measures proposed for policy-makers is to provide a favorable background and the right kind of incentives for individual financial planning. To this aim, an adaptation of regulations (specifically, the establishment of a standard for independent financial advisors, over time decreasing fiscal incentives to encourage financial planning and the quality of financial planning, transparency improvements for certain retirement saving products and a simplification of the system that coincides with an improvement of the defaults) is recommended. Furthermore, the introduction of mandatory retirement seminars is advisable. Compulsory “retirement sanity checks” should ensure that the individual is periodically and consciously confronted with his specific projected financial situation in retirement. Due to their personal contact with the individual and their position as experts, financial planners should focus on demonstrating individual shortcomings in retirement financial planning and at the same time offer adequate solutions. Since the reason for many limitations can be found in typical human tendencies, it is important that the financial planners learn

362

8 Conclusion

to recognize these human limitations, help the individuals to understand them and apply best practice techniques to overcome them. Furthermore, they should ensure a professionalization of financial planning advice both from a process-related and an investment management perspective (including asset and risk management). However, even if policy-makers change the legal framework and financial planners make limitations visible, it is the individual who needs to change his behavior and adapt his plans. Therefore, it is essential that the individual assumes the responsibility for his own actions and financial situation in retirement. This requires an increase in personal knowledge of the retirement system, basic financial market mechanisms and his own financial situation in retirement. The awareness about typical human tendencies would also contribute to the transformation from a naïve to a sophisticated self, which would then allow a more controlled and focused individual behavior. Furthermore, visualizing life in retirement and gaining transparency over the current expenses help to overcome the unconsidered financial planning approach. Finally, the individual needs to maintain the required flexibility with regard to (the vision of) his life in retirement to close a potential retirement gap.

8.2 Assessment and critique of this study The benefit of this research is its link between psychological attitudes and actual human behavior. From an academic perspective, it represents one of the first interview-based studies to examine a broadly defined individual retirement-specific FPB encompassing both the perspectives and expectations individuals have for retirement as well as the specific actions they take. It leads to an extensive discussion of how different human tendencies – derived from behavioral finance research – influence individual retirement-specific FPB. This discussion expands the existing retirementspecific behavioral finance research – traditionally focusing on individuals’ asset allocation choices and saving rates – to a wider discussion of how human limitations impact the typical perception of reality as well as the making and implementation of retirement-specific provision decisions. In analyzing this widely understood individual FPB, the study expands the application of behavioral finance and enhances it with modern portfolio theory and practitioners’ advice as well as sociological research. The definition of behavioral benchmarks for FP actions represents a new set of specific guidelines that build on the requirement for simplicity which might help individuals to better assess their retirement-provision-

8.2 Assessment and critique of this study

363

specific decisions. At the same time, they provide a norm against which actual FP behavior can be evaluated. By developing this gap analysis further and enriching it with a detailed assessment of the different FP perspectives that can also be compared to sociological trend analysis, areas are identified where individual FPB shows the most pronounced limitations. Suggestions are derived for how policy-makers, financial planners and the individual can improve individual FPB, demonstrating how this study’s findings can be transferred into practice. Given the need to make assumptions, certain elements of the study might look a bit simplistic. The retirement gap simulation, for example, serves as an illustration of the complexity of the financial planning problem individuals face with regard to retirement. As it helps to calculate different scenarios, it also provides a base from which to evaluate the impact of changing assumptions and perspectives. For a detailed assessment of the individual financial situation in retirement, however, this analysis would need to be further expanded, and the key assumptions about income and expense streams, keeping a reserve and leaving real estate assets as inheritance would need to be revised. Certain points such as the principle that individuals should start their financial planning on the very day they start to work might seem idealistic. However, given the underlying fact base, they can still be argued for and should be seen as a benchmark for ideal behavior. Beyond this, also the behavioral principles that everyone should consult an independent retirement advisor and that investing in classical saving products is recommended depend on policy-makers intervening to ensure fair and transparent product pricing and enforce a sound quality standard for financial planners. Finally, with regard to the suggestions derived for policy-makers, financial planers and the individual, the different levers presented should be considered as first ideas that would need to be further developed and would have to undergo scrutiny with regard to the guiding principles defined, specifically regarding the cost-benefit considerations and feasibility.

8.3 Further research questions The study analyzed individual retirement-specific FPB for the German affluent population in 2005. The results are thus valid for this specific sample only and represent a snapshot in time. As an area of further research, this study could be replicated in its entirety under different circumstances. One stream of research could conduct

364

8 Conclusion

the same analyses at a later moment in time with the same target group (but different individuals to avoid an answer bias). Such an analysis would test the stability of the findings over time and shed light on the factors influencing changes in perspectives and actions. At the same time, a replicated study could be used as a monitoring device for the implementation of specific measures proposed in sub-chapter 7.4. In another approach the target group could be changed to the mass retail or the high net worth segment. This would shed light on the different circumstances and challenges these individuals are exposed to and their impact on individual retirement-specific FPB. Similarly, as in this study, the identification of the most pronounced limitations in their perspectives and actions could help to tailor the proposed levers for policy-makers and financial planners to their needs. Additionally, the present results could be compared to the individual retirement-specific behavior of the affluent segment in other countries. Here, for example, it would be particularly interesting to compare German behavior with the perspectives and actions of the British or the US population, which tend to have a more pronounced risk appetite and a correspondingly more developed equity culture. In that research, it would be intriguing to understand the effect of different macroeconomic circumstances on individual FPB. In a different direction, the model of the inter-temporal financial optimization problem could be expanded. This could, for example, go in the direction of incorporating techniques such as the Monte Carlo simulation to treat future returns as stochastic variables or incorporate a simulation analysis for the individual life-expectancy. Furthermore, research could shed light on the maximization function of the utility of consumption before and in retirement that drives individual saving during work life. Another area for further research is selected additional aspects of individual retirement-specific FPB. Since the longevity risk is so central to the retirement topic, it would be interesting to complement this research with insights about the expected life-time of individuals and also about what share of the population believes itself to have already outlived its expected life-time. As for example THALER/BENARTZI 2004 have shown that there is a great difference between the amount individuals are prepared to save and the amount individuals effectively save, it would also be interesting to compare these two indications on the level of the individual and understand the reasons that are causing this difference. Furthermore, the aspect of selfishness could be analyzed, which is of central importance, particularly for the democratic process. Behavioral finance research has revealed

8.3 Further research questions

365

that individuals tend not to be selfish. 536 However, the research conducted by BOERI/BOERSCH-SUPAN/TABELLINI 2002 found a pronounced level of selfishness in wanting to shift the burden for securing the state retirement system onto future generations. 537 Finally, taking a different stance on personal finance, this study has proposed a new risk profile consisting of three dimensions. Here, it would be interesting to analyze this construct in more detail, test the connection between the objective risk capability and the subjective risk appetite and risk sophistication as well as explore their applicability in the actual decision process.

536

“All things equal, people prefer to be treated fairly and like to treat other people fairly. […] [Therefore,] concerns about fairness also matter and compete with purely selfish motives for scarce resources.” MULLAINATHAN/THALER 2000, p. 0 - abstract. 537 BOERI et al. 2002 found that a majority of individuals think that the state should not reallocate transfers away from pensions to the young and unemployed. Indeed, “only one out of five respondents who are aware of the crisis are also altruistic with respect to inter-generational redistribution.” BOERI et al. 2002, p. 400. This can be seen as a clear sign that selfishness plays a role if retirement is looked at from a more macro-economic perspective.

Appendix

Appendix 1 Analysis of selected FP actions for individuals with and without an advisor Individuals without a specialized advisor

Individuals with a specialized advisor

All investor types

an % of total sample n=

136

359

495

32% 32% 35%

8% 20% 73%

14% 23% 63%

84%

92%

90%

86%

91%

90%

48%

61%

57%

DS_2 Interest in an integrated financial plan Very/fairly unimportant Neither important nor unimportant Fairly/very important PC_1 Holding of classical pension saving vehicles n.a. Individuals who hold at least one of these products in their portfolio Subjective assessment of portfolio PC_2 diversification

n.a.

Individuals who say they have diversified Objective assessment of portfolio PC_3 diversification Individuals whose portfolio is objectively diversified

Remark:

n.a.

n.a.

Analysis based on question D. 2, A. 15, C. 14 and H. 7 Attribute whose distribution between the five investor types is different based on a 10% significance level As only two groups are compared with regard to one dimension, the Chi-square test to analyze the level of significance of group differences cannot be applied

368

Appendix

Appendix 2 Assumptions of the simulation analyses in sub-chapter 6.4

Determination of investor type specific time horizons General Each example individual for whom the analysis is percharacteristics formed is assumed to have the characteristics (age, share of women, share of different education types, planned age of retirement) of the average investor type. LifeLife-expectancy is calculated as gender-weighted averexpectancy age based on gender specific life-expectancy tables (2004 DAV tables). Saving period The remaining time to save for retirement during work life is calculated based on the age of the average individual in the survey year (2005) and the planned retirement age. Dissaving The time in retirement for which the assets need to sufperiod fice is calculated based on the planned retirement age and the life-expectancy. Working The time for which the individual has already been period working and thus collected EPs within the SSP, is calculated based on the average mix of education (secondary school, A-level and university degree), which is used to determine the age at which individuals entered the job market. 538 Investor type specific financial assumptions Each example individual is assumed to have the wealth Current wealth situa- situation and perspectives (current level of financial and tion and per- real estate wealth, current level of net income, percentage spectives on of last pre-retirement income needed to live comfortably in retirement) described by the average of each investor retirement type. The value of the last pre-retirement net income is calcuLast prelated by forecasting the current income level with the net retirement salary growth rate. This growth rate depends on the mix income of education of each example individual. 539 538

Individuals with a secondary education are assumed to enter the job market at the age of 18, individuals whose highest education are the A-levels are assumed to enter at 20 and university graduates are expected to enter the job market at 25. 539 The real salary growth level of individuals with a secondary education amounts to 0.2%, 0.8% for individuals with an A-level diploma and 1.1% for individuals with a university degree. Calculated from KIENBAUM 2001 and KIENBAUM

Appendix

Income needed to live comfortably in retirement

Financial objectives

Other income needs in retirement

Expected income to be received from SSP in retirement

369

This income is derived by multiplying the last preretirement income with the average share of income individuals have indicated needing to live comfortably in retirement. Based on the assumption that consumption is habit forming, the simulation analysis presumes that the amount individuals require to live comfortably in retirement will increase over time. Therefore, it assumes that the income needed in retirement is growing continuously in the dissaving period by the same real growth rate that the income was growing during work life (i.e., with the real salary growth rate). Based on the most cited financial objective to keep a reserve of funds to provide for unexpected needs in retirement (PL_4), individuals are assumed to reserve 30% of their current financial assets. Due to the importance of wanting to leave an inheritance, the simulation analysis assumes that the real estate values are intended for inheritance. Thus, these elements of wealth cannot be used in retirement to finance the pension gap. However, they are taken into consideration in the analysis of the duration of a secured retirement financing. Besides the explicitly stated share of the last preretirement income needed to live comfortably and the restrictions for the use of currently available wealth applying from the most prominent financial objectives, no other expenses such as e.g., planned donations are taken into consideration. The income an individual can expect in retirement has been calculated based on Equation 3.1, the German statutory state benefit formula. The accession factor reflects the effectively planned retirement age and is reduced for early retirement taking into account the gradual transition to a retirement age of 67 by the year 2029. 540 The type of pension is assumed to be equal to one as a pension due to age is presumed. Furthermore, an actual pension value of €26.13 per month that will remain constant in real terms

2004. The real salary growth rate is calculated as an education-weighted average. 540 See RASONYI 2006, p. 23 and RASONYI 2007, p. 23.

370

Other income sources in retirement

Appendix

(in the base scenario) is assumed. The EPs required for the calculation of the statutory state pension income in the German benefit formula are derived from the indicated level of actual net income for the average investor type. Based on its conversion to gross income and taking into account a real salary growth rate and historic inflation levels, the historic levels of gross income have been calculated. They have then been compared to the historic levels of the contribution ceiling and the average gross earnings in order to determine each year’s EP value. Since the individual dummies analyzed in this context all have income levels above the contribution ceiling, no additional EPs are granted for children or vocational education. Based on the historic average EP value per year, the EPs that can be expected from the remaining years until retirement (i.e., the saving period) have been calculated and added to the sum of the already accumulated EPs. Since it is the aim of this simulation analysis to illustrate the statutory state retirement income gap, no other income streams (such as company or private pension income) or income sources such as receiving donations or an inheritance are included.

Capital market and system related assumptions Real rate of The base case assumption for the real rate of return is return 4.5% for both calculating the future values as well as the present values (i.e., discounting). This rate has been chosen in accordance with the assumptions of the DIA. Furthermore, it is also confirmed by the MAP report which looks at the returns of the two main pension products, life-insurances and mutual funds, and indicates an average return of 6% nominally. 541 Growth rate Following the calculations of GEWOS 2005, the value of of real estate the real estate assets is assumed to grow with 2.5% nominally per year. 542 assets

541

Average nominal return calculations from for capital forming insurances or funds. See POWELEIT 2005, p. 25ff and DIA 2006b, p. 1. 542 According to the DEIX as of August 2005 (Deutscher Eigentums-ImmobilienIndex) that measures the price development of residential property (both estate

Appendix

Inflation

Net real calculations

371

For the past, the real inflation rates stemming from the German Statistical Federal Office have been used to model the development of the salaries. Going forward, inflation is assumed to be 1.5 %. 543 All calculations are based on a net basis which means that income taxes 544 and further deductions for health care and nursing care insurance are taken into account 545. The shift to deferred taxation is reflected in an increasing share of statutory state retirement income being taxed according to the Alterseinkünftegesetz. Furthermore, the values are calculated as equivalent to today’s purchasing power (i.e., values are real instead of nominal). One of the reasons for this procedure is to take into account the fact that individuals have problems calculating with inflation. Since individual interviewees were asked to give a percentage-indication of the amount of income needed to live comfortably in retirement, this indication can equally be applied to nominal or real values.

houses and single family homes) in Germany the value corresponds to the nominal development from 1989 to 2004. See GEWOS 2005. 543 This also corresponds to the assumptions of the BMAS 2006b, p. 51 or SCHNABEL 2003a, p. 9. 544 The calculations also take into consideration the changes in the tax system that are underway. Specifically, the shift to taxation of retirement income is considered as a progressive share of pension income is subject to income taxes: Starting with 50% in 2005, the share of pension subject to income taxes is increasing with 2% per annum to reach a level of 80% in 2020. Thereafter the share is increased by 1% p.a. to arrive at the full taxation of 100% in the year 2040. Apart from that a tax free lump sum of €7,464 is deducted. Starting from the fact that all example investor types are in the highest tax bracket during their work-life, an average tax rate of 30% is assumed for their retirement income. 545 The contribution of an individual to the health insurance amounts to an average of 7.3 %, the contribution to the care insurance for the long-term frail elderly amounts to 1.7% of retirement income. Indications according to DRV 2006b.

