GLOBAL - Allowing people to choose their own retirement fund is dangerous in a system where participants are not well informed, State Street Global Advisors group CIO Alan Brown argues.
Citing the findings of a paper titled Design Choices in Privatised Social Security Systems: Learning from the Swedish Experience, Brown suggests retirement is one area where people should be “saved from themselves”.
Privatisation of social security could well come back onto the political agenda in the US and other countries, Brown says. And the conclusions drawn in the paper are equally relevant to the design of defined contribution (DC) funds – the second pillar savings rout of choice in many countries – he adds.
The Australian government is introducing choice of fund in July 2005.
Under the Swedish system, people were given a choice of 456 funds. A default fund was offered to those who did not elect to make their own choice, but the Swedish government actively encouraged self selection.
Nearly 67% of participants chose their own portfolios but since the government stopped promoting self selection, nearly 92% of new joiners have since opted for the default, Brown notes.
However while the default fund performed well, the fund popular with the active choosers was up over 500% in the five years prior to choice and in the three years since has lost over two thirds of its value.
Brown argues well-intentioned plans to offer participants’ choice is leading to “perverse results” with “significant wealth consequences” for investors.
“Arguably, limited choice would provide for lower costs through very competitive bids from fund managers, and from significantly lower administrative costs,” Brown says.
“And arguably, for most participants who are relatively uninformed about investments, a default choice is likely to be superior to most portfolios that they might elect for themselves.
“For the minority who really could benefit from choice, they still can. They simply exercise that choice outside the second pillar savings system with their other investments.
“It seems almost heresy to argue for paternalism and against choice, but perhaps this is really one area which is so important that we should be saved from ourselves. After all we don’t get to prescribe our own medicines, perhaps we shouldn’t be selecting our own retirement fund choices either.”
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