IF you had thought that your pension, into which you contributed cash each month for years, was going to see you live decently in your retirement, the news yesterday from Aer Lingus is a rude awakening.
Aer Lingus announced that if its pension fund were redeemed this year, employees would only receive 4pc of what they had expected. Yes, you read right: 4pc.
Hundreds of thousand of Irish workers in their fifties and sixties are coming to the end of long careers and are facing the prospect that their pensions will only be worth a fraction of what they imagined.
A great deal of wealth has been destroyed by pension fund managers who, incidentally, are still paid handsomely. For many, who have already seen their wealth — or what they thought a few years ago was their wealth — diminished by the great housing crash, the news on the pension front is shocking.
Indeed, for companies that promised their workers a big lump sum at the end of their careers, there is a major hole in their accounts, which in many cases renders the companies insolvent. The same goes for the State. The contingent liabilities stored up in company accounts from what are termed defined benefit pension schemes are enormous.
The implication of the coming pension shock will be that hundreds of thousands of Irish people will have to stay working far beyond the time they had imagined. This will have a knock–on effect on employment opportunities in companies, because the longer the older ones hang in there, the less likely there will be opportunities for young workers.
These are long-term trends. But the problem with the long-term these days is that it is coming around much quicker than many of us expected.
To get some perspective on pensions and why they are not what they used to be, let’s take a bit of altitude and see what drives pension returns. What we will see is the tentacles of the great housing, credit/banking crash extend even to places we thought were safe and the prospects for a speedy recovery are not great.
Pensions are no more than saving today for our retirement. Therefore the first thing that affects the rate of return on a pension is the rate of interest, which is the return to savings. In the past three years, the return to savings has collapsed, and so too have the incentives to save.
Central bankers around the world are all following what could be termed a zero interest rate policy. Interest rates are at all-time low levels. This global policy destroys the return to savings because it punishes savers and rewards debtors.
The easy option for the pension fund manager was to take your money and put it on deposit, generating easy returns when interest rates were high. But this is over. Usually the fund manager would find an easy and relatively low risk home in government bonds, but again the return on government bonds — the ones that are not risky — has collapsed.
This means in the bond market the fund manager has to find riskier bonds, like junk bonds or other bonds which offer a higher rate of interest. But the old adage about risk and reward comes in because if a company is prepared to offer a much higher rate of interest than the others, it must be doing so because it is inherently riskier. Pension fund managers are not in the business of taking unnecessary risks — or at least they shouldn’t be.
So the fund manager will have to put the saver’s money in the stock market because if interest rates are low, then stock prices should be rising because (a) the general economy should be improving and (b) the interest rate on an individual company’s debts and future debts is lower so that the company is benefitting.
But the problem is that the interest rate is low because the economies all around the world are labouring.
When the credit binge was in full swing, everything looked good on the outside. Bank shares and property was rising in value, turning savings into what looked like wealth. As long as the merry go round didn’t stop, pensions looked gloriously bountiful.
Now the opposite is the case. In an age of deleveraging and low inflation, the return to savings diminishes dramatically and the risk that a company or a country is carrying too much debt and will be overwhelmed by this legacy of debt means that there is risk everywhere, despite the low interest rates.
In order for the fund manager to do well, he has to take risks, but he is not good at this and as he doesn’t want to lose his job, your money goes nowhere in his hands. This is why the notion of giving your money to someone else to manage has to be something that you reassess as you look to the future.
After all, no one cares as much about your money as you do.
As the workers at Aer Lingus found out, to blindly give your savings to someone else makes him rich in fees and you poor in return.
This global backdrop doesn’t look like it’s going to change in the years ahead, so maybe it’s time to think about managing your own savings.
Otherwise, you may be working harder than you ever imagined for longer than you ever feared.