How can people be made aware of their risk attitude towards pension schemes?
In a podcast from Netspar, Professor of Marketing at Erasmus School of Economics Bas Donkers elaborates on the research project that will start in 2021. Furthermore, he discusses academic insights on risk attitudes and the importance of communication on different investment strategies for pension building.
In the beginning of October, professor Bas Donkers and professor Benedict Dellaert received a grant from thinktank Netspar (Network for Studies on Pensions, Aging and Retirement) to set up a research project regarding pensions: Individual Pension Choices in Uncertain Times: Advancing Digital Support for Risky Pension Decisions. Due to a change in regulations, pension scheme members are to be given more responsibility and thus risk. In order to improve pension schemes, Donkers emphasizes that communication has to focus on the possible consequences of investment decisions one makes: people don’t need to have as much knowledge concerning investment vehicles, but need to have a crystal clear picture of their ideal future. Since pension funds are able to deliver expertise and a wide variety of investment strategies, they need to know exactly what people expect their pension to be. And since every person is unique and has different preferences, it is very hard to make an instrument that works for everybody. Are you prone to take risks, or do you want to play it safe? The so called ’70 percent norm’ is often referred to in the world of pensions: in order to enjoy your pension, you would have to have saved up at least 70 percent of the amount you currently earn. But what is the real goal of a retirement plan? Often times, this is the idyllic idea of living on without having to change your expenditure pattern. To make this translation to personal preferences however, is a very intricate question.
So how do we obtain the correct understanding of the preferences of an individual? According to Donkers, much has to do with the framing of concepts. There are many people that understand a formulation such as ’10 out of 100’, whereas 10 percent might be too abstract. In order to contribute to a clear picture of the consequences of the choice of a certain pension product, it is also better to refrain from expressions in nominal amounts. When the outcome of an investment strategy lies far in the future, inflation rates can cause certainty intervals to become too wide to make statements on someone’s purchasing power. Even though it is hard to achieve this in practice, it is necessary to have a personal conversation with a pension fund member to grasp one’s future image.
In the podcast, the hostess asked whether people think of their pension in terms of their money or in other ways. Since the project of both professors will officially start in the beginning of 2021, it is hard to say much on this topic. However, Donkers does want to point out the importance of context. Someone’s reference point is probably much depending on the conversation he or she is having at the moment. If an individual sketches his retirement plan with his wife and grandchildren, he is more likely to make a plan which doesn’t always correspond to other possible scenarios. The goal of the project is to be able to measure one’s true preferences in order to make a personalized plan that matches as many situations as possible. To give an illustration of two possible competing scenarios, one might want to travel the world and spend time with grandchildren: how do you fit the two financially different ideas in one plan? There is still a lot to learn and investigate on the subject of pension building and risk attitudes. One of the obstacles is that many people aren’t aware of their own risk attitude. Donkers points out that the risk attitude of an individual is domain dependent: ‘you can love bungee-jumping, but be risk averse with regards to your pension-building strategy. In addition, your risk attitude can differ over a given time period’. One of the challenges Donkers and Dellaert will have to overcome is the question of weight: what is the weight you appoint to a certain scenario?