Author: Romet Kreek
The article was first published in Ärileht.
Last week, the Government decided that joining and leaving the second pension pillar will be made voluntary. Placing the responsibility on the shoulders of people themselves has created strong responses. Head of Asset Management and Pensions at Luminor Baltic Rasmus Pikkani explains that the habit to save money does not run in the blood of Estonians, finding your way in the investment universe is difficult and creating a portfolio spread across different assets is expensive.
What are the saving habits of Estonians like?
The saving habits of Estonians are poor, no matter what you compare them with. Deposits is an asset class where Estonians are active. But in international comparisons, these habits are very poor.
Why do Estonians save and invest so little?
Low income doesn’t help. Try to find even one person who says their income is so big they don’t need to earn more – all of their needs are covered. The historical background also plays a role. We don’t have centuries of experience in saving capital, neither as individuals nor as families. Our assets have been zeroed so many times during the last year and we’ve had to start from scratch again. The criticism of the people opposed to the second pillar is also partly based on this argument. You can shrug your shoulders and say that we don’t know what will happen in the future, maybe the euro will turn to dust – claims like this have been made in the debate.
Let’s forget for a moment where we are. Let’s take a look at where the Brits, the Swedes, the Americans were 50 years ago. We’re in the periphery and a lot has happened to us. Saving is not a habit that runs in our blood. Young people are less stubborn about saving. This habit comes from the environment and the society. It will never emerge if the society doesn’t support it. I think we should ask psychologists rather than financial specialists why people are not saving.
Human nature is well adapted to understanding how one can survive until the next spring. How to cope after ten years is a considerably more difficult question. People can probably think about the risks that may materialise if they lose their job in the next 12 months, if a recession comes, but they don't think 20 or 50 years ahead. People tend to see themselves as a third party in this situation. We don’t see ourselves there and this is why we cannot align it with our current behaviour.
We tend to forget that time is linear and only moves in one direction. We cannot jump back and think: I wish I’d done it differently back then. We all think about our children and feel we should be spending more time with them. But I’m so knackered today, I don’t have time for this, I’ll do it tomorrow. It’s the same with saving: what you didn’t save yesterday cannot be saved today. I have no doubt that most people would actually want to save more.
How much is saving and investing affected by the fact that the income of many people is low and they don’t have the required skills?
Investing and saving are very different. Saving is nothing more than spending less than you earn. This way, you can save money in your account or in a term deposit. There are no skills needed her, just discipline and determination. This can be achieved by different methods. To illustrate this with cash, then imagine you have several wallets. Your long-term savings are in one of them, you use the other to cover your costs, your current income is paid there and your current expenses are paid from there. Fintech companies have created solutions for separating one from the other. This is what I like about the second [pension] pillar. You cannot see the money, you don’t get any ideas about things you could spend it on. I also have very interesting ideas of what I could with the savings I may have or already have. The whole point of the consumer society is to spend your money on consumption, not save it. The fiscal policy of the central banks with its negative interest rates also doesn’t promote saving.
And how to invest is a whole new ball game...
There are so many myths about investment. It may seem very easy. It’s easy to compare the incomparable. Most conclusions are made on the of history. It’s easy to have hindsight. Everything seems simple when you look back at it.
The left side of the graph is always clearer than the right one...
Exactly. When you look at the graph, you can always explain why things went the way they did. When you look at the factors that will shape future movements and [think] what the graph could look like six months later, then that’s a lot more difficult. Investing sometimes seems easier than it actually is. We can talk about different levels of investment – you can use comprehensive solutions whereby you’re given advice, or you can do it yourself.
Thus, there are no problems for as long as the client is prepared to answer questions. The bank uses them to assess the client’s experience, financial capacity, risk tolerance. It is possible to give advice to the client when this is done, but only to the extent of a comprehensive portfolio. The easiest thing is to offer the client financial instruments that have been extensively spread, whether they’re funds of funds or broadly invested fund portfolios.
Private banking clients have a lot of assets and can be advised, but it’s more difficult with clients who have small amounts of money and would like to start slowly. That’s where we can use the help of the digital world. A person is alone with a computer and there are questions in front of them. After answering the questions, a response appears: a recommendation, which usually related to extensively spread solutions. But is that what people want when they think about investing? No, they would rather have some rocking equity or instrument that would generate a rocking income. The bank cannot advise anyone about this. We must look at the client’s portfolio as a whole and cannot just focus on a single part. You cannot go to the doctor and have them look at just one part of you. No matter what they do with you, they will examine you from head to toe. It’s the same with investment advice.
If the second pillar is made voluntary, will people start investing more or spend the money?