372

Appendix

Appendix 3 Standardized questionnaire and its translation into English

===================================================== Retirement Studie – Fragebogen über das Individualverhalten in Bezug auf die Vorsorge für den Ruhestand Fragebogen Nummer: ________________ Angaben zur Befragungsperson Name des Befragten:__________________________________________ Adresse:____________________________________________________ Stadt:________________________Bundesland:_____________________ Telefonnummer:_______________ PLZ:__________________________ Datum des Interviews:___________Ort:___________________________ Uhrzeit Interviewbeginn:_____Interview-Ende:____Interviewlänge:_____ Begrüssung: Guten Morgen/ Tag/ Abend. Mein Name ist ……….von rtca, einem unabhängigen Marktforschungsinstitut. Wir führen momentan eine Studie zum Thema Finanzdienstleistungen und Ruhestand durch und wären an Ihrer Meinung interessiert. Wären Sie bereit, an dieser Studie teilzunehmen? Qualifikation und demographisches Profil Anmerkung: Wenn in einer Frage von Ersparnissen oder Investitionen gesprochen wird, dann sind stets die Ersparnisse und Investitionen des Haushalts und nicht nur der befragten Person gemeint. A. 1 Wir suchen nach Personen, die in bestimmten Branchen beschäftigt sind. Arbeiten Sie oder jemand aus Ihrem Haushalt in einer der folgenden Branchen? (Karte mit Antwortkategorien vorlegen) • Marketing/Marktforschung • PR (Öffentlichkeitsarbeit) • Werbung • Journalismus • Lebensversicherung, Bank, FondsGesellschaft, Vermittlung von Finanzdienstleistungen (z.B. Versicherungsvermittler, Finanzberater) • Keine von diesen

Interview wird beendet Interview wird beendet Interview wird beendet Interview wird beendet

Interview wird beendet Interview wird geführt

Appendix

373

A. 2 Was beschreibt am besten Ihren momentanen Beschäftigungsstatus? (Karte mit Antwortkategorien vorlegen) • Vollzeit beschäftigt • Teilzeit beschäftigt • Nicht beschäftigt

Weiter mit Frage A. 3 Weiter mit Frage A. 3 Weiter mit Frage A. 4

A. 3 Sind Sie selbstständig? • Ja • Nein A. 4 Unabhängig davon ob Sie gegenwärtig vollzeitig oder zeitweilig arbeiten oder nicht, befinden Sie sich Ihrer Meinung nach “im Ruhestand”? • Ja • Nein A. 5 In welche der folgenden Altersgruppen fallen Sie? (Karte mit Antwortkategorien vorlegen) • Unter 18 • 18-24 • 25-34 • 35-44 • 45-54 • 55-64 • 65-70 • 71+

Interview wird beendet Interview wird beendet Interview wird beendet Interview wird beendet

Interview wird beendet

A. 6 Geschlecht? (Wird direkt vom Interviewer notiert) • Männlich • Weiblich

374

Appendix

A. 7 Was ist Ihr gegenwärtiger oder ehemaliger Beruf? (Karte mit Antwortkategorien vorlegen) • Freiberufler (Arzt, Architekt, Anwalt etc), Inhaber von mittleren/ größeren Firmen • Leitender Angestellter/Beamter (Vorstand, Direktor, Geschäftsführer, Prokurist, Professor an der Universität, Chefarzt, usw.) • Inhaber von Kleinunternehmen (Kiosk, Marktstand, Schreibbüro, kleines Einzelhandelsgeschäft, kleiner Handwerksbetrieb etc.) • Mittlerer Angestellter/Beamter (Gruppen-/Abteilungsleiter, Produktmanager, Lehrer etc.) • Einfacher Angestellter/Beamter (Sachbearbeiter, Verkäufer etc.) • Facharbeiter (Lehre, spezielle Berufsausbildung) • Sonstige, ungelernte Arbeiter • Landwirt/Fischer • Arbeitslos • Hausfrau/Hausmann A. 8 Wie ist Ihr Familienstand? • Verheiratet/Zusammenlebend • Single • Geschieden/Getrennt lebend • Verwitwet A. 10 Wer trifft in Ihrem Haushalt hauptsächlich die finanziellen Entscheidungen? • Ich • Mein Partner/Ehepartner Interview wird beendet • Ich, zusammen mit meinem Partner/Ehepartner A. 11 Welches der folgenden ist Ihr höchster Bildungsabschluss? (Karte mit Antwortkategorien vorlegen) • Hauptschule ohne Abschluss • Hauptschul-/Realschulabschluss • Abitur/Hochschulreife • Hochschulabschluss

Appendix

375

A. 12 Wie viele Kinder haben Sie? • Keins • Eins • Zwei • Drei • Mehr als drei A. 14 Bitte nennen sie mir die Hauptquelle und die weiteren Quellen, aus denen Sie/Ihr Haushalt gegenwärtig Ruhestandsbezüge erhalten [wenn im Ruhestand] bzw. in Zukunft erhalten werden [wenn vor dem Ruhestand]? (Karte mit Antwortkategorien vorlegen) Hauptsächliche Quelle Gesetzliche Rentenversicherung (bei Selbständigen: einschl. berufsständische Versorgungswerke, z.B. Ärzteversorgung) Private Rentenversicherung Betriebliche Altersversorgung, die ich selbst durch Gehaltsumwandlung angespart habe (z.B. Direktversicherung) Betriebliche Altersversorgung/ Betriebsrente, die vom Arbeitgeber finanziert wird und sich an meinem letzten Einkommen orientiert Erbschaft Einkommen oder Kapital aus meinen sonstigen Ersparnissen und Finanzinvestitionen (ohne Immobilien) Einkommen aus Immobilien Einkommen durch die weitere Ausübung eines Berufs

Weitere Quellen

376

Appendix

A. 15 Ich werde Ihnen nun eine Liste mit Kapitalanlageprodukten vorlesen. Bitte sagen Sie mir zu jeder der folgenden Kapitalanlagen, ob Sie oder ein anderes Mitglied Ihres Haushalts diese besitzen? (Karte mit Antwortkategorien vorlegen) • Bargeld/Sparkonto/Festgeld (Termingeld) • Festverzinsliche Wertpapiere (z.B. Bundesschatzbriefe) • Private Rentenversicherung • Aktien • Investmentfonds • Lebensversicherung (einschl. fondsgebundene) • Betriebliche Altersversorgung, die ich selbst durch Gehaltsumwandlung anspare/angespart habe • Immobilien (einschl. unbebauter Grundstücke) • Sonstige • Keines (Nicht vorlesen) Interview wird beendet Fragen für Interviewte, die bereits im Ruhestand sind: A. 17 Unabhängig davon ob Sie momentan arbeiten oder nicht, wie lange sind Sie Ihrer Meinung nach schon “im Ruhestand”? Bitte tragen Sie die Anzahl der Jahre unten ein. Wenn es weniger als ein Jahr ist, bitte “1” eintragen. Anzahl der Jahre im Ruhestand:__________ A. 18 Ungefähr wie lange vor dem Ruhestand haben Sie zuerst ernsthaft darüber nachgedacht, was Ihre finanziellen Bedürfnisse im Ruhestand sein würden? Anzahl der Jahre:______________________ Fragen für Interviewte, die noch nicht im Ruhestand sind: A. 19 Ungefähr in welchem Alter planen Sie in den Ruhestand zu gehen? Alter notieren:_________________________ A. 20 Haben Sie bereits begonnen, ernsthaft über Ihre finanziellen Bedürfnisse im Ruhestand nachzudenken? Wenn ja, in welchem Alter haben Sie damit begonnen – wenn nein, in welchem Alter erwarten Sie, dies zu tun? • Habe begonnen, darüber nachzudenken • Erwarte, darüber nachzudenken Alter notieren:________

Appendix

377

Individuelle finanzielle Erfahrung B. 1 Welche der folgenden Quellen verwenden Sie, um allgemeine Informationen zu Finanzen zu erhalten, sich vor bestimmten Entscheidungen zu informieren oder allgemein auf dem Laufenden zu sein? Für die genannten Quellen fragen, wie oft diese in Anspruch genommen werden. (Karte mit Antwortkategorien vorlegen) Wird verwendet Fachzeitschriften (z.B. “Finanzen”, “Capital”, Börsenbriefe) Wirtschaftsteil der Tageszeitung/ Wochenzeitung Freunde/Familien mitglieder Bankmitarbeiter Versicherungsvertreter, der für ein bestimmtes Unternehmen arbeitet Versicherungsvertreter, der für mehrere Unternehmen arbeitet (Mehrfachagent) Unabhängiger Finanzberater, der nicht für bestimmte Unternehmen arbeitet Internet Sonstige (Bitte notieren)

Wöchentlich

Monatlich

Seltener als monatlich

378

Appendix

B. 2 Für wie finanziell fachkundig halten Sie sich in finanziellen Angelegenheiten im Vergleich zu Personen im ähnlichen Alter und mit ähnlichem Hintergrund wie Sie? Halten Sie sich für.... (Karte mit Antwortkategorien vorlegen) • Viel weniger fachkundig • Etwas weniger fachkundig • Ungefähr gleich fachkundig • Etwas fachkundiger • Viel fachkundiger B. 3 Ich werde Ihnen nun eine Liste mit Aussagen vorlesen, die Einstellungen zu Risiken und Chancen von Kapitalanlagen beschreiben. Bitte sagen Sie mir, welche Aussage auf Sie am besten zutrifft. (Karte mit Antwortkategorien vorlegen, nur eine Antwort zulassen) Aussage Ich bin nicht bereit, Verluste auch über kurze Zeiträume hinzunehmen und investiere deshalb in sichere Anlagen wie Sparbuch, Festgeld, Bundesschatzbriefe, usw. Ich wäre bereit, in schlechten Jahren auf eine Rendite zu verzichten, solange kein Kapitalverlust eintritt und ich insgesamt (über die gesamte Laufzeit, also Ausgleich schlechterer Erträge in einem Jahr durch höhere Erträge in anderen Jahren) eine Rendite von 5%-7% pro Jahr erwarten kann. Ich wäre bereit, einen Verlust von bis zu 5% meines Kapitals in einem Jahr zu riskieren, wenn ich dafür insgesamt eine Rendite von 10-12% pro Jahr erzielen kann. Ich wäre bereit, einen Verlust von bis zu 10% meines Kapitals in einem Jahr zu riskieren, wenn ich dafür insgesamt eine Rendite von bis zu 20% pro Jahr erzielen kann. Ich wäre bereit, auch einen größeren Kapitalverlust (>15%) zu riskieren, wenn ich dafür insgesamt einen erheblichen Gewinn (z.B. 25% pro Jahr) erzielen kann.

Stimme am meisten zu

Appendix

379

Leben im Ruhestand und spezifische Risiken C. 1 Ich werde Ihnen nun eine Liste mit Aktivitäten vorlesen, denen Personen im Ruhestand nachgehen. Welchen davon gehen Sie nach bzw. planen Sie, in Ihrem Ruhestand nachzugehen? (Karte mit Antwortkategorien vorlegen) Plane durchzuführen Ausgiebig reisen Weiterhin (Teilzeit) arbeiten Freiwillige/Wohltätigkeitsarbeit Kinderbetreuung innerhalb der Familie Viel Zeit mit der Familie zu verbringen Längere Zeiträume im Ausland zu verbringen Ins Ausland ziehen Hobbys, die man im Haus durchführt (z.B. lesen) Hobbys, die man draußen durchführt (z.B. Sport, Wandern) Weiterbildungskurse belegen, studieren Keines davon (steht nicht auf der Karte)

380

Appendix

C. 2 Denken Sie nun bitte an Ihre finanziellen Ziele im Ruhestand. Inwieweit stimmen Sie den folgenden Aussagen zu? (Karte mit Antwortkategorien vorlegen) Stimme eindeutig nicht zu

Stimme nicht zu

Stimme weder zu noch nicht zu

Stimme zu

Stimme eindeu tig zu

Trifft nicht zu

Ich kann mein gesamtes Vermögen ausgeben, da ich nicht unbedingt eine Erbschaft hinterlassen muss Ich werde etwas von meinem Vermögen beiseite legen, um etwas vererben zu können Ich beabsichtige, Geldmittel in Reserve zu behalten, um unvorhergesehene Ereignisse in Zukunft abdecken zu können Ich beabsichtige, im Ruhestand weiter Vermögen anzusammeln Ich erwarte im Ruhestand eine oder mehrere größere Ausgaben (z.B. ein neues Haus kaufen) und will entsprechend vorsorgen

Fragen für Interviewte, die noch nicht im Ruhestand sind: C. 4 Was glauben Sie, wie hoch wird Ihr monatliches Haushaltsnettoeinkommen unmittelbar vor dem Ruhestand ungefähr sein? EUR __________________(Schätzung) (Falls Befragter keine Antwort gibt, zeigen Sie folgende Karte) € 0 - 14,999 € 15,000 - 29,999 € 30,000 - 44,999 € 45,000- 59,999 € 60,000 -74,999

