Retirement Savings – Games that Asset Managers, Distributors and Investors Play

Prof. Joseph E. Stiglitz, Columbia University

The decisions individuals make concerning retirement savings – both how much to save and how to invest their savings – are among the most important they face in their life time. With increasing longevity, individuals are spending an increasing fraction of their lifetime in retirement. Just seventy five years ago, few people lived much beyond retirement. Today, it is not uncommon for individuals to be retired for thirty years or more – an amount equal to half or more of their working lives.

Unlike other decisions individuals make, they have little foundation on which to base their retirement decisions. When they choose among beef, chicken, and pork, or between one kind of lettuce and another, they can try one or the other, find out what they like and do not like, and make future decisions using the information acquired.

But in their retirement decisions, individuals do not have a second chance. If they save too little, when they are 90 years old they cannot do it over again. They have to live with the consequences. Making matters even worse is the fact that they cannot learn from their elders. With the marked changes in wages, securities markets, and public social security programs the choices facing individuals today and the consequences are markedly different from those of previous generations.

Making matters worse, such decisions are among the most complicated facing an individual. At a technical level, they involve intertemporal optimization with risk. While economists have begun to formulate models describing how such decisions should be made, the models are complicated and clearly beyond the scope of ordinary individuals to solve. Individuals in making their decisions will thus have to rely on simple heuristics, hunches, hearsay, advice, and judgment. They may look to peers for ‘norms’. If they see everyone around them saving 10%, they will be inclined to save 10%. A few people who see themselves as particularly healthy and lived, or particularly worried about old age poverty, might save a little more than 10%. But 10% becomes the norm.

How norms get established, or changed, is a matter that would take us beyond the scope of this paper. But analysis may play an important role. If individuals see that, at current interest rates, increases in wage rates, etc. they are likely to be left with what they view as insufficient funds in their retirement at a 10% savings rate will be induced to save more.

This provides those in the investment community trying to provide products and advice to retirees both an opportunity and a responsibility. Individuals are more vulnerable, perhaps more easily misled - because it will be years before mistakes become evident. There are many who would willingly take advantage of this limited information.

For those who take their responsibilities seriously, the task of providing guidelines for retirement savings is not easy. They want to guide individuals, but they recognize that they are not fully informed about the preferences or circumstances of their customers; and that their customers may not fully understand their circumstances and preferences. So while they may wish to provide guidance, they must also provide choices. The guidance they provide must be based on what we know of ‘average’ individuals, or ‘average’ individuals in different circumstances, how their incomes and assets and needs evolve over time.

For instance, some individual’s career paths and wage profiles may be highly predictable; others may not. Some individuals may own a home, an important asset; others may not.

This paper looks at the overall problem of providing retirement security from the perspective of the three major ‘actors’ in the market – the individual investor/retiree, the distributor, and the asset manager.

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