It’s the beginning of a new year, and a good time to look ahead at some of the developments we may see both in the economy and capital markets and some of the issues that will have an impact on Canadians’ plans for their retirement in the years ahead. Together, they add to an outlook for the economics of retirement in 2011.
Let’s begin with the economy and capital markets.
Some of the bigger trends from 2010 will continue to play out in 2011. Experience tells us there will be some unexpected twists and turns in these trends but it is inevitable that there will also be new – and unforeseen – events that played no role at all in 2010.
As we begin the new year, all eyes will continue to watch the European government deficit and debt crisis. Progress – or lack of it – on the part of the governments struggling to raise tax revenue and cut spending will be an important part of this story but there are two other important parts. One will be the extent to which the 16 European governments who make up the entire Economic and Monetary Union come together to set rules and penalties around how individual governments run their budgets.
Doing this will be difficult, but it would go a long way toward ensuring the future economic viability of the EMU. The core of the story – the thing that may well determine what additional actions might be necessary to shore up the countries in difficulty – will be the judgment of financial markets, especially bond markets, on progress in solving the problems. It could be argued that the financial rescue activity in 2010 directed to Greece and Ireland occurred in large measure because bond markets expressed doubt that the individual governments could or would solve the problems on their own.
A second trend to watch will be the economic recovery, and economic policy, in the United States. There is much more optimism now than a few months ago that the recovery will continue. That optimism is for good reason. Consumers have continued to make a contribution to economic growth and are likely to make a bigger contribution in 2011, especially if the modest improvement in the U.S. labour market continues – and hopefully, strengthens – in 2011. U.S. businesses have been investing in capital equipment and are likely to step up the pace. It’s not all roses though, as the U.S. housing market continues to remain a concern. Although housing prices have stabilized from their sharp fall in 2006 through 2008, end-of-year releases showed some modest declines compared with the fall of 2009.
On the economic policy front, the most prominent issue will be progress in achieving a credible, long-term plan to reduce the U.S. Federal budget deficit. A second issue – one recently announced as part of the Administration’s economic agenda – is the plan to deal with the increasing income inequality in the United States. Solving this might not seem of much interest to investors but it is part of ensuring the economic underpinnings exist to make investing in the U.S. worthwhile. Both of these are long-term policies and we shouldn’t expect much in the way of near-term results, although markets could react quite favourably to a credible budget-deficit reduction plan.
A third trend to watch will be economic growth and inflation in the emerging economies in Latin America and Asia. The economic policy challenges in these areas are different than the ones in Europe and the United States. Particularly in Asia, the problem is inflation – an off-shoot of strong economic growth. Both India and China face this problem and both countries have been taking steps to keep inflation in check by raising interest rates and putting some curbs on bank lending.
This isn’t just a domestic Asian issue. Getting inflation under control is crucial not only for the health of the countries directly affected but also for the many countries in the rest of the world that look to sell their exports in these fast-growing markets
Let’s turn to prospective developments around retirement itself. One that is heating up is public policy. Retirement policies have been discussed for several years among governments, think tanks and academics, but so far, it has been pretty much all discussion and little in the way of action. The single most significant issue is that far too few Canadian workers – only about four in ten – participate in a workplace pension plan. Simply stated, governments are anxious to close that gap. At a meeting of the Federal and Provincial Finance Ministers in December 2010, Federal Finance Minister Flaherty proposed the creation of pooled pension funds operated by private-sector financial institutions. Going into the meeting this idea was touted as an alternative to an enhanced Canada Pension Plan (CPP). Coming out of the meeting, it appears that pooled pension funds are a go. An enhanced CPP is not necessarily dead, but rather one that is to receive more study with a report on the subject to be presented at the June 2011 Finance Ministers’ meeting.
While details about the proposal were still sketchy as this article was being prepared, some important aspects have emerged. Basically, the investments and administration of the new pension plans would be handled by ‘regulated financial institutions that are capable of taking on a fiduciary role’. The Department of Finance release indicates that this means insurance companies, trust companies and other financial institutions with a trust subsidiary.
From the perspective of those making retirement policy in Canada, the proposal achieves several goals:
- While one of the two plans proposed will involve the employer doing some of the administration, collecting the employee contribution and potentially contributing themselves, it will also be possible for workers to use a second plan and enroll either as an employee whose work place doesn’t have a plan or as a self-employed individual. Not only does the proposal make it possible for self-employed individuals to join a plan, but it also relieves employers – particularly small- and medium-sized businesses – of the responsibility of sponsoring and running a plan, which some may not want to do. An additional nudge toward participation on the part of employees is the apparent intention to require a specific opting-out process for those who don’t want to join.
- The policy makers likely see the use of pooled funds as a means of keeping risk contained and costs down.
- Having the private sector financial institutions run the plan (presumably under some government supervision) means less government bureaucracy and government spending than would be required under a public system. A government intent on moving back to a balanced budget would surely have considered this.
- It is apparently easier to get agreement with the provinces to initiate a private-sector plan than it would to add to the Canada Pension Plan.
A second development around retirement – spurred partly by discussion of the proposed pooled pension plans – is likely to be renewed discussion and debate on how to save for retirement. In other words, should clients think primarily in terms of the replacement of pre-retirement income levels, should they focus solely on expected expenses or should there be another approach entirely? Part of this discussion will revolve around whether there actually are simple, universal rules or whether each client’s situation is unique. I will be contributing to this discussion in a future column, both in terms of the specifics I mentioned above and the question around whether the industry should be highly prescriptive in its advice – do this regardless of your situation – or highly cognizant that every client is unique.
The third area of discussion that I’m expecting is around retirement income. Even though the great market correction is fading from some client’s memories, it is still fresh for many. Fidelity recently updated its ground-breaking research on the Five Key Risks to Retirement Income. In the coming months, I’ll report on what we found, in particular, what was changed by the global financial crisis and economic recession and what wasn’t.
Together, these trends point to a very busy year ahead for financial advisors. I look forward to weighing in each month to help provide you with perspectives on each of these important issues so that you can, in turn, help your clients make sense of the economics of retirement in 2011.