€ 75,000 - 109,999 € 110,000 - 139,999€ € 140,000 - 210,000 € 210,000+

Appendix

381

C. 5 Wie hoch ist der Prozentsatz dieses Einkommens, den Sie im Ruhestand benötigen? __________% C. 6 Welchen Prozentsatz Ihres letzten Einkommens erwarten Sie als gesetzliche Rente? __________% C. 6a Welchen Prozentsatz Ihres letzten Einkommens erwarten Sie aus betrieblicher Altersvorsorge (Betriebsrente oder selbst angesparte betriebliche Altersvorsorge wie z.B. Direktversicherung)? __________% C. 6b Welchen Prozentsatz Ihres letzten Einkommens erwarten Sie aus eigenen Ersparnissen, z.B. einer privaten Rentenversicherung? __________% C. 8 Was ist der maximale Prozentsatz Ihres Nettoeinkommen, den Sie bereit wären bis zum Eintritt Ihres Rentenalters zu investieren (einschließlich der derzeit getätigten Spareinlagen und Finanzinvestitionen), um im Alter abgesichert zu sein? (Karte mit Antwortkategorien vorlegen) • 0% • 1-9% • 10-19% • 20-29% • 30-39% • 40-49% • 50-59% • 60% und mehr

382

Appendix

C. 9 Wenn Sie mit Umständen konfrontiert werden würden, die eine Reduzierung Ihrer Lebenshaltungskosten oder ein Anzapfen Ihrer festen Anlagen erforderlich machen, wären Sie bereit, folgende Maßnahmen zu ergreifen? (Karte mit Antwortkategorien vorlegen) Überhaupt nicht bereit In eine preiswertere Gegend/ kleinere Wohnung umziehen Bei der Familie einziehen Sonstigen Lebensstil einschränken (z.B. weniger Urlaub) Weiter arbeiten, z.B. Teilzeit oder Vollzeit Geld-Investitionen auflösen (z.B. Fonds verkaufen) Eine selbst genutzte zweite Immobilie verkaufen (z.B. Ferienhaus) Eine Anlageimmobilie verkaufen Kapital aus dem eigenen Heim freisetzen (z.B. durch Aufnahme einer Hypothek, Übertragung gegen Leibrente)

Eher nicht bereit

Etwas bereit

Äußerst bereit

Appendix

383

C. 11 Ich werde Ihnen nun eine Liste von finanziellen Risiken vorlesen, die Personen im Ruhestand betreffen können. Wie wichtig (gravierend) finden Sie diese Risiken? C. 12 Haben Sie persönlich etwas gegen diese Risiken unternommen? (Karte mit Antwortkategorien vorlegen) Nicht Kaum Eher Sehr Äußerst Habe wichtig wichtig wichtig wichtig wichtig etwas gegen dieses Risiko unternommen Ich werde die gesetzliche Rente, die ich momentan erwarte, nicht erhalten (z.B. durch Gesetzesänderungen) Inflation wird die Kaufkraft meiner Ersparnisse untergraben Steuererhöhungen werden die Kaufkraft meiner Ersparnisse untergraben Meine Ersparnisse könnten durch negative Marktentwicklungen reduziert werden (z.B. Kursverfall) Die gesetzliche Rente wird künftige Steigerungen der Lebenshaltungskosten nicht ausgleichen Ich werde kein gesichertes laufendes Einkommen haben Ich werde mein Vermögen verbraucht haben, bevor ich versterbe

384

Appendix Nicht Kaum Eher Sehr Äußerst Habe wichtig wichtig wichtig wichtig wichtig etwas gegen dieses Risiko unternommen

Krankheits- und Arztkosten werden mein Vermögen aufzehren Ich werde dafür bezahlen müssen, über längere Zeit in einem Altersheim oder Pflegeheim zu leben Das Einkommen aus meinen Ersparnissen könnte niedriger sein als erwartet (z.B. auf Grund niedriger Zinsen, schlechter Kursentwicklung) Die Überschussbeteiligung meiner Lebensoder Rentenversicherung könnte niedriger ausfallen als erwartet Mein Geld wird fest angelegt und nicht zugänglich sein, wenn ich es für besondere Ausgaben brauche Ich werde meinen Angehörigen nichts/ weniger vererben, als ich vorhatte Andere (Bitte notieren)

Appendix

385

C. 13 Versuchen Sie diese Risiken durch Streuung Ihrer Anlagen abzumildern? Verwenden Sie z.B. mehrere Produktarten (Verteilung Ersparnisse auf Lebensversicherung, Immobilien, Aktien) • Ja • Nein C. 14 Wie interessiert wären Sie am Kauf eines Finanzproduktes, das Sie vor den folgenden Risiken schützt? (Karte mit Antwortkategorien vorlegen) Reihenfolge rotieren Langlebigkeit (das Risiko, mein Vermögen zu überleben) Gesetzliche Rentenlücke, d.h. das Risiko, dass meine gesetzliche Rente z.B. durch Gesetzesänderungen deutlich niedriger ausfällt als heute erwartet Gesundheitsvorsorge (Kosten, die nicht durch die normale Krankenversicherung abgedeckt sind) Kursrisiko (das Risiko, dass schlechte Kursentwicklungen von Aktien, Fonds usw. mein Vermögen reduzieren) Inflation (das Risiko, dass steigende Lebenshaltungskosten die Kaufkraft meiner Ersparnisse untergräbt)

Nicht interessiert

Kaum Etwas Sehr Äußerst interessiert interessiert interessiert interessiert

386

Reihenfolge rotieren

Appendix Nicht interessiert

Kaum Etwas Sehr Äußerst interessiert interessiert interessiert interessiert

Kurzfristiges Zinsrisiko (das Risiko, dass das Einkommen aus meinen Ersparnissen auf Grund niedriger Zinssätze reduziert wird) Langfristiges Zinsrisiko (das Risiko, dass die Überschussbeteiligung meiner Renten-versicherung auf Grund niedriger langfristiger Zinssätze reduziert wird)

C. 15 Die allgemeine Lebenserwartung ist in den letzten 20 Jahren stark gestiegen. Zum Beispiel kann ein heute 65 Jahre alter Mann damit rechnen, im Durchschnitt 81 Jahre alt zu werden (Frauen sogar 84 Jahre). Nachdem Sie dies wissen, würden Sie folgende Produkte interessant finden? (Karte mit Antwortkategorien vorlegen) Reihenfolge rotieren Absicherung gegen Langlebigkeit (Risiko, mein Vermögen zu überleben) Absicherung gegen gesetzliche Rentenlücke, d.h. das Risiko, dass meine gesetzliche Rente z.B. durch Gesetzesänderungen deutlich niedriger ausfällt als heute erwartet Absicherung der Gesundheitsvorsorge (Kosten, die nicht durch normale Kranken- oder Pflegeversicherung gedeckt sind)

Nicht interessiert

Kaum interes siert

Etwas intere ssiert

Sehr interes siert

Äußerst interessiert

Appendix

387

Fragen für Interviewte, die noch nicht im Ruhestand sind: C. 18a Wie gut fühlen Sie sich finanziell auf Ihren Ruhestand vorbereitet? • Sehr schlecht vorbereitet • Ziemlich schlecht vorbereitet • Weder gut noch schlecht vorbereitet • Ziemlich gut vorbereitet • Sehr gut vorbereitet • Weiss nicht Fragen für Interviewte, die bereits im Ruhestand sind: C. 18b Wie gut fühlten Sie sich finanziell auf Ihren Ruhestand vorbereitet? Wie gut waren Sie wirklich auf Ihren Ruhestand vorbereitet? Fühlte mich vorbereitet War vorbereitet • Sehr schlecht vorbereitet • Ziemlich schlecht vorbereitet • Weder gut noch schlecht vorbereitet • Ziemlich gut vorbereitet • Sehr gut vorbereitet

x x x x x

x x x x x

Beratungspräferenzen D. 1 Was halten Sie für das beste Vorgehen, um sich finanziell auf den Ruhestand vorzubereiten bzw. Ihre finanziellen Angelegenheiten im Ruhestand zu regeln? (Karte mit Antwortkategorien vorlegen, nur eine Antwort zulassen)¨ • Informationen aus verschiedenen Quellen sammeln (Finanzberater, Zeitschriften, …) und die Entscheidungen selber treffen • Informationen von mehreren Finanzberatern sammeln, aber die Entscheidungen selber treffen • Informationen bei einem Finanzberater sammeln, aber die Entscheidungen selber treffen • Einem Finanzberater meine Vorstellungen schildern und diesen die Entscheidungen für mich treffen lassen • Sonstige (Bitte notieren)_________________________________

388

Appendix

D. 2 Wie wichtig finden Sie eine umfassende Beratung zur finanziellen Planung Ihres Ruhestands? (Karte mit Antwortkategorien vorlegen) • Sehr unwichtig • Ziemlich unwichtig • Weder wichtig noch unwichtig • Ziemlich wichtig • Sehr wichtig D. 5 Haben Sie einen Finanzberater, mit dem Sie die finanziellen Aspekte Ihres Ruhestands besprechen können (z.B. von Ihrer Bank oder Versicherung)? • Nein, kein Berater • Ja Ergänzende Fragen für Selbstausfüller Diese Fragen sind auf ein separates Blatt zu drucken, damit die Befragten es am Ende der Befragung ausfüllen können. H. 1 Bitte kreisen Sie bei jeder der folgenden Aussagen, die sich auf Ihr Eigentum beziehen, “Ja” oder “Nein” ein. Ja

Nein

Das Haus, in dem ich wohne, gehört mir Ich miete das Haus, in dem ich wohne Ich besitze eine Immobilie, die ich vermiete Ich besitze ein Ferienhaus oder eine zweite selbst genutzte Immobilie

H. 2 Welche der folgenden Kategorien beschreibt den Gesamtwert aller Immobilien, die Sie besitzen, am besten? Null – Ich besitze keine Immobilien (Weiter mit Frage H.4) Weniger als €100.000 €100.000 bis €150.000 €150.000 bis €200.000 €200.000 bis €250.000 €250.000 bis €400.000

€400.000 bis €550.000 €550.000 bis €700.000 €700.000 bis €1.050.000 €1.050.000 bis €1.400.000 €1.400.000 +

Appendix

389

H. 3 Wie hoch sind insgesamt die Belastungen (Hypotheken usw.) auf diesen Immobilien? Null Weniger als €100.000 €100.000 bis €150.000 €150.000 bis €200.000 €200.000 bis €250.000 €250.000 bis €400.000

€400.000 bis €550.000 €550.000 bis €700.000 €700.000 bis €1.050.000 €1.050.000 bis €1.400.000 €1.400.000 +

H. 4 Denken Sie nun bitte an alle Kapitalanlagen Ihres Haushalts, ausgenommen staatliche Renten, Betriebsrenten und Immobilen (sowohl die Immobile, in der Sie leben als auch die Immobilen, die Sie zu Investitionszwecken besitzen). Sagen Sie mir bitte, in welcher der folgenden Größenordnungen liegt der Wert Ihrer Kapitalanlagen? Bis €50,000 €50,000 bis €100,000 €100.000 bis €150.000 €150.000 bis €200.000 €200.000 bis €250.000 €250.000 bis €400.000

€400.000 bis €550.000 €550.000 bis €700.000 €700.000 bis €1.050.000 €1.050.000 bis €1.400.000 €1.400.000 +

H. 5 Wie hoch muss Ihrer Meinung nach Ihr Jahreseinkommen (netto) im Ruhestand sein, damit Sie bequem leben können? € 0 - 14,999 € 15,000 – 29,999 € 30,000 – 44,999 € 45,000- 59,999 € 60,000 -74,999

€ 75,000 - 109,999 € 110,000 - 139,999€ € 140,000 - 210,000 € 210,000+

H. 6 Wie hoch ist das jährliche Nettoeinkommen, das Sie und Ihre Familie im Ruhestand erwarten? € 0 - 14,999 € 15,000 - 29,999 € 30,000 - 44,999 € 45,000 - 59,999 € 60,000 - 74,999

€ 75,000 - 109,999 € 110,000 - 139,999€ € 140,000 - 210,000 € 210,000+

390

Appendix

H. 7 Denken Sie bitte an die verschiedenen Investitionen, die Sie und Ihr Haushalt haben. Welchen prozentualen Anteil hat der Wert jeder Investition an Ihrem Gesamtvermögen? Achtung: Alle Investitionen müssen zusammen 100% ergeben % der gesamten Kapitalanlagen

Bargeld/ Sparkonto /Termingeld

Festverzinslichte Wertpapiere (z.B. Bundesschatzbriefe)

Aktien

Investmentfonds

Lebensversicherung, private Rentenversicherung

Immobilien

Sonstige

0 - 10% 10 – 25% 25 – 50% 50 – 75% 75 100%

H. 9 Wie hoch ist derzeit das jährliche Nettoeinkommen Ihres Haushalts? € 0 - 14,999 € 15,000 - 29,999 € 30,000 - 44,999 € 45,000- 59,999 € 60,000 -74,999

€ 75,000 - 109,999 € 110,000 - 139,999€ € 140,000 - 210,000 € 210,000+

H. 11 Wie würden Sie Ihren Gesundheitszustand insgesamt beschreiben? • Schlecht • Mittelmäßig • Gut • Sehr gut • Ausgezeichnet H. 12 Und zum Schluss, wie alt sind Sie? Alter notieren [

]

Appendix

391

Dem Befragten danken und das Interview beenden. “Ich erkläre, dass ich dieses Interview entsprechend der Interviewanleitung und dem Fragebogen folgend durchgeführt habe und dass ich die Antworten, so wie sie mir von dem Befragten gegeben wurden, notiert habe. Ich erkläre, dass ich dieses Interview entsprechend der Richtlinien der Marktforschung durchgeführt habe. Es ist mir bewusst, dass ein Teil meiner Arbeit überprüft wird, indem der Befragte noch einmal kontaktiert wird.” Name und Unterschrift des Interviewers (Druckbuchstaben bitte):_______ ____________________________________________________________ Retirement Study – Questionnaire about individual behavior with regard to provision for retirement Respondent Number: ________________ Details about interviewee Name of interviewee:__________________________________________ Address:_____________________________________________________ City:__________________________Federal state:___________________ Phone number:__________________Zip-code:______________________ Date of interview:________________Location:______________________ Start time of interview:____________End of interview:_______________ Length of interview:______________ Introduction: Good morning/ afternoon/ evening. My name is ........... from rtca, an independent market research agency. We are carrying out a survey on financial services and retirement and would be interested in getting to know your point of view. Would you be prepared to participate to this study?

