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Most of the available empirical research supports the dynamic asset allocation strategy in comparison to other traditional asset allocation strategies where retirement benefit schemes involving members switching of assets is concerned. A member is faced with two decisions of either persevering to the end in an investment fund despite its performance or switching their investment between different succeeding funds with the aim of maximizing returns on their investment. According to Delpachitra Sarath et al 2014, the Rational and Informed Investors – One study concluded that lack of financial knowledge and capacity continued to be the key barrier.
This barrier hindered the choice architecture from achieving its objective of creating a thriving superannuation market in which funds compete to produce higher returns at a lower cost to members (Gallery & Gallery 2005).
Gallery proposed the ‘universal default fund’ as one possible solution to overcoming this problem. Gallery et al. (2011) offered a detailed analysis of superannuation members’ literacy and financial decision-making capacity. This study led to the development of a choice-decision model.
The fact that the superannuation or pension system still suffers from a lack of decision-making in the initial or subsequent selection of superannuation funds points to a gap in addressing the drivers of the selection decision.
Gallery & Gallery (2005) and Gallery et al. (2011) did not explain, first, what level of knowledge is sufficient for members’ success and, second, whether at any level of knowledge, individuals can compete in a market that is dominated by well-informed institutional investors such as JPM Chase, Goldman and others.
This resulted in a research gap. It may also be argued that the miners, factory workers, farmers, teachers, retail clerks, construction workers, doctors, lawyers, teachers and others who form the majority of members, should not be expected to become rational and knowledgeable investors to be entitled to a comfortable retirement (Willmore 2000). In a market economy superannuation members may not be behaving as investors. Other studies that either blames financial illiteracy as being a key driver of non-selection (default), or widespread financial illiteracy as a key cause of mismanagement of superannuation investment, offer similar solutions. These solutions include: first, similar frameworks for financial education of members; second, standardization of fund information to simplify the selection decision and; third, a combination thereof (Cooper 2010; Ntalianis 2011).
Question 1: What is the current level of understanding of members about the superannuation industry and how do performance and fees affect net income upon retirement?
Study of this two-pronged question required exploring both members’ current knowledge and understanding of the superannuation industry and the effects of superannuation performance and fees on members’ retirement incomes. This was accomplished by analyzing the data collected in this research and the qualitative analysis of related industry research and secondary data. For the first prong of Question 1 (Q1), data including financial investment knowledge, the objective of superannuation, selection of superannuation fund, what factors contributed to the selection of fund, and investing views were analyzed before addressing the second prong.
Financial Investment Knowledge – Respondents ranked their current level of knowledge ranging from very limited knowledge and dependence on advice (low = 1.00) to considerable knowledge and self-reliance (competent = 5.00). These data show members well realize the limitations of their investment knowledge, complementing the member type response. While 14% did not give an answer, over half of respondents identified their level of investment knowledge as ‘very limited (28%) or ‘basic’ (27%); another 26% selected ‘general’. Only a very small percentage (4%) of respondents ranked their investment knowledge as ‘good’ and only (0.7%) as ‘considerable’.
‘Which fund best meets your need?’ – There were five possible responses, ranged from: Defensive= 1, Moderate = 2, Growth = 3, to High Growth = 4 and don’t know = 5. According to the responses the members identifying themselves as consumers primarily chose ‘don’t know (42%)3 then ‘moderate’ (33%), while the investors predominantly selected ‘growth’ (56%) with confidence and knowledge (4% ‘don’t know’). This tabulation rejects the traditional superannuation myths of member knowledge, better retirement planning and better application or utilization of fund information
Question 3: What factors influence members’ decisions to switch funds? This question was analyzed using factors such as employment, funds performances and fee structure that influenced their decisions when switching their superannuation fund.
Changed Employment – This question asked the participants to clarify the primary reason for switching their superannuation. This shows that the majority of participants (73%) confirmed by selecting ‘Strongly Agree’ (58%) or ‘Agree’ (15%) that a change in employment resulted in them switching their superannuation fund. Only 18% respondents cited non-employment related reasons for switching funds. However, the responses were sharply divided by member type.
Fund Performance – About half of the participants responded to ‘I switched superannuation because of my old fund’s performance’; 54% were in agreement or strong agreement with this statement, while 39% disagreed or strongly disagreed with ‘fund’s performance as a factor for switching decision.
Fund Fees – About the same percentage of respondents answered ‘I switched super because of fees”. Of these respondents, 47.3% strongly agreed or agreed with this assertion, while almost the same number (48.6%) disagreed or strongly disagreed with fees as the reason for their superannuation fund switching.
‘Which Super fund would you invest in?’ – The survey provided the following fund portfolios to choose from as a simple 50:50 chance of gain or loss for typical risk tolerance testing.
Basu et al 2009, argues the case for a dynamic lifestyle strategy where the switching of assets at any stage is based on cumulative investment performance of the portfolio relative to the investors target at that stage, by investing in all equity portfolio for the first thirty years and then adjusting asset allocation on an annual basis and switching assets in both directions from from aggressive to conservative and vice versa over the conventional lifecycle asset allocation rules where switching of assets is preordained to be unidirectional by investing all equity portfolio for the entire horizon.
