Wednesday, 5 December 2007

Default funds again

There was a supplement in the FT last week titled 'long-term investing' (although it didin't really have much on that subject in it) which included some discussion of default funds in defined contribution (DC) schemes. This is becoming another area of geeky interest for me as I think it will become very important because a) occupational schemes in the UK will be overwhelmingly DC in future and b) Personal Accounts will be a huge influence.

There was a good interview with Joseph Stiglitz in there. He said some interesting things about choice in pensions which are below (you can find the interview here):

"The economic theory of rationality is really informed by the notion that people learn from experience what their preferences are. How do you decide if you like red lettuce or green? You taste them and you find out. If red lettuce is more expensive, you decide whether it is worth that to you. After repeated buying, maybe you see you made a mistake.

"But the nature of the decision on saving for retirement means that that is no longer an option. You can’t go through your life and say: “I’ve saved too little; I’ll save more in the next life.” There’s no way that people can learn. It’s even impossible for people to learn from their parents or from society. Social learning isn’t going to work because the world today is so different from the world of our parents. The social security system in the US is stronger. In other countries it’s weaker. Longevity is different. Markets are different.

"That makes this decision very difficult."

The FT supplement was tied to a conference which is reported on by There was another interesting comment from David Laibson, Professor of Economics at Harvard University, defending the idea of defaulting people into funds:

"Matching contributions are a socially expensive way to achieve very little… financial education is a very expensive and weak lever for making changes."

I think this is exactly right, and just the sort of argument the unions used in the pension reform debate in the UK in favour of compulsion.

Personally I am very much of the opinion that the decision of the Government to go for a quasi-compulsory approach to pension saving in the UK has really important political ramifications that haven't yet been understood. It is an implicit acknowledgment (in my view) both that the financial services 'market' doesn't work very well (see the Sandler report for more details....) and that people do not make economically 'rational' decisions in relation to their finances.

This is big stuff, but this doesn't seem to have been realised by many on the Left. As a Treasury official once commented to me a decision about choice in pensions has an impact elsewhere. If the Government acknowledges that people do not need a choice in pensions (or that choice isn't actually that good for them) why do we need to give them a choice of mortgages?

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