392

Appendix

Qualification and demographic profile Note: Throughout the survey, whenever a question is asked about savings or investment it refers to all the savings and investments in the household and not just to those of the individual responding. A. 1 We are looking for people who work in certain occupations. Do you or anyone of your household work in any of these occupations? (Show card with answer options) • Marketing/Market Research Close interview • Public relations Close interview • Advertising Close interview • Journalism Close interview • Life-insurance, Bank, Mutual Fund companies, advisor for financial services (Advisor working for an insurance company, Financial advisor) Close interview • None of these Continue interview A. 2 Which best describes your current employment status? (Show card with answer options) • Employed full-time • Employed part-time • Not employed

Go to question A. 3 Go to question A. 3 Go to question A. 4

A. 3 Are you self-employed? • Yes • No A. 4 Whether or not you are currently working (part-time), do you consider yourself to be retired? • Yes • No

Appendix

393

A. 5 Into which of the following age-bands do you fall? (Show card with answer options) • Under 18 • 18-24 • 25-34 • 35-44 • 45-54 • 55-64 • 65-70 • 71+

Close interview Close interview Close interview Close interview

Close interview

A. 6 Gender (To be noted directly by the interviewer) • Male • Female A. 7 What is your current or former occupation? (Show card with answer options) • Professional (freelance) occupations (e.g., doctors, architects, lawyers), owner of medium or large companies • Senior management/civil servant occupations (e.g., management/ board member, director, professor, head physician, associate director) • Owner of small scale businesses (e.g., kiosk, secretarial services, convenience store, small handicraft business) • Middle management/middle civil servant occupations (e.g., head of group or department, product manager, teacher) • Lower management/civil servant occupations (e.g., clerk, sales person) • Skilled trades occupations (e.g., apprenticeship, professional training) • Other (e.g., unskilled trades occupations) • Agriculture, farming, fishing • Unemployed • Homemaker

394

Appendix

A. 8 What is your marital status? • Married/co-habiting • Single • Divorced/living separately • Widowed A. 10 Who makes the main financial decisions in your household? • Me • My partner/spouse • Me, jointly with my partner/spouse

Close interview

A. 11 At which of the following educational institutions did you complete your education? (Show card with answer options) • Secondary school without diploma • Secondary school with diploma • A-levels • University A. 12 How many children do you have? • None • One • Two • Three • More than three

Appendix

395

Question for retirees: A. 14 Can you please tell me the main source and complementary sources from which you/your household currently receive retirement income? Question for pre-retirees: A. 14 Can you please tell me the main source and complementary sources from which you/your household expects to receive retirement income? (Show card with answer options) Main source

Complementary source

State pension (for self-employed including corporate pensions, e.g., medical doctors provision) Private pension Employer-based contributory pension (e.g., Direct insurance) Employer-based defined benefit pension (i.e., financed by the employer, based on the level of the last salary) Inheritance Income or capital from savings and investments (excl real estate investments) Income from second property Income from continued forms of work

A. 15 I will now show you a list of financial investment products. Please tell me which of them is owned by you or another member of your household? (Show card with answer options) • Cash/savings account/fixed term deposit (time deposits) • Fixed interest securities (e.g., government bonds) • Private pension insurance (e.g., annuities) • Stocks and shares held directly • Mutual funds • Life-insurances (including unit-linked life) • Employer-based contributory pension plan where the individual saves through conversion of income • Property (including land) • Other • None (Do not read this as an option) Close interview

396

Appendix

Questions for retirees: A. 17 Whether or not you are currently working, for how long have you considered yourself to be retired? Your best estimate is fine. Please indicate the number of years below. If less than one year, indicate a "1." Number of years retired:__________ A. 18 How many years before entering retirement did you first start thinking seriously about what your financial needs in retirement would be? Please indicate your best estimate. Number of years:__________ Questions for pre-retirees: A. 19 At approximately what age do you plan to retire? Please indicate your best estimate. Record age:________ A. 20 Have you already started to think seriously about your financial needs in retirement? If yes, at what age did you start? If no, at what age do you expect to do this? (Interviewer to record if interviewee has already started or is expecting to start, then record the age)¨ • Have started to think about it • Expecting to start Record age:________

Appendix

397

Individual financial sophistication B. 1 Which of the following sources do you use to obtain general financial information, to inform a specific decision or generally keep you up to date? Using those sources that are chosen, proceed to ask how often those are checked. (Show card with answer options) Is being used

Weekly

Monthly

Less than monthly

Investment magazines (e.g., “Finanzen“, “Capital“, Börsenbriefe) Money pages of daily/weekly newspaper Friends and family Bank advisor Insurance advisor working for one firm Insurance advisor working for several firms IFA Internet Other (Please note)

B. 2 When planning for your retirement, how financially knowledgeable do you consider yourself to be compared to people of a similar age and background to yourself? (Show card with answer options) • Very unknowledgeable • Fairly unknowledgeable • About the same • Fairly knowledgeable • Very knowledgeable

398

Appendix

B. 3 I will now read to you a showcard with a list of attitudes towards risk and reward of capital investments. Please tell me which one most applies to you. (Show card with answer options, only one option is possible) Statement

Most agree

I am not prepared to accept any losses over even short periods on my capital and so invest only in secure investments such as cash type investments, savings accounts, term deposits, government bonds I would be prepared to risk a 0% p.a. return (but no worse) in a bad year, if I could generally expect to make returns of 5%-7% p.a. in the long run (i.e., balancing of bad years with good years over the entire horizon) I would be prepared to risk small losses of up to 5% p.a. if I could make up to 10-12% p.a. return in the long run I would be prepared to risk losses of up to 10% p.a. if I could make up to 20% p.a. return in the long run I am prepared to accept the risk that I might lose a large proportion of my investments (15%+ p.a.) if it meant I could achieve significant return (25%+ p.a.) in the long run

Life in retirement and specific risks C. 1 I will read to you now a list of activities that individuals do in their retirement. Which of these activities do you plan to do (pre-retirees) or are you already doing in your retirement (retirees)? (Show card with answer options) Plan to do /Are doing Travel extensively Continue to work (part-time) Perform voluntary/charitable activities Provide childcare for family Spend a lot of time with the family Spend extended time periods abroad Move abroad Pursue indoor hobbies (e.g., reading) Pursue outdoor hobbies (e.g., hiking, sports) Study None of these (does not show on the showcard)

Appendix

399

C. 2 Thinking about your financial objectives in retirement, to what extent do you agree or disagree with the following statements? (Show card with answer option) Stron- Disgly agrdisee agree

Neither agree nor disagree

Agree

Strongly agree

Not applicable

I can spend all my assets as there is no absolute necessity to leave an inheritance I intend to keep some of my assets to leave an inheritance I intend to keep a reserve of funds to cover uncertain future events I intend to continue to accumulate savings in retirement I expect one or more large items of discretionary spending in retirement (e.g., buying a new house) and want to provide accordingly

Question for pre-retirees: C. 4 What do you think your net monthly household income will be immediately prior to retirement? EUR __________________ (Estimate) If interviewee does not give a response, show card: € 0 – 14,999 € 15,000 - 29,999 € 30,000 - 44,999 € 45,000- 59,999 € 60,000 -74,999

€ 75,000 - 109,999 € 110,000 - 139,999€ € 140,000 - 210,000 € 210,000+

C. 5 What percentage of your net household income immediately prior to retirement will you need in retirement? __________%

400

Appendix

C. 6 What percentage of your last pre-retirement income do you anticipate you will receive as state pension income in retirement? __________% C. 6a What percentage of your last pre-retirement income do you anticipate you will receive as corporate pensions (i.e., corporate pension plan like a “Betriebsrente” or self-accrued corporate pension provision like a “Direktversicherung”)? __________% C. 6b What percentage of your last pre-retirement income do you anticipate you will receive as private pension from your own savings (e.g., private pension insurance)? __________% C. 8 What is the maximum proportion of your net income that you would be prepared to invest (including any savings/investments you are already making) over the period to retirement to ensure financial security in retirement? (Show card with answer options) • 0% • 1 – 9% • 10 – 19% • 20 – 29% • 30 – 39% • 40 – 49% • 50 – 59% • 60% and more

Appendix

401

C. 9 If you were faced with circumstances that required you either to reduce your living expenses or tap into your non-liquid assets, how willing would you be to consider each of the following activities? (Show card with answer options) Extremely unwilling Moving to a less expensive area/ smaller property Moving in with the family Restricting lifestyle (e.g., fewer holidays) Continuing working, either part time or full-time Releasing investments made (e.g., selling mutual funds) Selling a second property (e.g., vacation home) Selling an investment property Releasing some home equity (e.g., taking out a mortgage, transferring it for an annuity)

Somewhat unwilling

Somewhat willing

Extremely willing

402

Appendix

C. 11 I am about to read out a list of financial risks that might affect individuals in retirement. How important do you consider each of the following risks to be? C. 12 Have you personally taken any actions to mitigate them? (Show card with answer options) Strong- Disly dis- agree agree

Neither agree nor disagree

Agree

Strongly agree

Not applicable

I can spend all my assets as there is no absolute necessity to leave an inheritance I intend to keep some of my assets to leave an inheritance I intend to keep a reserve of funds to cover uncertain future events I intend to continue to accumulate savings in retirement I expect one or more large items of discretionary spending in retirement (e.g., buying a new house) and want to provide accordingly

C. 13 Do you seek to mitigate these risks as a whole by diversifying your assets, with regard to product types (e.g., division of savings into life-insurance, property, share based investments)? • Yes • No

Appendix

403

C. 14 How interested would you be in purchasing financial products that would protect you against each of the following risks? (Show card with answer options) Rotate list Longevity risk (I will outlive my wealth and financial assets before I die) Regulatory retirement gap - i.e., the risk that my state pension income will be reduced due to legislative changes Health care risk (Poor health and medical bills not covered by the health insurance will run down my retirement assets) Performance risk (My savings will be reduced due to unfavorable market developments (e.g., negative performance)) Inflation risk (Increasing living costs will erode the buying power of my retirement savings) Short-term interest rate risk (Income from my savings will be lower than expected due to low short-term interest rates)

Not interested

Slightly interested

Somewhat interested

Very interested

Extremely interested

404

Rotate list Long-term interest rate risk (Surplus/profit participation of pension or life-insurance will be lower than anticipated due to lower long-term interest rates)

Appendix Not interested

Slightly interested

Somewhat interested

Very interested

Extremely interested

C. 15 General life-expectancy has increased substantially in the past 20 years. A man who is 65 years old today can expect to live to 81 years of age (and women even to 84). Taking this into account, how interested would you be in purchasing financial products that would protect you against each of the following risks? (Show card with answer options) Rotate list Protection against the longevity risk (I will outlive my financial assets and wealth before I die) Protection against regulatory retirement gap - i.e., the risk that my pension income will be reduced due to legislative changes Protection against health care risk (Poor health and medical bills that are not covered by the health insurance will run down my retirement assets)

Not interested

Slightly interested

Somewhat interested

Very interested

Extremely interested

Appendix

405

Question for pre-retirees: C. 18a How well prepared do you feel you are financially for retirement? • Very unprepared • Fairly unprepared • Neither prepared nor unprepared • Fairly well prepared • Very well prepared • Don’t know Question for retirees: C. 18b How well prepared did you feel you were financially for retire ment? How well were you actually prepared financially for retirement? Felt preparedness Actual preparedness • Very unprepared • Fairly unprepared • Neither prepared nor unprepared • Fairly well prepared • Very well prepared

x x x x x

x x x x x

Advice preferences D. 1 Which of the following do you think is the best way to prepare financially for retirement or to arrange your financial affairs in retirement? Show card with answer options, only one option is possible • Collect information from various sources (financial advisor, newspaper, etc) and make decisions myself • Collect information from multiple financial professionals/advisors, but make decisions myself • Collect information from one financial advisor, but make decisions myself • Have a relationship with one financial advisor to whom I sketch out my ideas and rely on this advisor to make the best decisions for me • Other (Please specify)____________________________________

406

Appendix

D. 2 How important do you judge holistic advice leading to an integrated financial plan for your retirement?(Show card with answer options) • Very unimportant • Quite unimportant • Neither important nor unimportant • Quite important • Very important D. 5 Do you have a primary financial advisor with whom you can discuss the financial aspects of your retirement (e.g., from your bank or insurance)? • No, no advisor • Yes Supplementary information (for self-completion) These questions are to be printed on a separate sheet so that the interviewees can self-complete these questions at the end of the interview. H. 1 Please select Yes or No for each of the following statements about your property interest. Yes

No

I own the house I live in I rent my current home I own a rental property I own a vacation property or second home

H. 2 Which of the following categories best describes the total value of the homes you own? Zero – I do not own any property (continue with question H.4) Less than €100.000 €100.000 to €150.000 €150.000 to €200.000 €200.000 to €250.000 €250.000 to €400.000

€400.000 to €550.000 €550.000 to €700.000 €700.000 to €1.050.000 €1.050.000 to €1.400.000 €1.400.000 +

Appendix

407

H. 3 What is the value of any outstanding mortgages on those properties? Zero Less than €100.000 €100.000 to €150.000 €150.000 to €200.000 €200.000 to €250.000 €250.000 to €400.000

€400.000 to €550.000 €550.000 to €700.000 €700.000 to €1.050.000 €1.050.000 to €1.400.000 €1.400.000 +

H. 4 Thinking about the total financial investments in your household, excluding state/employer pensions and property (both your primary residence and any property owned for investment purposes), please can you tell me within the following ranges how much you estimate these investments to be worth? Up to €50,000 €50,000 to €100,000 €100.000 to €150.000 €150.000 to €200.000 €200.000 to €250.000 €250.000 to €400.000

