Investing for your pension

You probably know, that life expectancy is increasing, which is obviously a good thing. But have you ever wondered, what effect does it have on the pension system? The annual World Economic Forum, which took place in January 2019 has raised a worrying concern- we can’t really afford to live that long. This means that the retirement system will not be able to cope with the longevity of our lives.  What can you do to protect yourself?

You are working all your life, paying taxes and the government is choosing the best social policy that will redistribute the tax money, so everyone will feel looked after. Why do you need to save for your retirement, won’t pension be enough? Sure, having investments is better than not- you will be able to afford extra consumption in the retirement age, the period of life when you can freely enjoy your time. However, the investments are not considered luxury anymore, it has become a necessity. The study conducted by World Economic Forum1 (WEF) has actually found out that with our expected life span the retirement systems won’t be able to handle.

What’s happening?

The population worldwide has a rising life expectancy. This is the consequence of improved medical services, better diet, and lifestyle. The developed world population is hitting records. In the UK for example, the probability to live until 100 years old is rising. Some women, already aged 65 have a probability of 7% to live until 100, whilst today’s 25-year-olds have a twice higher chance to live until century. For men, the picture is very similar. On the other hand, the usual retirement age in the EU member states is around 65 years2. This means that people, who are destined to live until 100 will live 35 years with no salary, receiving a pension, or living on other income such as savings and investments.

Aging population

Another problem is the fall in the birth rate and aging population. The thing is, during the post-WW2 period the developed world saw a rise in births, those who were born back then are now nicknamed baby-boomers. This was an extreme spike in birth rate, based on favorable peace conditions that followed the dark times of war. Now, baby-boomers are getting older, so the new smaller population of the current work-force need to pay taxes to pay for the pension of the growing number of retirees. Moreover, the number of retirees will keep increasing and the population in the EU of over 80-year-olds will reach 66.1 million people by 2080.3

The pension system

Most European countries are offering three-pillar pension systems consisting of mandatory state pension, private voluntary pensions offered by employers and private individual pension plans.

In major economies around the globe, the guaranteed pensions are getting under the strain and the future retirees will have to rely on their own savings. The problem is that savings are not growing fast enough to compensate for the deterioration of the retirement plans. In July 2019 World Economic Forum published the results of the analysis of six large economies. The findings are shocking- the savings gap (years lived with no income, nor savings) is predicted to be around nine years.

According to NATIXIS 2018 Retirement Index the Netherlands, Canada and Australia (the countries with 9-year savings gap analyzed by WEF) are in Top 10 countries for Retirement security4. The index is based on 18 different factors across four big areas- finances, material wellbeing, quality of life, and health. If this relatively safe countries for retirement are having such a large savings gap, what can we say about countries like Spain or Portugal, which are taking 31st and 32nd places respectively, among 43 countries analyzed?

What can be done?

It is not a secret anymore, that you need to start saving early to accumulate a reasonable amount to spend during the retirement days. You need to make a budget and stick to it. It is a well-known fact that the pension funds are one of the most risk-averse managed funds there is, as this is not the money for pleasure, but for necessity. Despite that, WEF has pointed out, that “many people are too risk-averse in their retirement savings”. The recommendation of the study was to reconsider the risk-tolerance level of young and middle-aged investors, as the risk to outlive your savings is a far greater risk, that losing some investment income.

Another important point is diversification. It does not only apply to individual savers, but also to institutional, who manage the pension funds. The problem with state funds is that they are too pro-domestic traditional financial assets, like shares and bonds. The real protection will come from diversification among different geographies and revolutionary new investment assets.

Investing in alternatives is an option, however, the customers need to fully understand the risk he/she is facing. P2P lending is a form of alternative finance, which can be added to your retirement portfolio. The returns from P2P investments are too impressive to miss out. Sure, there are risks, but make sure to diversify your portfolio as much as possible. If you look at the historical performance of the biggest asset classes, you will understand that the returns are not even beating inflation.

We hope that everyone now understands that investing for the future is not a whim, but a necessity. You have to calculate your desired budget, the monthly contributions you need to set aside and of course invest in products, which are promising return above the inflation. Finally, most importantly, don’t forget the golden rule of investing- diversify your portfolio.

Sources:

  1. http://www3.weforum.org/docs/WEF_Investing_in_our_Future_report_2019.pdf
  2. https://www.etk.fi/en/the-pension-system/international-comparison/retirement-ages/
  3. https://ec.europa.eu/eurostat/statistics-explained/index.php/People_in_the_EU_-_population_projections
  4. https://www.im.natixis.com/us/research/2018-global-retirement-index

 

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