Pensions – (Young) People Just Don’t Get It!

Your correspondent has recently been asking young people about what they know about their future pensions. The result of the informal survey has been that young people between the ages of 25 and 60 years (I am a little older) was that 100% have no idea about the possible size of the pension, nor do they understand how much cash is being saved for the pension each month, and how it is invested. They have no idea about the cost of managing these investments, nor do they have much idea about what companies are involved. 

The picture they have in their minds is that a sufficient amount of money will appear each month into their bank account when they are 67 to 70 years old, and that will be enough for them to live a comfortable life in retirement before they die.

When I explain to them that they can expect to receive around 40% of their last income they look at me as if I am nuts. It appears that very few of them have ever done any research about their pensions and what they can expect to receive, although they do complain about the new later ages of retirement. 

It appears that they have little idea about the investment process and about the amounts of money that are being generously spent by the big pension companies to ensure that their staff and investment managers are enjoying some of the highest salary packages known in this country and in many other countries. 

The impression is that the government is somehow going to ensure that they will receive a pension that is more or less the same as their last expected salary. It is a shocking piece of information that they are wrong by a huge amount! 

Your correspondent is an objective and totally independent financial expert who has no financial or other connections to the pension or investment business. He has written many articles about the  excessive costs of the present pension system that was set up in Finland after the early 1950s. The whole system was originally based on public and altruistic oversight, but now its has been high-jacked by banks and investment professionals who are feathering their own beds at the cost to taxpayers an pensioners who are obliged to be members of the compulsory pension system. 

Recently the Finnish President, Mr. Niinistö, said that Finland immigration policy should not be naive. He was talking about the potential threat of terrorists infiltrating Finnish society as a result of an open-door policy that failed to catch threats from fanatics with bad intentions. The same should be said about the present pension system. It has failed to inform, it has failed to seek out the lowest possible costs, and has been allowed because of lax controls to be highly inefficient. 

The whole system is a closed group of a few big companies each replicating one another with big boards, many levels of senior management and the over 100 administrative representatives from the employee and employer unions, all enjoying exceptionally generous benefits. Their combined investment performance is no better than the average performance of their respective asset classes.

In fact, it is so well organised that there are no foreign-owned pension funds operating in Finland. Foreign pension managers must set up a fund in Finland as a domestic operation and the current laws here and the state of competition has stopped all efforts to enter this market. The whole system is so cleverly constructed between the three big funds that even the biggest foreign pension funds see no opportunities to enter such a closed market.

These three funds, together with the state and municipal pension funds, largely replicate their investment strategies. The differences are minimal and their results are similar. Their asset allocations are also similar – they say that they must diversify their funds into several asset classes but the results are similar since they all use the same consultants.

They have large equity and bond investments which are separately managed at home and abroad with their annual investment costs, they claim, below 1% of the amount managed. The world’s largest funds make do with one-tenth of that amount. The impact of the claimed 1% annual cost reduces pensioners’ pensions by quite a large amount. The actual costs are challenging to measure because but judging from the results there appears to be leakage above this figure…

If you can invest at 3% real rate of return over 40 years, (this is the rate they claim they want to achieve open average each year), that means 6% assuming inflation is 3% on average over such a long period during which people work, then you would only need to invest 12% to 13% of your gross salary every year to receive most 100% of your last salary.

In today’s pension system you must invest together with your company 25% of your gross salary and receive around 40% of your last salary as a pension.

The calculation can be made on an Excel spread sheet relatively easily. The assumptions are valid for such large groups because this pension system includes all workers and retired pensioners in Finland by law.

It is estimated that around 30% of today’s payments into the pension funds goes out as pension payments to current retirees. Thus using that percentage, you can assume that 16% should be sufficient for much better pensions for current and future retirees – something close enough to the last salary as a pension!

There are three truths about investing over the long term that every fund manager knows:

The bigger the fund in absolute terms, the easier it is to demand and receive lower management costs. Smaller funds pay higher management costs to third parties.

The lower the costs in percentage terms, the higher the return.

Small funds, big fund management salaries, and higher administration costs mean  lower total returns for the portfolio, which means that they eat up what pensioners should be receiving!

But you will never hear the above three stories from Ilmarinen, Varma and Elo because of truth number 3…

… and no matter how many times this column repeats these three statements, you can be sure that not one fund manager or other “Stakeholder”, or should we say “Steakholder”, will open their mouth because number 3 is where the beef is!

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