€400.000 to €550.000 €550.000 to €700.000 €700.000 to €1.050.000 €1.050.000 to €1.400.000 €1.400.000 +

H. 5 What level of net annual household income do you think you will need to live comfortably in retirement? € 0 – 14,999 € 15,000 - 29,999 € 30,000 - 44,999 € 45,000- 59,999 € 60,000 -74,999

€ 75,000 - 109,999 € 110,000 - 139,999€ € 140,000 - 210,000 € 210,000+

H. 6 What level of net annual household income do you and your family expect to receive in retirement? € 0 – 14,999 € 15,000 - 29,999 € 30,000 - 44,999 € 45,000 - 59,999 € 60,000 -74,999

€ 75,000 - 109,999 € 110,000 - 139,999€ € 140,000 - 210,000 € 210,000+

408

Appendix

H. 7 Thinking about the different types of investment you and your household have, into which of the following bands does the value of each investment on your total assets fall? Attention: all investments must add up to 100% % of total assets

Cash/ Savings account, deposit accounts

Fixed interest securities (e.g., government bond)

Stocks and shares directly held

Mutual funds

Savings linked to lifeinsurance, private pension insurance

Property

Other

0 – 10% 10 – 25% 25 – 50% 50 – 75% 75 – 100%

H. 9 What is the current level of your annual net household income? € 0 – 14,999 € 15,000 - 29,999 € 30,000 - 44,999 € 45,000- 59,999 € 60,000 -74,999

€ 75,000 - 109,999 € 110,000 - 139,999€ € 140,000 - 210,000 € 210,000+

H. 11 How would you describe your overall level of health? • Poor • Fair • Good • Very good • Excellent H. 12 And finally, what is your exact age in years? Please Write in Your Age [

]

Appendix

409

Thank the respondent and close the interview “I declare that I have conducted this interview according to the interview guidelines and following the questionnaire and that I have noted the answers as communicated by the interviewee. I declare that I have conducted this interview according to the guidelines for market research. I am conscious that a part of my work will be verified through re-contacting the interviewee.” Name and signature of the interviewer (Print letters please):___________ Appendix 4 Market research agencies in charge of conducting the interviews and the Omnibus survey

Interviews with German affluents:

Omnibus Survey:

rtca Research & Consultancy Thomas Ansorge GmbH Theodorstrasse 41 R 22761 Hamburg Germany

TNS Kirkgate 19-31 Church Street Epsom KT17 4PF UK

List of symbols

AFi

Accession factor – adjustment factor for early or late retirement of individual i

ast

Annualized savings for year t (labor incomet – consumptiont)

ct

Expense stream in period t

CPIt

Consumer price index for year t

cRVt

Current retirement value – value of pension entitlement at period t

et

Nominal expenses (ongoing or singular) for year t

EPi

Earnings points – number of years of coverage scaled by average earnings for individual i

L

Expected life-time

LW

Life-time wealth

opt

Nominal other pension income for year t (e.g., private pension, employer-based retirement income, or income from wealth)

ost

Other savings/investments for year t (labor incomet – consumptiont)

PTFi

Pension type factor – distinction of pension allowance according to different insured cases (old-age, accident, death) for individual i

R

Retirement age

rt

Real discount rate or forecasting rate for year t

spt

Nominal state pension income for year t

spt i

Monthly gross income from the statutory state pension scheme for individual i in year t

t

Year or period t

wt

Wealth level in year t or changes of wealth ( ) in year t

yt

Income stream in period t

Abbreviations 546

aba ABI ASID BMAS BPT BVG BVI BVV CFA CFP CPF cRV DAI DAV DAX DB DC DEIX DIA DoD DRV EBK EET EP EVS FP FPB FSA GDI GDV GRV 546

Arbeitsgemeinschaft für betriebliche Altersversorgung Association of British Insurers Alterssicherung in Deutschland Bundesministerium für Arbeit und Soziales Behavioral Portfolio Theory Berufliche Vorsorge Gesetz Bundesverband Investment und Asset Management Berufliche Vorsorge Verordnung Chartered Financial Analyst Certified Financial Planner Central Provident Fund Current Retirement Value Deutsches Aktieninstitut Deutsche Aktuars Vereinigung Deutscher Aktienindex Defined Benefit Defined Contribution Deutscher Eigentums-Immobilienindex Deutsches Institut für Altersvorsorge Department of Defense Deutsche Rentenversicherung Eidgenössische Bankenkommission Exempt, Exempt, Taxed Earnings Points Einkommens- und Verbrauchsstichprobe Financial Planning Financial Planning Behavior Financial Services Authority Gottlieb Duttweiler Institut Gesamtverband der Deutschen Versicherungswirtschaft Gesetzliche Rentenversicherung

Note: Only specific abbreviations used in this book have been listed here. For general abbreviations please refer to the corresponding literature.

414

HNWI IFA IRA MPT OECD OPALS OPS PAS PAYG PC PTF SEC SGB SMarT SOR SSP STBA TIAA-CREF UNPD VDR VPP WEF

Abbreviations

High Net Worth Individuals Independent Financial Advisor Individual Retirement Account Modern Portfolio Theory Organization for Economic Cooperation and Development Older People with Active Lifestyles Occupational Pension Scheme Pension Advisory Service Pay As You Go Pensions Commission Pension Type Factor Securities and Exchange Commission Sozialgesetzbuch Save More Tomorrow Stimulus-Organism-Response Statutory State Pension Statistisches Bundesamt Teachers Insurance and Annuity Association – College Retirement Equities Fund United Nations Populations Division Verband Deutscher Rentenversicherungsträger Voluntary Personal Pensions World Economic Forum

Bibliography

ANDERHUB, V./GÜTH, W./GNEEZY, U./SONSINO, D. (2001): On the Interaction of Risk and Time Preferences: An Experimental Study, German Economic Review, 2, 3, August, 239-253. ANDO, A./MODIGLIANI, F. (1963): The ‘Life Cycle’ Hypothesis of Saving: Aggregate Implications and Tests, American Economic Review, 53, 1, March, 55-84. ANGELETOS, G./LAIBSON, D./REPETTO, A./TOBACMAN, J./WEINBERG, S. (2001): The Hyperbolic Consumption Model: Calibration, Simulation and Empirical Evaluation, Journal of Economic Perspectives, 15, 3, Summer, 47-68. AXA (2006a): AXA Retirement Scope 2006 – Retirement, a New Life After Work? – Wave 2 Germany, AXA Group, 23.05.06, www.retirement-scope.axa.com/country/download/ germany_en.pdf. AXA (2006b): AXA Retirement Scope 2006 – Retirement: Dawn of a New Age, AXA Group, 24.05.06, www.retirement-scope.axa.com/ synthesis/download/retirementscope.pdf. BACKHAUS, K./ERICHSON, B./PLINKE, W./WEIBER, R. (2003): Multivariate Analysemethoden – Eine anwendungsorientierte Einführung, Springer-Lehrbuch, 10th Edn, Berlin: Springer. BANKS, J./BLUNDELL, R./TANNER, S. (1998): Is There a RetirementSavings Puzzle?, American Economic Review, 88, 4, September, 769-788. BARBER, B./ODEAN, T. (2001): Boys Will Be Boys: Gender, Overconfidence, and Common Stock Investment, Quarterly Journal of Economics, 116, 1, February, 261-292.

416

Bibliography

BECK, H. (2006): Eins, zwei, drei: Das Eigenheim als Altersvorsorge, Frankfurter Allgemeine Zeitung, 195, 23.08.06, 9. BENARTZI, S. (2001): Excessive Extrapolation and the Allocation of 401(k) Accounts to Company Stock, Journal of Finance, 56, 5, 1747-1764. BENARTZI, S./THALER, R. (1995): Myopic Loss Aversion and the Equity Premium Puzzle, Quarterly Journal of Economics, 110, 1, February, 73-92. BENARTZI, S./THALER, R. (1999): Risk Aversion or Myopia? Choices in Repeated Gambles and Retirement Investments, Management Science, 45, 3, March, 364-381. BENARTZI, S./THALER, R. (2001): Naive Diversification Strategies in Defined Contribution Saving Plans, American Economic Review, 91, 1, March, 79-98. BENARTZI, S./THALER, R. (2002): How Much is Investor Autonomy Worth?, Journal of Finance, 57, 4, August, 1593-1616. BENENNI, M. (2006): Interview With UBS Client Advisor About How to Address Retirement Challenges With Individual Clients, UBS, Zurich, 20.09.06. BERNET, B. (1982): Struktur und Prozess der betriebswirtschaftlichen Forschung, Zurich: ADAG Administration & Druck AG. BERNET, B. (2005a): Die Demographie fordert die Finanzbranche heraus, in: GDI: Generation Gold – GDI_Impuls, 1.05, Rueschlikon/ Zurich: Gottlieb Duttweiler Institut, 26-30. BERNET, B. (2005b): Geld und Geist – Finanzplatz Schweiz zwischen Evolution und Revolution, Zurich: Orell Füssli Verlag. BIEDENKOPF, K. (2005): Presentation About the State of the German Economy, University of Passau, Passau, 25.08.05.

Bibliography

417

BMAS (2006a): "Generation Arbeit" als Leitbild der Initiative 50plus, Pressemitteilung vom 29.11.06, Bundesministerium für Arbeit und Soziales, 16.01.07, http://www.bmas.bund.de/BMAS/Navigation/ Presse/pressemitteilungen,did=173630,render=renderPrint.html. BMAS

(2006b): Rentenversicherungsbericht 2005 – Bericht der Bundesregierung über die gesetzliche Rentenversicherung, insbesondere über die Entwicklung der Einnahmen und Ausgaben, der Nachhaltigkeitsrücklage sowie des jeweils erforderlichen Beitragssatzes in den künftigen 15 Kalenderjahren gemäss § 154 SGB VI, Bundesministerium für Arbeit und Soziales.

BMAS (2007a): Altersvorsorge macht Schule, Bundesministerium für Arbeit und Soziales, 20.02.07, http://www.altersvorsorge-machtschule.de/default.html. BMAS (2007b): Entwicklung der privaten Altersvorsorge – Stand: 31.12.2006, Bundesministerium für Arbeit und Soziales, 20.02.07, http://www.bmas.bund.de/BMAS/Redaktion/Pdf/Rente/entwicklung-der-privaten-altersvorsorge-12-06,property=pdf,bereich= bmas,sprache=de,rwb=true.pdf. BMAS (2007c): Rekorde bei Riester-Rente – Ende 2006 über acht Millionen Verträge, Bundesministerium für Arbeit und Soziales: Pressemitteilung vom 31.01.07, 20.02.07, http://www.bmas.bund. de/BMAS/Navigation/Presse/pressemitteilungen,did=184938.html. BODIE, Z./HAMMOND, B./MITCHELL, O. (2002): Analyzing and Managing Retirement Risks, in: Bodie, Z./Hammond, B./Mitchell, O./Zeldes, S.: Innovations in Retirement Financing, Philadelphia: University of Pennsylvania Press, 3-19. BODIE, Z./MERTON, R./SAMUELSON, W. (1992): Labor Supply Flexibility and Portfolio Choice in a Life Cycle Model, Journal of Economic Dynamics and Control, 16, North-Holland, 427-449. BOERI, T./BOERSCH-SUPAN, A./TABELLINI, G. (2001): Welfare State Reform – Would You Like to Shrink the Welfare State? A Survey of European Citizens, Economic Policy, April, 9-50.

418

Bibliography

BOERI, T./BOERSCH-SUPAN, A./TABELLINI, G. (2002): Social Security Reform – Pension Reforms and the Opinions of European Citizens, AEA Papers and Proceedings, 92, 2, May, 396-401. BOFINGER, P./FRANZ, W./RÜRUP, B./WEDER DI MAURO, B./WIEGAND, W. (2005): Rentenversicherung im Jahr 2004: Stabilisierung durch Nachhaltigkeitsfaktor (Ziffer 313 bis 328), in: Sachverständigenrat: Erfolge im Ausland, Herausforderungen im Inland – Jahresgutachten 2004/2005, Wiesbaden: Statistisches Bundesamt, 237246. BORGMANN, C. (2005): Social Security, Demographics, and Risk, Berlin: Springer. BORGMANN, C./HEIDLER, M. (2006): Volatility of Social Security Wealth: Political Risks of Benefit Rule Changes in Germany, Unpublished Working Paper, Albert-Ludwigs-Universität Freiburg, 1-20. BÖRSCH-SUPAN, A./ESSIG, L. (2002): Sparen in Deutschland – Ergebnisse der ersten SAVE-Studie, Cologne: Deutsches Institut für Altersvorsorge. BÖRSCH-SUPAN, A./ESSIG, L./SOMMER, M. (2003): Demographie und Kapitalmärkte. Die Auswirkungen der Bevölkerungsalterung auf Aktien-, Renten-, und Immobilienvermögen, Cologne: DIA – Deutsches Institut für Altersvorsorge. BÖRSCH-SUPAN, A./ESSIG, L./WILKE, C. (2005): Rentenlücke und Lebenserwartung – Wie sich die Deutschen auf den Anstieg vorbereiten, Cologne: Deutsches Institut für Altersvorsorge. BÖRSCH-SUPAN, A./LUDWIG, A./SOMMER, M. (2003): Demographie und Kapitalmärkte – Die Auswirkungen der Bevölkerungsalterung auf Aktien-, Renten-, und Immobilienvermögen, Cologne: Deutsches Institut für Altersvorsorge. BÖRSCH-SUPAN, A./REIL-HELD, A./RODEPETER, R./SCHNABEL, R./WINTER, J. (1999): Ersparnisbildung in Deutschland: Messkonzepte und Ergebnisse auf Basis der EVS, Universität Mannheim, Sonderforschungsbereich 504, No. 99-02, January.

