PensionReforms' summary and comments
At an individual level, planning for retirement is complicated and is likely to become more so.  It is no longer sensible to assume that an employee will remain in work, even at the same or an increasing pay from now until the employee's selected retirement age.  Nor that the country's retirement income arrangements will continue unchanged.  Then there are life's other exigencies - such as the consequences of the global economic crisis, ill health or family break down.  These can all have a disastrous effect on the best-laid plans.

Financial modelling software can help both individuals and their advisers to map a rough way forward so how do they rate?  The report looks at a number of options for how the post-retirement risks are handled. Five free "consumer programs", one "fee-based consumer program" and six "professional programs" are reviewed.  The overall verdict: there is much room for improvement.

"Not surprisingly, we find that web-based programs aimed at the general consumer are less complex than programs used by professional financial planners.  The five free web-based approaches considered here can provide a rough idea of whether the user is on target for retirement, how much additional, if any, he would need to save, and whether he should consider postponing retirement."

The individual programs had different but quite serious flaws, including that:
-   ". everyone, even if not married, receives the same Social Security benefits."
-    ".income sufficiency [is] based on life expectancy and overlooks the chances of living longer."
-   Spouse's entitlements are ignored.
-   Benefits from Defined Benefit schemes (and other income sources) are ignored.

"Programs used by financial planners are far more complex, yet none is capable of dealing with variable rate mortgages.  Nor do they anticipate the situation of falling housing prices, job loss and foreclosures.  We conclude that on the whole, the tools do not highlight nor address retirement risk particularly well; rather, they mainly mask risk."

The report recommends that individuals (and financial professionals) ".could benefit from trying alternative programs and scenarios within each program."

One of the problems faced by software developers is that the 'experts' themselves disagree on what might be 'optimal' advice.  The developers have an apparently moving target to aim at.

The 'answer' to a financial planning question as complex as what to save for retirement is that there cannot be a single number that is 'right'.  Individuals and their advisers, apparently, need to understand that a range of results must be a necessary result.  

"Deterministic approaches direct consumers in appropriate to single answers, unless they undertake their own scenario testing. Stochastic modeling is seen as preferred approach, but it may not appropriately focus people on tail events or how to deal with them."

Models must allow people to see the implications of working longer, of falling house prices, variable house mortgage interest rates and even losing a job.

"In short, the software programs under-represent or fail to represent the impact of extreme events.  The next generation of software must do better to inform users of such uncertainties."

PensionReforms thinks it is curious that after, perhaps, 15 years or more of computer-aided financial planning, there are so many gaps in the available tools.  It is certainly a reflection of complexity - no two individuals will have the same history or future with respect to retirement income provision; even with something as basic as 'how long will I live?'  In the face of such uncertainties, the answer will be delivered by a combination of skills in financial planning, communication, behaviour, technology and HR experience (much depends on the willingness of employers to help).  That combination will eventually surface.  Then it will not matter so much if individuals lack financial literacy, as long as they can use a computer or be helped through the process.

In the meantime, the 'answers' delivered by software provided by a firm with something to sell (other than advice) will need to be looked at with considerable caution.  Paying off debt is likely to be a more sensible strategy for many than buying an investment product.  But who wins from reducing debt?  Not the lender (that has to find another borrower) or the promoter of an investment opportunity.  (File size 92KB; 32 pp) 366

 

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