Default Investment Strategies and

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Default Investment Strategies and Life-styling

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The financial dilemma

• Humans often make bad financial decisions
• Overconfident
• Not clear on objectives
• Heavily influenced by current developments
• Herd instinct-asset bubbles
• Not good at probability
• Cash is king

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(No Transcript)
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• I can calculate the movement of the stars, but
  not the madness of men Isaac Newton

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Lets think about cash
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Inflation
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Diversified Assets
Sector B
Sector A
Sector C
Sector D
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Strategy 1

• Strategy 1 invest in only one sector

• 90 100,000
• 10 0

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Strategy 2

• Strategy 2 invest 25 in each of 4 sectors
• 65 100,000
• 29 75,000
• 5 50,000
• 0.4 25,000
• 1/10,000 0
• Works but only if the 4 sectors are independent.

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The financial dilemma

• Should Product providers
• Design products that customers want?
• Design products that customers need?

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20 years of drawdown

• Next year cash
• Next four years bonds for extra return
• Next fifteen years equities for inflation
  protection
• Answer- invest in a managed fund

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Want an annuity ?

• Make sure you are in bonds towards retirement

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Want Cash ?

• Are you sure?

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Happiness and Income
X
Happiness
0
30,000
50,000
70,000
90,000
110,000
130,000
150,000
170,000
190,000
210,000
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What should be the aims of a DIS

• A DIS should reduce the possibility of
  unacceptable outcomes.
• Allow appropriate exposure to higher return
  assets.

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How to compare DIS

• Stochastic Processing on equity and risk free
  asset portfolio
• Infinite possible variety of shapes of
  distributions
• Log normal distribution
• Real return over risk free assets 4 SD 15

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The Contributor

• 30 years to retirement
• Funds for 10 times salary on a 2 gap with an
  initial 24.17 contribution
• Two scenarios
• A. fixed contribution
• B. variable contribution
• First 10 years up to
  15
• Second 10 years up to 25
• Third 10 years up to 40

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The Contributor Cost Basis

• Fixed contribution Cost is 7.25 times salary
• 100 equity investment gives expectation of 10
  times salary
• Reduced equity leads to same cost and lower
  expectation

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Fixed Contribution modal score 6.5
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10 year switch to cash modal 6.5 expected 8.5
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Variable contribution cost 6.9 expected 9 modal
7.5
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10 year switching and variable contributionscost
7.2 expectation 8 and modal 8.5
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Clearly no uniquely right answer
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Fixed contribution 10 year switch and 70
equities
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Variable contributions
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Insights

• Variability of outcomes is surprising
• Late switching and fixed proportion can give
  remarkably similar distributions.
• This is changed if client actively changes
  contributions.

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Additional Point

• What is not measured is the clients emotional
  position throughout the period and this may
  implicitly be a driver for design.

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Asset position for 30 year old
Equity 10
Property 90
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Asset position for 50 year old
Income generating 30
Property 50
Equity 20
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Asset position for 70 year old
Income generating 33
Property 33
Equity 33
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Three alternatives

• Smoothed investment fund
• Guided switching
• Blind switching

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PensionSTAR - Lifestyle Strategy
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PensionSTAR - Lifestyle Strategy
Source Eagle Star
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How did it work out in 2008

• Percentage of maturities that had higher value
  compared to 1 year earlier. 87

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• What we learn from history is that people don't
  learn from history
• Warren Buffett