This is a very complicated question. The sceptic in me says that survey responses are not correct. People image their best selves when they participate in surveys. When the opportunity finally arrives, then a lot depends on the details. I suspect that when the short- and long-term ‘self’ of a person are compared, the voice of the short-time self is a lot louder when financial savings are discussed and the money will be withdrawn. Above all, this applies to people with smaller savings, who need to save more, who need more security and protection. There are certainly families that will be tempted to withdraw the money and spend it when they discuss the family budget and the money in second pension pillar is within reach.
If you could take the money to an investment account and manage it yourself, would it pay off?
If people are given the option to withdraw their money, then an investment account system will not help at all. Even if its taxed or something, it will make the money accessible. It’ll be within reach. And it will be very easy to reach for it in hard times. What can be done with that investment account is another question. The current system of investment accounts is very liberal. It’s great that this investment account system was established, it’s simple and pretty, and reporting is easy. We can be proud of setting this up. It was not overdone by limiting the circle of investment objects.
So the people who know how to handle their money can do it anyway. They can also do rather toxic things: you can step into a financial affair where you know that your score in the game will be either a hundred or zero.
The investments of second pension pillar funds are restricted in order to prevent this. Although the restrictions have been relaxed in recent years, the freedom of operating with pension funds or investment accounts cannot be compared. And now they’re planning to give access to the entire investment universe, where making decisions is very difficult. Building your own dispersed portfolio is expensive.
What happens when someone starts investing without giving it much thought, puts all of their money in one equity and then loses everything? Will they see the connection between their decision and the consequences, or will they blame everyone else for the failed transaction?
People may find investments themselves, or they may have heard someone speak about it. Maybe their heard an idea on the radio or read about in the paper. Should they even be looking for someone to blame? It’s very human to blame everyone else when things fail, but praise yourself when something was done well. If people are allowed to invest [their money] in a restricted investment account where only dispersed solutions can be purchased, then why can’t we continue using second pillar funds? When you look into the funds, you see that they’re not bad.
The entire second pillar system was too focused on avoiding risks at first. The biggest risk allowed to someone very young like me was up to 50% of equity risk in the second pension pillar. So, when someone takes out the graphs and compares the returns of the pension fund with the US equity index S&P 500, then you don’t have to be a rocket scientist to see that they’re not comparable. The system was too strongly against risk. This problem has been eliminated by now. Today, pension funds can invest almost 100% of their assets in equities.
What kind of an added value is created if a client buys another solution with a spread risk into their investment account? Would that alternative even be cheaper? If you by exchange-traded funds (ETFs), then you have to pay purchase and redemption fees and the bank will also charge you for the management of your securities account.
Can there even be cheaper alternatives? I don’t think this would be easier and cheaper for clients. If people started buying single instruments themselves, then there would certainly be someone who gets lucky. However, it’s hard to imagine an average person winning from this in the long term. If they get to the area that I called toxic, then financial institutions don’t advise clients to go there at present. You can go and buy if you want, but you will not be advised to do it. Some people are not qualified to take risks at all, but they will be doing it. So how do you guarantee they don’t invest everything in the same equity? I have no good solution to this.
What is the problem that the renovation of the second pillar is supposed to solve?
I have no idea what problem it will solve. This was my only question when the whole thing kicked off. I am only aware of one problem in the pension system. The present second pillar is also far from sufficient. The second pillar is too thin. Even now, saving in the second pillar is not adequate. This also leads to disappointment in the second pillar. Expectations and financial problems don’t take anyone to fairy land. There is no magic that could create amazing returns.
The other massive problem is that pensions have always been the state’s business as well. This blurs personal responsibility. When you know that the state will look after you and you only have to do a little yourself, then in the end, it will be difficult to understand where the state’s responsibility ends and yours begins. Responsibility always gets blurred when it comes to pensions. Speaking of the extent to which we can rely on the state, let’s look at the demographic pyramid and forecast. The expectation that the smaller future generation will pay the pensions of the earlier, bigger generation – it just can’t work. It works when the population is increasing, not decreasing. This shows how much money we have to save to be able to pay out [the pensions]. The present reform of the second pillar cannot solve this problem.
Giving more freedom to people – that’s great, but it does not increase people’s security about their coping after they retire 20 or 40 years down the line. Why don’t we talk just as passionately about cancelling speed limits, more freedom to choose what I breathe into my lungs, how much alcohol I pour into myself, maybe drugs as well... Why aren’t we just as passionate about all that? What’s the point of mandatory motor insurance? There are areas where freedoms don’t work in favour of social prosperity.
Let’s imagine that we don’t have a pension system like this after 30 years, when the demographic problems become particularity serious. We’re a social society. I’m assuming we will not let people starve to death. The society will pay for this. Future generations will pay for the stupidity of the people who fail to save for their retirement today. The agreement between generations is very unfair at present, as our great-grandchildren cannot pay for our pensions. It’s mathematically impossible. All of these decisions are made at the expense of the future generations, who will have to pay the bill.