According to Baker et al 2014, although individuals cannot prevent all behavioral biases, investment professionals can advise clients how to reduce their influence during the financial planning process. This requires gaining an understanding of the clients’ psychological biases, resisting the inclination to engage in such investor behaviors, and establishing and implementing disciplined investment strategies and trading rules. An important strategy is to invest for the long-term, identify the client’s level of risk tolerance and risk perception, determine an appropriate asset allocation strategy, and rebalance the client’s portfolio on a yearly basis.
Benartzi et al 2007, says that saving for retirement is a difficult problem, and most employees have little training upon which to draw in making the relevant decisions. Perhaps as a result, investors are relatively passive. They are slow to join advantageous plans; they make infrequent changes; and they adopt naive diversification strategies. In short, they need all the help they can get. Fortunately, many effective ways to help participants are also the least costly interventions: namely, small changes in plan design, sensible default options, and opportunities to increase savings rates and rebalance portfolios automatically. These design features help less sophisticated investors while maintaining flexibility for more sophisticated types.
Basu 2008, demonstrates using empirical evidence that demonstrate that strategies that dynamically alter allocation between growth and conservative asset classes at different points on the investment horizon based on cumulative portfolio performance relative to a set target generally result in superior wealth outcomes compared to those of conventional lifecycle strategies. The dynamic allocation strategy exhibits clear second-degree stochastic dominance over conventional strategies which switch assets in a deterministic manner as well as balanced diversified strategies.
According to Varadi 2015, the standard approach in the investment industry is to produce a policy or strategic allocation for investors. This was built upon portfolio theory developed over 50 years ago that is out of touch with modern research. This methodology fails to address the realities of financial planning and investor behavior. More importantly it does not provide an adequate framework for investment management. A Dynamic Asset Allocation directly manages exposure to market cycles and seeks to remove the source of poor investor decision-making. The dynamic asset allocation approach is a better solution for creating a roadmap for how to get from the present to reaching their financial goals. The better solution is a “Dynamic Asset Allocation” approach that takes advantage of global opportunities across asset classes while managing risk at the portfolio level. The principles underlying dynamic asset allocation are timeless and enduring.
Cairns et al 2000, considers the asset-allocation strategies open to members of a defined contribution pension plans. He investigates a model that incorporates three sources of risk: asset risk and salary (or labor-income) risk in the accumulation phase; and interest-rate risk at the point of retirement. He proposes a new form of terminal utility function, incorporating habit formation, which uses the plan member’s final salary as a numeraire. The paper discusses various properties and characteristics of the optimal stochastic asset-allocation strategy (which is called stochastic lifestyling) both with and without the presence of non-hedgeable salary risk. He compares the performance of stochastic lifestlying with some popular strategies used by pension providers, including deterministic lifestyling (which involves a gradual switch from equities to bonds according to preset rules) and static strategies that invest in benchmark mixed funds. He finds that the use of stochastic lifestyling significantly enhances the welfare of a wide range of potential plan members relative to these other strategies.
Plan members can (typically) expect to be substantially better if they adopt a stochastic lifestyling strategy rather than a either a static or a deterministic-lifestyling asset-allocation strategy. The portfolio pension plan – PPP reiterated by Shea et al 2012, in their paper on risk sharing between the employer and the individual outdoes the other two alternative risk sharing designs (variable annuity plan with minimum benefit and collective pension plan). This is because it is the only plan among the three which benefits both the employer and the individual as a deviation from the traditional methods which force the employer to place risk entirely on the individual. Christensen et al 2014, exposes and criticizes the opponents of reform who claim various reasons against moving from a direct benefits to a direct contribution plans. State and local governments are facing difficult budgetary choices as government sponsored and maintained pension systems’ costs are skyrocketing and unsustainable, endangering other budgetary priorities.
While there are many different options for pension reform, the most effective long-term reform for dramatically reducing—if not eliminating—unfunded pension liabilities is converting defined benefit plans (DB) to defined contribution plans (DC). This will minimize taxpayer risk and offers public workers the same type of retirement benefits that most private sector workers receive. Converting from DB to DC plans faces steady resistance from those who benefit from the status quo. Rather than confront the numbers directly. Before tackling the arguments against DC plans in favor of DB plans, one should keep in mind a key difference between the two types of pensions.
The critical difference between DC plans and DB plans is not necessarily in whether employers or employees contribute to the fund, how the assets are invested, but in who bears the investment risks in the timing of benefit promises and payouts the employee or the taxpayer? In a Direct Benefit “DB” system, benefit promises are made well before they must be paid out, and the employer bears the risks of the investment returns (as pension benefits are guaranteed regardless of the fund’s returns). In contrast, in a Direct Contribution “DC” system, the employer is obligated to deposit money into employee accounts each pay period and employees bear the risks of the investment returns. This crucial distinction between the two pension types helps expose many weaknesses in attacks on DC plans and explain why DC plans are superior to DB plans.
When deciding on the way to go in structuring superannuation funds, it is critical to consider dynamic asset allocation strategies and the portfolio pension plan among other which distribute risk equally between the employer and the individual. It would also be wise to keep with the times and place preference on a direct contribution plan as opposed to a direct benefit plan, as pre-supposed by the old adage goes – “If you don’t change with the changing times, the changing times will change you”.
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