Bibliography

419

BÖRSCH-SUPAN, A./SCHNABEL, R./KOHNZ, S./MASTROBUONI, G. (2004): Micro-Modeling of Retirement Decisions in Germany, in: Gruber, J./Wise, D.: Social Security Programs and Retirement Around the World: Micro Estimation, NBER-C: National Bureau of Economic Research Conference Report, 285-343. BÖRSCH-SUPAN, A./WILKE, C. (2004): The German Public Pension System: How it Was, How it Will Be, NBER Working Paper Series, 10525, Cambridge, Mass.: National Bureau of Economic Research. BORTZ, J. (2005): Statistik für Human- und Sozialwissenschaftler, Springer-Lehrbuch, 6th Edn, Heidelberg: Springer. BORTZ, J./DÖRING, N. (2002): Forschungsmethoden und Evaluation für Human- und Sozialwissenschaftler, Springer-Lehrbuch, 3rd Edn, Berlin: Springer. BOSCALJON, B. (2005): Maximizing Retirement Income and Leisure Time, Journal of Financial Planning, July, 46-53. BOSSHART, D./NUENO, J./STAIB, D. (2004): The Age of Cheap – Why Customers Intend to Pay Less and Less as Prices Become More Important Than Ever, GDI-Study, No. 13, Rueschlikon/Zurich: Gottlieb-Duttweiler-Institut. BOWDITCH, D. (2005): NEFE Think Tank Provides Insight on Motivating Clients to Improve Financial Behavior, Journal of Financial Planning, July, 54-59. BRAUN, R./BURGER, F./MIEGEL, M./PFEIFFER, U./SCHULTE, K. (2002): Erben in Deutschland – Volumen, Psychologie und gesamtwirtschaftliche Auswirkungen, Cologne: Deutsches Institut für Altersvorsorge. BRINSON, G./HOOD, R./BEEBOWER, G. (1986): Determinants of Portfolio Performance, Financial Analysts Journal, July/August, 39-44. BRINSON, G./SINGER, B./BEEBOWER, G. (1991): Determinants of Portfolio Performance II: An Update, Financial Analysts Journal, May/June, 40-48.

420

Bibliography

BROSIUS, F. (2004): SPSS 12 – Das mitp-Standardwerk, Bonn: mitpVerlag. BROWNING, M./CROSSLEY, T. (2001): The Life-Cycle Model of Consumption and Saving, Journal of Economic Perspectives, 15, 3, Summer, 3-22. CFP (2004): What Should You Know About Financial Planning, Certified Financial Planner Board of Standards, 27.10.05, http://www.cfp. net/Upload/Publications/187.pdf. CHIEFFE, N./RAKES, G. (1999): An Integrated Model for Financial Planning, Financial Services Review, 8, 261-268. CHOI, J./LAIBSON, D./MADRIAN, B./METRICK, A. (2002): Defined Contribution Pensions: Plan Rules, Participant Choices, and the Path of Least Resistance, NBER/Tax Policy & the Economy, 16, 1, 67113. CLARK, R./D’AMBROSIO, M./MCDERMED, A./SAWANT, K. (2004): Sex Differences, Financial Education, and Retirement Goals, in: Mitchell, O./Utkus, S.: Pension Design and Structure – New Lessons from Behavioral Finance, Oxford: Oxford University Press, 185-206. COTIS, J.-P./COPPEL, J./DE MELLO, L. (2004): The Macroeconomics of Fiscal Policy – Is the U.S. Prone to "Over-Consumption"?, Federal Reserve Bank of Boston Economic Conference, June 14-16, Chatham, Massachusetts. CRONQVIST, H. (2003): Advertising and Portfolio Choice, Working Paper, Graduate School of Business, University of Chicago. CRONQVIST, H./THALER, R. (2004): Design Choices in Privatized Socialsecurity Systems: Learning From the Swedish Experience, American Economic Review, 94, 2, 424-428. CS (2005a): Tipps und Tricks für zukünftige Wohneigentümer, Zurich: Credit Suisse. CS (2005b): Willkommen zu Hause – Hypotheken, Zurich: Credit Suisse.

Bibliography

421

DAI (2006): Geldvermögen der privaten Haushalte und privater Organisationen ohne Erwerbszweck seit 1991, DAI-Factbook, Stand: Oktober 2006, Deutsches Aktieninstitut, 23.01.07, http:// www.dai.de/internet/dai/dai-2-0.nsf/dai_statistiken_e.htm. DAVIES, J. (1981): Uncertain Lifetime, Consumption and Dissaving in Retirement, Journal of Political Economy, 89, 3, June, 561-577. DE BONDT, W. (1998): A Portrait of the Individual Investor, European Economic Review, 42, 831-844. DE BONDT, W./THALER, R. (1990): Stock Market Volatility – Do Security Analysts Overreact?, AEA Papers and Proceedings, 80, 2, May, 52-57. DEFUSCO, R./MCLEAVEY, J./PINTO, J./RUNKLE, D. (2004): Quantitative Methods for Investment Analysis, 2nd Edn, Charlottesville, VA: Association for Investment Management and Research, CFA. DEHM,

H./KILBERTH, E./PSYCHONOMICS (2000): Repräsentative Befragung: Frauen und ihre Altersvorsorge – Fakten und Meinungen, Cologne: Deutsches Institut für Altersvorsorge.

DIA (2005a): Aktuelle Prognosen zum Rentenniveau, Deutsches Institut für Altersvorsorge, 20.05.06, http://www.dia-vorsorge.de/ downloads/df050108.pdf. DIA (2005b): Die volkswirtschaftliche Sparquote seit 1950, Deutsches Institut für Altersvorsorge, 07.05.06, http://www.dia-vorsorge.de/ downloads/df010113.pdf. DIA (2005c): Einstellung und Wissensstand zur Rente in verschiedenen Ländern, Deutsches Institut für Altersvorsorge, 20.05.06, http://www.dia-vorsorge.de/downloads/df060114.pdf. DIA (2005d): Vermögen nach soziodemographischen Merkmalen, Deutsches Institut für Altersvorsorge, 20.05.06, http://www.diavorsorge.de/df_020327.htm.

422

Bibliography

DIA (2006a): Alterssicherung im internationalen Vergleich, Deutsches Institut für Altersvorsorge, 15.06.06, http://www.dia-vorsorge.de/ df_010320.htm. DIA (2006b): DIA-Rentenschätzer, Deutsches Institut für Altersvorsorge, 18.05.06, www.dia-vorsorge.de/Rentenschätzer/. DIA (2006c): Die Altersrente – Zugangsvoraussetzungen nach Geburtsjahrgängen, Deutsches Institut für Altersvorsorge, 15.06.06, http://www.dia-vorsorge.de/downloads/df050205.pdf. DIA (2006d): Die Zahl der Riesterverträge zum ersten Quartal 2006, Deutsches Institut für Altersvorsorge, 15.06.06, http://www.diavorsorge.de/downloads/df030307.pdf. DIA (2006e): Gesetzliche Rentenversicherung – Die Renteninformation 2006, Deutsches Institut für Altersvorsorge, 12.06.06, http://www.dia-vorsorge.de/downloads/df050106.pdf. DIA (2006f): Gesetzliche Rentenversicherung – Von Bismarck bis heute: die wichtigsten Entwicklungen in der GRV, Deutsches Institut für Altersvorsorge, 20.05.06, http://www.dia-vorsorge.de/downloads/ df050102.pdf. DIA

(2006g): Historische Beitragstabelle, Deutsches Institut für Altersvorsorge, 20.05.06, http://www.dia-vorsorge.de/downloads/ df050207.pdf.

DIA (2006h): Steigende Akzeptanz der Riesterrente – DIA Rentenbarometer zur geförderten Altersvorsorge, Pressemitteilung vom 13.02.06, Deutsches Institut für Altersvorsorge, 12.06.06, http://www.dia-vorsorge.de/downloads/pr000054a.doc. DIAMOND, P./HAUSMAN, J. (1984): Individual Retirement and Savings Behavior, Journal of Public Economics, 23, February/March, 81114. DILIBERTO, R./ANTHONY, M. (2004): Retirement Destinations, Journal of Financial Planning, 17, 11, November, 30-32. DOWNES, J./GOODMAN, J. (1998): Dictionary of Finance and Investment Terms, Barron’s financial guides, Hauppage, NY: Barron’s.

Bibliography

423

DRINKWATER, M./SONDERGELD, E. (2004): Perceptions of Mortality Risk: Implications for Annuities, in: Mitchell, O./Utkus, S.: Pension Design and Structure – New Lessons from Behavioral Finance, Oxford: Oxford University Press, 275-286. DRV (2006a): Die richtige Altersrente für Sie, Berlin: Deutsche Rentenversicherung Bund. DRV (2006b): Fragen zur Berechnung der Rente, Berlin: Deutsche Rentenversichung Bund. DRV (2006c): Jeder Monat zählt für die Rente, Berlin: Deutsche Rentenversicherung Bund. DRV (2006d): Wie berechne ich meine Rente? – Alte Bundesländer, Berlin: Deutsche Rentenversicherung Bund. DUFLO, E./SAEZ, E. (2004): Implications of Pension Plan Features, Information, and Social Interactions for Retirement Saving Decisions, in: Mitchell, O./Utkus, S.: Pension Design and Structure – New Lessons from Behavioral Finance, Oxford: Oxford University Press, 137-153. DYCHTWALD, K. (1999): Age Power – How the 21st Century Will Be Ruled By the New Old, New York: Tarcher/Putnam. DYCHTWALD, K. (2004): Boomer Times or Bust?, ABA Banking Journal, February, 69-80. DYCHTWALD, K./ERICKSON, T./MORISON, B. (2004): It’s Time to Retire Retirement, Harvard Business Review, 82, 3, March, 49-57. EDWARDS, W. (1968): Conservatism in Human Information Processing, in: Kleinmuntz, B.: Formal Representation of Human Judgement, New York: John Wiley and Sons, 17-52. EHRENTRAUT, O./HEIDLER, M./RAFFELHÜSCHEN, B. (2005): En Route to Sustainablity: History, Status Quo, and Future Reforms of the German Public Pension Scheme, Forschungszentrum Generationenverträge der Albert-Ludwigs-Universität Freiburg, Discussion papers, No. 3, September.

424

Bibliography

EISENBERG, L. (2006): The Number – A Completely Different Way to Think About the Rest of Your Life, New York: Free Press. EISENFÜHR, F./WEBER, M. (2003): Rationales Entscheiden, SpringerLehrbuch, 4th Edn, Berlin: Springer. ELLSBERG, D. (1961): Risk, Ambiguity, and the Savage Axioms, Quarterly Journal of Economics, 75, 4, November, 643-669. ELTON, E. (2003): Modern Portfolio Theory and Investment Analysis, 6th Edn, New York: Wiley. FABRICIUS, M. (2001): Höhere Lebenserwartung und geringe Kinderzahl bringen das Sozialsystem an den Rand des Zusammenbruchs, erschienen in: Die Welt, 07.12.01, 05.10.06, http://www.diavorsorge.de/ps000024.htm. FAMA, E./FRENCH, K. (2004): Disagreement, Tastes, and Asset Prices, Working Paper, University of Chicago. FIDELITY (2006a): Fidelity Target 2010 Euro Fund, 04.08.06, http://www. fidelity.de/at/targetfunds.html. FIDELITY (2006b): Fidelity Target Fund 2010, 04.08.06, http://www. fidelity.de/at/targetfunds.html. FIDELITY (2007): Fidelity Retirement Income Advantage, 02.02.07, http://personal.fidelity.com/planning/retirement/retiree/content/fria .shtml.cvsr. FISCHER, D. (2006): Interview With UBS Branch Manager About How to Address Retirement Challenges With Individual Clients, UBS, Zurich, 16.11.06. FISCHER, I. (1930): The Theory of Interest, London: Macmillan. FRENCH, K./POTERBA, J. (1991): Investor Diversification and International Equity Markets, AEA Papers and Proceedings, 81, 2, May, 222226.

Bibliography

425

FRICK, K. (2005): Generation Gold – How Values, Wishes and Lifestyles Change Between 50 and 80, GDI-Study, No. 18, Rueschlikon/Zurich: Gottlieb-Duttweiler-Institut. FRIEDMAN, M. (1957): A Theory of the Consumption Function, New Jersey: Princeton University Press. FRIEDRICHS, J. (1990): Methoden empirischer Sozialforschung, 14th Edn, Opladen: Westdeutscher Verlag GmBH. FSA (2002): FSA Guide to Financial Advice, Financial Services Authority, 04.02.07, http://www.fsa.gov.uk/pubs/public/financial_ advice.pdf. GAST, Y. (2005): Interview With Credit Suisse Client Advisor About How to Address Retirement Challenges With Individual Clients, Credit Suisse, Küsnacht, 31.10.05. GDV (2004): FAQ zu den neuen Sterbetafeln DAV 2004 R für Rentenversicherungen, 08.06.06, http://www.teufl.com/img/ content/gdv_zu_lebenserwartung.pdf. GEBISTORF, L. (2004): Preisgestaltung für die Private Finanzplanung, Bank- und finanzwirtschaftliche Forschungen, Bern: Haupt. GEIS, U./BÄHR, C. (2006): Healthcare – Stationäre Pflege, Eine Research Publikation der DZ Bank AG, 31.10.06, Frankfurt: DZ Bank. GEWOS (2005): Der DEIX Deutscher Eigentums-Immobilien-Index – Entwicklung der Durchschnittspreise für Wohneigentum in Deutschland 1991 - 2004, Institut für Stadt-, Regional- und Wohnforschung, 21.07.06, http://www.ifs-staedtebauinstitut.de/ publikationen/deix.htm. GLASS, C./KILPATRICK, B. (1998): Financial Planning for Retirement: An Imperative for Baby Boomer Women, Educational Gerontology, 24, 6, September, 595-617. GOKHALE, J./KOTLIKOFF, L./SABELHAUS, J. (1996): Understanding the Postwar Decline in U.S. Saving: A Cohort Analysis, NBER Working Paper Series, 5571, May.

