The sweet life as a pensioner is probably something many look forward to. But before these expectations can be realised, many factors need to be carefully considered. One of the most important factors is doubtlessly one’s financial foundation.
This is what makes the right pension savings so important.
Without an adequate financial foundation, life as a pensioner might not be quite as sweet as one had hoped. Savings for old age are therefore critical. Many Danes also save every month via an occupational pension scheme, and many supplement with additional contributions under private management.
Planning of pension savings is often based on how great a portion of one’s salary the individual saver wishes to retain. There is no universal answer as to what this level should be, as this depends on the individual’s expectations of life as a pensioner, but need will often be less than 100 per cent of salary.
This is because, among other things, a series of expenses are either reduced or cease to apply, and many will receive social benefits from public funds. A rule of thumb is somewhere between 70-80 percent of salary, and this level will typically be higher in the low-income segment. But the question is whether these contributions will ensure the necessary pension savings? This question is pressing in light of, among other things, lower expectations on future returns and the fact that we live longer.
Living longer has consequences on savings
Naturally, it is nice that we can expect to live longer than previous generations. According to Statistics Denmark, girls born today can look forward to a life expectancy of 83.2 years, while boys can count on 79.3 years.
Longer life expectancy and early retirement age mean that pension savings need to be sufficient to last many years. At the same time, studies show that we actually wish to retire earlier than forecasts say that we can.
Most professionally active people save for retirement through their employers. The size of the pension contribution is set as part of the salary package. The question is whether these contributions ensure the necessary pension savings once individual wishes regarding retirement date are factored in? 4-5 additional years as a pensioner and living outside the labour market easily means a few million extra in savings are required.
Additional pension savings may therefore be necessary for many. This is an easy way to compensate for increased savings demand, but it can mean less funds available now, which can be a difficult thing for many to sacrifice.
Low returns are bad for savings
Low expectations of future returns are another challenge that must be managed. The problem with lower returns is that savings grow less during the savings cycle, and the account is drained more quickly in the retirement cycle.
Even for stocks the expected returns are modest. The industry association for pension companies, F&P, expects stocks to deliver a 6.2% annual return over the next 10 years. For government bonds, the F&P projects a return of around -0.1%, annually.
Inflation and costs must be deducted from this. F&P expects inflation will be 1.5% and as costs in Danish pension schemes are just below 1%, there is not much real return left in the bond segment. One should therefore make sure that pension savings do not include more bonds than absolutely necessary.
The immediate solution is, again, more savings now, but this negatively impacts spending availability. One alternative is to defer the date of retirement. This serves to extend the period of pension contributions, and savings need to last for fewer years.
A third possibility, if pension savings are insufficient, is simply a lower level of spending once the retirement date arrives.
Pension savings are further complicated by being highly individual. It can be hard to establish a definite rule as to how much one should save. This depends on the individual’s expectations of life as a pensioner outside the labour market.
Investing & risk
The combination of sufficient continual contributions to pension savings and the right benefit plan will for many be a good starting point for pension savings to last throughout all of retired life. It is, however, also extremely important to choose the right level of risk in relation to timeline and risk appetite.
The alternative is a passive strategy that has become extremely popular in recent years. In a passively managed strategy, investments are pooled so the return follows development in a given index. The goal is to keep costs down and deliver a return that is equivalent to the market average, less costs. The market can be, for example, the Danish stock market or the entire global stock market.
The reason for the explosive growth in passive strategies is doubtlessly the modest forecast many investors see in active strategies, and furthermore, the fact that many have become increasingly price-conscious. When investing, it is important to remember that there is no connection between high price and high quality. It is far more often the opposite- that high price equates to low quality, and on the other hand, low price is an expression of consistent performance.
Pension savings are long-term, which in itself supports an allocation to shares that may be significantly higher than the level one might initially imagine. Not only during the savings cycle, but also from the point of retirement, the timeframe will still be long and call for a relatively high proportion of stocks.
Stocks can be a necessity for an meaningful return
For some it may seem unsettling when pensions savings consist almost entirely of stocks. None the less, this will likely be a requirement for a reasonable return as a payoff on savings. In addition to a long timeline, continuous contributions to the pension will also make use of any drop in prices to buy stocks at a lower price. In this way, pension savings are almost tailor-made to take advantage of price drops.
Costs are another significant factor for the size of your pension savings. The more you can keep costs down, the more you get to keep for yourself. It’s as simple as that.
Lower returns and longer lifetimes are a hurdle to overcome for a sweet life as a pensioner. If you want to be sure that the money will be sufficient, then now is the time to act- not when you are ready to retire. Focus on the right balance between risk and stable assets, keep costs down, save continually, and stick to your strategy – even when there is turbulence on the financial markets. This way you will be in a strong position to realise your pension dreams.
Active or passive strategy
Investing generally follows one of two widespread strategies: 1) Active management and 2) passive management
Active management
In the active management strategy, the aim is to beat the market. Investments are compiled based on expectations of economic development, company earnings, interest rates, demand, etc. The goal is to deliver a return after expenses that is equal to or greater than benchmark developments.
A benchmark is an index that measures the average movements in a stock- or bond market. If, for example, a benchmark delivers a 5% return, this strategy must outperform or at least match 5% before one can be satisfied. However, all experience indicates that most of these strategies struggle to deliver results that are better than the market. Instead the reality – in contrast to the goal -is a lukewarm return. For those who actually succeed in outperforming the market, continuity is a rare commodity.
In other words, those who happen to do well one year rarely also do well the following year, and definitely not year on year. If you want to have higher returns than the market, the active strategy may be right for you.
Passively managed
The alternative is a passive strategy that has become extremely popular in recent years. In a passively managed strategy, investments are pooled so the return follows development in a given index. The goal is to keep costs down and deliver a return that is equivalent to the market average, less costs. The market can be, for example, the Danish stock market or the entire global stock market.
The reason for the explosive growth in passive strategies is doubtlessly the modest forecast many investors see in active strategies, and furthermore, the fact that many have become increasingly price-conscious. When investing, it is important to remember that there is no connection between high price and high quality. It is far more often the opposite- that high price equates to low quality, and on the other hand, low price is an expression of consistent performance.
