I have been doing a series of talks for the PFS on retirement planning. In the brief there was the need to consider retirement income options - so the standard ‘annuity versus income drawdown' debate with some consideration of the alternatives and variations. I also tried to look at the decision-making process facing individuals.
It is very easy for us, as product providers and advisers, to work out theories about how we think consumers will react but, in reality, much research has been done to show that consumers tend not to react in an entirely rational way.
What is retirement planning about? How much income do we need to live on? How much tax will be paid? What is the most efficient way of leaving an inheritance? All of these issues are wrapped up in an attitude to risk, and there are many variables that are interlinked.
But when it comes to investment and financial planning issues, do consumers act as we would expect them to do? The answer appears to be ‘no' - consumers act in irrational ways. If this irrationality can be addressed, it may be possible for outcomes to be improved.
How people make choices
There has been research on how people make choices, how people react to specific situations and even how people react to marketing language. Indeed, one of the first things the FCA did when it came into being in April 2013 was to publish what they refer to as: "Two occasional papers on behavioural economics to explore how people make financial decisions."
There has been a whole lot more. In March 2013 Barclays produced a white paper entitled: Overcoming the cost of being human (or the pursuit of anxiety adjusted returns). Again, the aim was to look at how consumers' investment strategies are influenced by their own views and anxieties, and the factors that influence decisions.
A good example of how such questions can affect retirement behaviour is the whole question of annuity purchase. The decision to hand over a lump sum in return for a fixed income for as long as you live is a big one, and for many people it will be the right thing to do. But do they see it that way?
One study in the US looked at some of the factors that consumers considered when buying an annuity, and which put them off making what could have been the best decision for them:
Fear of leaving money on the table
Overlooking the risks of volatile markets
The main strengths of an annuity - the certainty and the insurance against living a long time -were overshadowed by irrationality.
Another study in the US looked at annuities from a different perspective, and argued that the key to whether someone would purchase was ‘framing' theory. If an annuity was framed as a consumption solution, then more people would seek to overcome the investment concerns. People prefer positive framing.
There are other theories which can be examined, including:
Retirement is a big ‘life decision', possibly involving a long period of time, a number of variables and a real fear that the limited resources could run out. Therefore, understanding how people make decisions can be very valuable - particularly when it comes to seeking the optimum outcome for clients.
Mike Morrison is head of platform marketing at AJ Bell