426

Bibliography

GRÜNBICHLER, A. (2004a): Aktive contra passive Anlagestrategien, Neue Zürcher Zeitung, 27.01.04, 67. GRÜNBICHLER, A. (2004b): Guarantee Products in the European Insurance Business, in: 3. WestLB Versicherungsforum, Düsseldorf: 29.04.04. HARRISON, K. (1999): Tales from the Screen: Enduring Fright Reactions to Scary Media, Media Psychology, Spring, 1-21. HOFMANN (2006): Anlage-Perspektiven, December 2006, Zurich: Bank Hofmann AG. HÖLLGER, T./SOBULL, D. (2001): Repräsentative Befragung: Frauen und ihre Altersvorsorge II – Wunsch und Wirklichkeit, Cologne: Deutsches Institut für Altersvorsorge. HUNT, D./KSHIRSAGAR, A./RAMJI, S./WALKER, P. (2005): The Retirement Journey – Pathways to Success in the New Retirement Market, New York: McKinsey & Company. HURD, M./PANIS, C. (2006): The Choice to Cash Out Pension Rights at Job Change or Retirement, Journal of Public Economics, 90, 22132227. KAHNEMAN, D./KNETSCH, J.L./THALER, R. (1986): Fairness and the Assumptions of Economics, Journal of Business, 59, 4, 285-300. KAHNEMAN, D./RIEPE, M. (1998): Aspects of Investor Psychology, Journal of Portfolio Management, 24, 4, Summer, 52-65. KAHNEMAN, D./SLOVIC, P./TVERSKY, A. (1982): Judgment Under Uncertainty: Heuristics and Biases, Cambridge: Cambridge University Press. KAHNEMAN, D./TVERSKY, A. (1979): Prospect Theory: an Analysis of Decision Under Risk, Econometrica, 47, 2, March, 263-292. KAISER, R. (1990): Individual Investors, in: Maginn, J./Tuttle, D.: Managing Investment Portfolios – A Dynamic Process, 2nd Edn, Boston, MA: Warren, Gorham & Lamont, Chapter 3, 3-1 - 3-46.

Bibliography

427

KEATING, G./TSCHANZ, B. (2006): Research Monthly, Credit Suisse, Global Research, 19.04.06. KEMP, C./ROSENTHAL, C./DENTON, M. (2005): Financial Planning for Later Life: Subjective Understandings of Catalysts and Constraints, Journal of Aging Studies, 19, 3, September, 273-290. KENNICKELL, A./STARR-MCCLUER, M./SUNDÉN, A. (1997): Saving and Financial Planning: Some Findings From a Focus Group, Financial Counseling and Planning, 8, 1, 1-8. KIENBAUM (2001): Führungs- und Fachkräfte in der Informationstechnologie 2001, Vergütungsstudie IT-Fach- und Führungskräfte, Gummersbach: Kienbaum Consultants International GmbH. KIENBAUM (2004): Führungs- und Fachkräfte in der Informationstechnologie 2004, Vergütungsstudie IT-Fach- und Führungskräfte, Gummersbach: Kienbaum Consultants International GmbH. KLÖCKNER, B. (1995): Mehr Geld für’s Alter – Vermögensaufbau für scharfe Rechner, Frankfurt a.M.: Campus Verlag. KNETSCH, J. (1989): The Endowment Effect and Evidence of Nonreversible Indifference Curves, American Economic Review, 79, 5, December, 1277-1282. KOBLINER, B. (2000): Get a Financial Life – Personal Finance in Your Twenties and Thirties, New York: Fireside. KORTMANN, K./HAGHIRI, P./PUPETER, M. (2005): Old-age Pension Schemes in Germany 2003 (ASID ‘03) – Summary of Survey Results, TNS Infratest Sozialforschung. KOTLER, P. (1999): Marketing Management: Analysis, Planning, Implementation, and Control, The Milliennium Edn, New Jersey: Prentice-Hall. KOTLER, P./BLIEMEL, F. (1995): Marketing-Management – Analyse, Planung, Umsetzung und Steuerung, 8. Edn, Stuttgart: SchaefferPoeschel Verlag.

428

Bibliography

KRITZMAN, M. (2003): The Portable Financial Analyst – What Practitioners Need to Know, Wiley Finance Series, 2nd Edn, Hoboken, NJ: Wiley. KROEBER-RIEL, W./WEINBERG, P. (1996): Konsumentenverhalten, 6th Edn, München: Verlag Vahlen. KROMREY, H. (1995): Empirische Sozialforschung – Modelle und Methoden der Datenerhebung und Datenauswertung, UniTaschenbücher, 1040, 7th Edn, Opladen: Leske und Budrich. LAIBSON, D. (1997): Golden Eggs and Hyperbolic Discounting, Quarterly Journal of Economics, 112, 2, May, 443-477. LEU (2006): Erleben Sie eine neue Dimension der Anlageberatung – Leu Investment Advisory Process, Zurich: Bank Leu AG. LINDLEY, D. (1990): Making Decisions, 2nd Edn, London: Wiley. LOEWENSTEIN, G./O’DONOGHUE, T./RABIN, M. (2003): Projection Bias in Predicting Future Utility, Quarterly Journal of Economics, 118, 4, November, 1209-1248. LUSARDI, A. (2004): Saving and the Effectiveness of Financial Education, in: Mitchell, O./Utkus, S.: Pension Design and Structure – New Lessons from Behavioral Finance, Oxford: Oxford University Press, 157-184. MACFARLAND, D./MARCONI, C./UTKUS, S. (2004): "Money Attitudes" and Retirement Plan Design: One Size Does Not Fit All, in: Mitchell, O./Utkus, S.: Pension Design and Structure – New Lessons from Behavioral Finance, Oxford: Oxford University Press, 97-120. MADRIAN, B./SHEA, D. (2001): The Power of Suggestion: Inertia in 401(k) Participation and Savings Behavior, Quarterly Journal of Economics, 66, 4, November, 1149-1187.

Bibliography

429

MAGINN, J./TUTTLE, D. (1990): The Portfolio Management Process and Its Dynamics, in: Maginn, J./Tuttle, D.: Managing Investment Portfolios – A Dynamic Process, 2nd Edn, Boston, MA: Warren, Gorham & Lamont, Chapter 1, 1-1 - 1-11. MARKOWITZ, H. (1952): Portfolio Selection, Journal of Finance, 7, 1, March, 77-91. MEFFERT, H. (2000): Marketing – Grundlagen marktorientierter Unternehmensführung – Konzepte, Instrumente – Praxisbeispiele, Wiesbaden: Gabler. MEIER-RUST, K. (2006): Weise werden kann jeder – der Bauer, der Professor und die Grossmutter, NZZ am Sonntag, 26.11.06, 70. MIRER, T. (1979): The Wealth-Age Relation Among the Aged, American Economic Review, June, 435-443. MITCHELL, O./MOORE, J./PHILIPPS, J. (2000): Explaining Retirement Saving Shortfalls, in: Mitchell, O./Hammond, B./Rappaport, A.: Forecasting Retirement Needs and Retirement Wealth, Philadelphia: University of Pennsylvania, 139-163. MITCHELL, O./SMETTERS, K. (2003): The Pension Challenge – Risk Transfers and Retirement Income Security, Oxford: Oxford University Press. MITCHELL, O./UTKUS, S. (2004a): Lessons from Behavioral Finance for Retirement Plan Design, in: Mitchell, O./Utkus, S.: Pension Design and Structure – New Lessons from Behavioral Finance, Oxford: Oxford University Press, 3-41. MITCHELL, O./UTKUS, S. (2004b): Pension Design and Structure – New Lessons From Behavioral Finance, Oxford: Oxford University Press. MITCHELL, O./UTKUS, S. (2006): How Behavioral Finance can Inform Retirement Plan Design, Journal of Applied Corporate Finance, 18, 1, Winter, 82-94. MOORE, J./MULLER, L. (2002): An Analysis of Lump-sum Pension Distribution Recipients, Monthly Labor Review, May, 29-46.

430

Bibliography

MULLAINATHAN, S./THALER, R. (2000): Behavioral Economics, NBER Working Paper Series, 7949, October. N.N. (2006a): The Avuncular State, The Economist, 08.04.06, 69-71. N.N. (2006b): Economic and Financial Indicators – Households’ Saving Rates, The Economist, 04.02.06, 89. N.N. (2006c): Financial Literacy – Caveat Investor, The Economist, 14.01.06, 71-72. N.N. (2006d): Sachkundenachweis für Hundehalterinner und -halter, Amt für Presse- und Öffentlichkeitsarbeit, 02.01.07, http://www.stadtkoeln.de/bol/tiere/hunde/produkte/03905/index.html. NIEHUES, K. (1997): Immobilien als Vermögensanlage, Münster: KMUInstitut. ODEAN, T. (1998): Are Investors Reluctant to Realize Their Losses?, Journal of Finance, 53, 5, October, 1775-1798. O’DONOGHUE, T./RABIN, M. (1999a): Doing it Now or Later, The American Economic Review, 89, 1, March, 103-124. O’DONOGHUE, T./RABIN, M. (1999b): Procrastination in Preparing for Retirement, in: Aaron, H.: Behavioral Dimensions of Retirement Economics, Washington D.C.: The Brookings Institution, 125-156. OECD (2001): Ageing and Income: Financial Resources and Retirement in 9 OECD Countries, OECD Publications Service, Paris: OECD. OECD (2005): Improving Financial Literacy – Analysis of Issues and Policies, Paris: Organisation for Economic Co-operation and Development. OPIELA, N. (2005): Rational Investing Despite Irrational Behaviors, Journal of Financial Planning, 18, 1, 34-42. ORGLAND, M. (2006): Interview With Partner from Wegelin & Co, Privatbankiers, St.Gallen About How to Address Retirement Challenges With Individual Clients, Zurich, 31.08.06.

Bibliography

431

OTTNAD, A./WAHL, S. (2005): Die Rendite der gesetzlichen Rente – Für Junge ein schlechtes Geschäft, Cologne: Deutsches Institut für Altersvorsorge. PALME, M./SUNDÉN, A./SÖDERLIND, P. (2004): Investment Choices in the Swedish Premium Pension Plan, Working Paper, 1-20. PANIS, C. (2004): Annunities and Retirement Well-Being, in: Mitchell, O./Utkus, S.: Pension Design and Structure – New Lessons from Behavioral Finance, Oxford: Oxford University Press, 259-274. PAS

(2007): Annual Statements, Pension Advisory Service, http://www.pensionsadvisoryservice.org.uk/personal_and_stakehol der_pensions/annual_statements/.

PC (2005): A New Pension Settlement for the Twenty-First Century: The Second Report of the Pensions Commission, London: Pensions Commission. PEAPE, N. (2004): European Pension Reform and Private Pensions – An Analysis of the EU’s Six Largest Countries, May, London: ABIAssociation of British Insurers. PEIJAN, A. (2006): Looking at Risk from All Sides, Focusing on Your Financial Goals – Wealth Management International, 1st quarter 2006, UBS Wealth Management, 28-29. POLKOVNICHENKO, V. (2005): Household Portfolio Diversification: A Case for Rank-Dependent Preferences, Review of Financial Studies, 18, 4, Winter, 1467-1502. POMPIAN, M./LONGO, J. (2005): Incorporating Behavioral Finance Into Your Practice, Journal of Financial Planning, 18, 3, March, 58-63. PÖTZSCH, O./SOMMER, B. (2003): Bevölkerung Deutschlands bis 2050 – 10. koordinierte Bevölkerungsvorausberechnung, Wiesbaden: Statistisches Bundesamt. POWELEIT, M. (2005): Performancevergleich: Lebensversicherung contra Fonds, map-report, Nr. 600.

432

Bibliography

RASONYI, P. (2006): Deutschland erhöht das Rentenalter auf 67 Jahre, NZZ am Sonntag, 30.11.2006, 23. RASONYI, P. (2007): Rentenalter 67 in Deutschland beschlossen, NZZ, 10./11.03.07, 23. REIFNER, U./TIFFE, A./TURNER, A. (2003): Vorsorgereport – Private Alterssicherung in Deutschland, Guetersloh: Verlag Bertelsmann Stiftung. REILLY, F./BROWN, K. (2000): Investment Analysis and Portfolio Management, 6th Edn, Forth Worth: The Dryden Press – Harcourt College Publishers. REIMANN, K. (2006): Alterung der Gesellschaft, UBS Research Fokus, Zürich: UBS Wealth Management Research. RICHARDS, R. (1986): The Dow Jones-Irwing Dictionary of Financial Planning, Chicago: Homewood. RICHTER, J. (2001): Grundsätze ordnungsmässiger Finanzberatung, Financial Planning, Vol 4, Bad Soden/Ts: Uhlenbruch. ROSENBERG, J. (2004): The Essential Dictionary of Investing & Finance, New York: Barnes & Noble. SAMUELSON, W./ZECKHAUSER, R. (1988): Status Quo Bias in Decision Making, Journal of Risk and Uncertainty, 1, March, 7-59. SCHARDT, G./VON BARBY, H. (2005): Investment 2005 – Daten, Fakten, Entwicklungen, Heidelberg: Hörning Bogenoffset. SCHARFSTEIN, D./STEIN, J. (1990): Herd Behavior and Investment, American Economic Review, 80, 3, June, 465-479. SCHNABEL, R. (2003a): Die neue Rentenreform: Die Nettorenten sinken, Cologne: Deutsches Institut für Altersvorsorge. SCHNABEL, R. (2003b): Die Rentenlücke: Das Problem wächst, Cologne: Deutsches Institut für Altersvorsorge.

