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Education no substitute for good default – Harvard academic

GLOBAL - Financial education and matching contributions from employers for DC schemes will not help raise the pensions savings rate, David Laibson, Professor of Economics at Harvard University, has suggested.

Speaking at Pioneer Investment's European colloquia event in Vienna last week, he said people's retirement saving pots could only be filled with default solutions which make it hard for people not to participate.

"Matching contributions are a socially expensive way to achieve very little," he explained.

Similarly, "financial education is a very expensive and weak lever for making changes," Laibson added, albeit stressing he was not against educating people.

"Even if they understand the problem and the subject their follow through is abysmal and only slightly better than that of the next person," he cited as findings from his studies.

His explanation is people value future benefits only half as much as benefits they can get in the present.

"Individuals have problems judging probabilities and future retirement needs," Nobel Laureate Joseph Stiglitz also said at the same event.

"Defaults are a natural solution to this problem as they are a powerful tool to ‘manipulate' behaviour," Laibson noted.

However, he warned he believes many default funds are constructed "wrongly", for example, with too conservative asset allocation, leading to a much lower savings rate.

Laibson wants default funds to be tailored to each company's needs with the government providing minimum standards for the solutions.

"Governments need to build parameters which exclude nasty defaults," he explained. "But within these parameters companies should be able to choose."

He noted it was "difficult to know what is good but very easy to know what is wrong" such as a money market fund with 2% contribution rate.
 
Judging good from bad is also a problem for people when they assess advice given on retirement plans, Stiglitz added.

"People often fall prey to advice some of which is exploitive as asset managers and distributors often seem to have an incentive to increase their profits by exploiting people's ignorance and living - mildly - off reputation," the 2001 Nobel winner pointed out.

He urged regulators to "identify deceptive and unacceptable practices" by asset managers. As one example, he suggested firms hiding bad assets in complicated instruments should to reviewed.

"Better regulation will help restore confidence in the market," Stiglitz is convinced.

The economist noted it was important to "give individuals the right to choose as, firstly, they value choice and, secondly, they know more about themselves than anyone else".

If you have any comments you would like to add to this or any other story, contact Julie Henderson on + 44 (0)20 7261 4602 or email julie.henderson@ipe.com

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