Bibliography

433

SCHOTT, J./ARBEITER, J. (1998): Emotional., Psychology Today, 31, 1, January/February, 56-62. SCOTT, J./STEIN, G. (2004): Retirement Security in a DC World: Using Behavioral Finance to Bridge the Expertise Gap, in: Mitchell, O./Utkus, S.: Pension Design and Structure – New Lessons from Behavioral Finance, Oxford: Oxford University Press, 207-219. SEC (2005): Advisers Act Release No. 1092, 07.09.00, in: SEC: 17 CFR Part 275 Final Rule, Securities and Exchange Commission. SEILER, A. (1991): Marketing – Erfolgreiche Umsetzung in der Praxis, Zürich: Orell Füssli. SELNOW, G. (2004): Motivating Retirement Planning: Problems and Solutions, in: Mitchell, O./Utkus, S.: Pension Design and Structure – New Lessons from Behavioral Finance, Oxford: Oxford University Press, 43-51. SETHI-JYENGAR, S./HUBERMAN, G./JIANG, W. (2004): How Much Choice is Too Much? Contributions to 401(k) Retirement Plans, in: Mitchell, O./Utkus, S.: Pension Design and Structure – New Lessons from Behavioral Finance, Oxford: Oxford University Press, 83-95. SHARPE, W. (1964): Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk, Journal of Finance, 19, 3, September, 425-442. SHARPE, W. (1990): Asset Allocation, in: Maginn, J./Tuttle, D.: Managing Investment Portfolios – A Dynamic Process, 2nd Edn, Boston, MA: Warren, Gorham & Lamont, Chapter 7, 7-1 - 7-71. SHEFRIN, H. (2002): Beyond Greed and Fear – Understanding Behavioral Finance and the Psychology of Investing, Financial Management Association Survey and Synthesis Series, Oxford: Oxford University Press. SHEFRIN, H./STATMAN, M. (1985): The Disposition to Sell Winners Too Early and Ride Losers Too Long: Theory and Evidence, Journal of Finance, 40, 3, July, 777-790.

434

Bibliography

SHEFRIN, H./STATMAN, M. (1993): Behavioral Aspects of the Design and Marketing of Financial Products, Financial Management, Summer, 123-134. SHEFRIN, H./STATMAN, M. (2000): Behavioral Portfolio Theory, Journal of Financial and Quantitative Analysis, 35, 2, June, 127-151. SHEFRIN, H./THALER, R. (1988): The Behavioral Life-Cycle Hypothesis, Economic Inquiry, 26, 4, October, 609-643. SHILLER, R. (2003): The New Financial Order – Risk in the 21st Century, Princeton: Princeton University Press. SHIM, J./SIEGEL, J. (1991): Schaum’s Outline of Theory and Problems of Personal Finance, Schaum’s Outline Series, New York: McGrawHill. SHIV, B./LOEWENSTEIN, G./BECHARA, A./DAMASIO, H./DAMASIO, A. (2005): Investment Behavior and the Negative Side of Emotion, Psychological Science, 16, 6, 435-439. SHLEIFER, A. (2000): Inefficient Markets – An Introduction to Behavioral Finance, Clarendon Lectures in Economics, Oxford: Oxford University press. SIEGEL, J./SHIM, J./HARTMAN, S. (1992): Dictionary of Personal Finance, New York: Macmillan Publishing Company. SIERMINSKA, E./BRANDOLINI, A./SMEEDING, T. (2006): Comparing Wealth Distribution Across Rich Countries: First Results From the Luxembourg Wealth Study, Luxembourg Wealth Study Working Paper Series, Working Paper No. 1. SIMON, H. (1955): A Behavioral Model of Rational Choice, Quarterly Journal of Economics, 69, February, 99-118. SPREMANN, K. (1995): Asset-Allokation im Lebenszyklus und VintageProgramm, in: Gehrig, B.: Private Banking – Aktuelle Probleme und neue Herausforderungen, Zürich: Verlag Neue Zürcher Zeitung, 115-146.

Bibliography

435

SPREMANN, K. (1999): Wieviel Aktien? Eine Anleitung, in: Ballhaus, C.: Vorsorge Privat – Magazin zur Ausgabe Nr. 12 der "Finanz- und Wirtschaft" vom 13.02.99, Zurich: Finanz und Wirtschaft, 22-23. STAIB, D. (2005): Best Age Shoppers – How Ageing Consumers are Using the Offers of the Multichannel World, GDI-Study, No. 17, Rueschlikon/Zurich: Gottlieb-Duttweiler-Institut. STATMAN, M. (2005): Normal Investors, Then and Now, Financial Analysts Journal, 61, 2, March/April, 31-37. STBA

(1997): Statement vom Präsident Johann Hahlen zur Pressekonferenz "Einkommens- und Verbraucherstichprobe 1993/1998", 04.09.97, Statistisches Bundesamt, 28.01.07, http://www.destatis. de/presse/deutsch/pm/evs_ein.htm.

STBA

(2003a): 10. koordinierte Bevölkerungsvorausberechnung, Statistisches Bundesamt, 16.05.06.

STBA (2003b): Einkommensverbraucherstichprobe 2003, Statistisches Bundesamt, 22.06.06. STBA (2005a): Bevölkerung in Deutschland nach Altersgruppen nach 1950 bis 1995 und mehr, Statistisches Bundesamt, 21.06.06. STBA (2005b): Erwerbstätige nach Stellung im Beruf, Statistisches Bundesamt, 21.06.06. STBA (2005c): Lebenserwartungs-Tabellen, Statistisches Bundesamt, 22.06.06. STBA (2006): Entwicklung des Preisindex, Statistisches Bundesamt, 21.06.06. STIEFERMANN, K. (2005): Mit der Betriebsrente in eine sichere Zukunft, Heidelberg: aba-Arbeitsgemeinschaft für eine betriebliche Altersversorgung e.V. STIER, W. (1996): Empirische Forschungsmethoden, Springer-Lehrbuch, Berlin: Springer.

436

Bibliography

STROTZ, R. (1956): Myopia and Inconsistency in Dynamic Utility Maximization, Review of Economic Studies, 23, 165-180. SWISSCANTO (2006): Swisscanto Life Cycle Fund 2020, 04.08.06, http://www.swisscanto.ch/swc/. THALER, R. (1994): Psychology and Savings Policies, AEA Papers and Proceedings, 84, 2, May, 186-192. THALER, R. (1995): Behavioral Economics, NBER Reporter, Fall, 9-14. THALER, R./BENARTZI, S. (2004): Save More Tomorrow: Using Behavioral Economics to Increase Employee Saving, Journal of Political Economy, 112, 1, 164-187. THALER, R./TVERSKY, A./KAHNEMAN, D./SCHWARTZ, A. (1997): The Effect of Myopia and Loss Aversion on Risk Taking – An Experimental Test, Quarterly Journal of Economics, 112, 2, May, 647661. TILMES, R. (2001): Financial Planning im Private Banking Kundenorientierte Gestaltung einer Beratungsdienstleistung, Financial Planning, Vol 1, Bad Soden/Ts.: Uhlenbruch. TRACHSLER, J. (2001): Big Money – Strategien zur individuellen Vermögensbildung, Wien: Ueberreuter. TROMMSDORFF, V. (1998): Konsumentenverhalten, Stuttgart: Kohlhammer. TVERSKY, A. (1990): The Psychology of Risk, in: Sharpe, W./Sherrerd, K.: Quantifying the Market Risk Premium Phenomenon for Investment Decision Making, Charlottesville, VA: Association for Investment Management and Research, 73-77. UBS (2005): Handbook 2005/2006, Zurich, Basel: UBS. ULRICH, H. (1981): Die Betriebswirtschaftslehre als anwendungsorienierte Sozialwissenschaft, in: Geist, M./Köhler, R.: Die Führung des Betriebes, Stuttgart: C.E. Poeschel Verlag, 1-25.

Bibliography

437

UNPD (2005): The 2004 Revision, United Nations Population Division, 22.06.06, http://www.un.org/esa/population/aboutpop.htm. VDR (2005): Rentenversicherung in Zahlen – 2005, Berlin: Verband Deutscher Rentenversicherungsträger. VON NEUMANN, R./MORGENSTERN, O. (1947): Theory of Games and Economic Behavior, 2nd Edn, Princeton: Princeton University Press. WAGGLE, D./ENGLIS, B. (2000): Asset Allocation Decisions in Retirement Accounts: an All-or-nothing Proposition?, Financial Services Review, 9, 79-92. WALTER, I. (1993): High Performance Financial Systems, Institute of Southeast Asian Studies (ISEAS): Current Economic Affairs Series, Singapore: Institute of Southeast Asian Studies. WARNER, J./PLEETER, S. (2001): The Personal Discount Rate: Evidence from Military Downsizing Programs, American Economic Review, 91, 1, March, 33-53. WEBER, E. (2004): Who’s Afraid of a Poor Old Age? Risk Perception in Risk Management Decisions, in: Mitchell, O./Utkus, S.: Pension Design and Structure – New Lessons from Behavioral Finance, Oxford: Oxford University Press, 53-66. WEF (2004): Living Happily Ever After: The Economic Implications of Aging Societies, Geneva: World Economic Forum, Watson Wyatt. WEGELIN (2006): FIA Freiheit Im Alter – Das Vorsorgekonzept nach Mass, Wegelin & Co., 20.04.06, http://www.wegelin.ch/ser/fia. asp. WERNER, U./GEISSLER, H. (2000): Studenten und ihre Altersvorsorge, A Study Under the Chair of Insurances at the University of Karlsruhe (Lehrstuhl für Versicherungswissenschaft Universität Karlsruhe (TH)), in Collaboration with Psychonomics and the DIA (Deutsches Institut für Altersvorsorge), Winter Term 1999/2000. WYDER, A. (2002): Private Finanzplanung, Publikation der Swiss Banking School, 261, Bern: Haupt.

438

Bibliography

YATES, F. (1990): Judgment and Decision Making, Englewood Cliffs, NJ: Prentice-Hall. ZULAUF, D. (2006): Swisscanto erhöht Gebühren, Sonntagszeitung, 29.01.06, 64. ZWEIG, J. (1998): Five Investing Lessons from America’s Top Pension Fund – The Sages at TIAA-CREF manage $210 billion for America’s Teachers and Earn High Returns the Old-fashioned Way: With Long Horizons and Low Expenses, Money Magazine, 27, 1, January, 114-115.

Index

A

E

acceptance of default options, 109 adjustment factor, 69 age distribution, 44 ambiguity aversion, 105 anchoring, 88 asset melt-down, 4 availability bias, 82

earning points (EPs), 71 Eckrentner (standard retiree), 57 Einkommens- und Verbrauchsstichprobe (EVS), 152 Ellsberg paradox, 105 expense streams, 20 F

B Baby Boomer, 45, 151 behavioral finance, 36, 76 behavioral life-cycle hypothesis, 114 behavioral portfolio theory, 116 bounded rationality, 92 budget constraint, 15

fertility rate, 46 financial planning, 25, 27 financial risk, 21 FP actions, 34, 147, 311 FP perspectives, 30, 141, 306 framing, 88 G

C choice overload, 105 Civil Servant’s Pension Scheme, 60 complexity aversion, 105 compulsory state pension, 55 conservatism, 83 contribution ceiling (Beitragsbemessungsgrenze), 58 coping strategy, 31, 205 D decision theory, 14 dependency ratio, 2, 49 dissaving, 18, 19

Generation Gold, 203, 306 Generation X, 45 groups of individuals, 38 H Health-risk Employee, 165 Highly-educated, 170 High-potential, 318 hindsight bias, 86 home bias, 112 homo economicus, 16, 79 human capital, 162 hyperbolic discounting, 94

440

Index

I

O

income streams, 20 inertia, 108 inter-temporal financial optimization problem, 22 investor group, 163, 181 investor type, 191

occupational pension scheme (OPS), 59 old-age-dependency ratio, 2, 49 omnibus survey, 153 OPALS, 203 overconfidence, 84

K

P

knowledge aim, 7

passive decision making, 109 passivity, 107 PAYG, 52 pension benefit formula, 67 pension gap, 281 pension type factor, 70 permanent income hypothesis, 16 personal risk, 21 population pyramid, 44 portfolio segregation, 102 positive bias, 84 procrastination, 107 projection bias, 100 prospect theory, 87

L lack of firm preferences, 101 lack of self-control, 110 libertarian paternalism, 330 life-cycle hypothesis, 14 life-cycle investing, 161 life-expectancy, 45, 46 limited cognitive abilities, 92 Limited-wealth Risk-groups, 315 Limited-wealth Self-employed, 167, 317 longevity risk, 295 loss aversion, 89 Lost Generation, 4 M mental accounting, 102 mental accounts, 20 migration, 2, 47 modern portfolio theory, 36 money illusion, 99 myopia, 103 N naïf self, 96 net migration rate, 47 normal, 75 normal investor, 80

R regret, 113 replacement rate, 286 representativeness bias, 81 Retirees, 168, 313 retirement gap, 280 retirement income gap, 281 Retirement Initiative, 157 Riester Reform, 62 risk appetite, 33 risk averse, 39 risk aversion, 33 risk capability, 33 risk profile, 32 risk sophistication, 33 Rürup Commission, 64

Index

441

S

U

saliency bias, 82 SAVE study, 28 saving, 15 saving period, 19 segmentation, 38 Single Mothers, 165 SMarT plan, 5 social empirical research, 8 sophisticated self, 96 SOR model, 37 standard economic theory of decision making, 78 state-reliant free rider, 155, 331 status quo bias, 108 statutory state pension (SSP), 55 statutory state retirement income gap, 282 system inherent risk, 21

unbounded optimism, 85 utility function, 78

T

Zillmerung, 127, 336

target group, 151, 176 total retirement gap, 281 Typical Employee, 167

V Value at Risk concept, 21 value of pension entitlement, 68 vehicles for analysis, 40 voluntary personal pension (VPP), 61 W wealth stock, 23 Wealthy, 171, 319 Well-off Middle-aged, 170 worry indicator, 238 Z

Nicole Brunhart was born in 1975 in Liechtenstein, where she also grew up. From 1995 to 2000, she studied business administration at the University of St. Gallen (HSG) in Switzerland. During this period, she spent an exchange term at the Ecole des Hautes Etudes Commercials (HEC) in Paris, France in 1998, and participated in the 1999 MBA program at the HAAS School of Business of the University of California at Berkeley, USA. Nicole graduated in 2000 with a Master of Arts HSG, specializing in finance, accounting and controlling, in addition to a Master’s diploma from the Community of European Management Schools (CEMS). After graduation, Nicole joined McKinsey & Company, Inc., Switzerland as a strategy consultant. With McKinsey she is now serving as a project manager financial institutions with a special focus on asset management and private banking. Nicole received her Doctor of Business Administration in September 2007.