The overlooked failure in pension markets

Public economics textbooks have lists of reasons why pension markets fail. 

People aren't aware of the need for for retirement savings, either because they're short sighted, or have limited cognitive abilities. Annuities markets fail, because only people who know they are likely will live a long time will choose to purchase annuities. Private markets may fail to provide adequate indexation for inflation. Finally, the outcome of a competitive private pension market may be unacceptable on equity grounds: some people's earnings are so low that they have no money left over for retirement savings.

These are all serious issues in private pension markets.

But the standard analysis often overlooks another source of market failure: financial industry moral hazard.

Think, for a moment, about what many people do when they save for retirement.

They give $100,000 or $500,000 or $1,000,000 to a financial advisor or mutual fund manager, and say: "take care of this for me, make it grow, and give it back to me in 20 or 30 years time."  What could possibly go wrong?

Moral hazard, that's what.

Moral hazard occurs when a financial advisor or manager uses an individual's retirement savings to further the advisor's or manager's own interests. 

Bernie Madoff and Earl Jones exemplify the most extreme form of moral hazard: taking other people's money and using it to support a lavish lifestyle, rather than investing it. Such gross moral hazard is, fortunately, relatively rare.

But little scams, minor forms of moral hazard, are common. 

One example is inflated management fees, for example, on mutual funds. The moral hazard at play here was nicely summed up by Rob Carrick in the Globe and Mail. He wonders "why investment advisers aren’t bigger advocates for lower mutual fund fees, which would instantly raise the returns of their clients. Oh, wait – lower fees might mean lower commissions for advisers." It's using an individual's retirement savings to further the adviser's own interests. 

Another example of moral hazard is the creation of complex financial instruments that provide inferior risk/return combinations. Index-linked GICs are one example. If you tell a financial adviser that you are a conservative investor, you don't know that much about financial markets, and you are concerned with long-term growth, the odds are fairly high that they will recommend purchasing an index-linked GIC. The return on index-linked GICs is, as the name suggests, linked to various stock market indices, so if the market goes up, you get a reasonable return - higher than the return that you would get on a standard GIC. But if the market tanks, your investment is protected: you will still retain your capital. What could go wrong?

These products will not generate a positive return unless the stock market does well, better than it has in the last little while. As Rob Carrick put it "They’re engineered to be good little money makers for the people selling them, not the people investing in them." 

I could go on, but won't. It's not like I can give anyone financial advice (I just wish I had followed the advice my father gave me: put your money in a discount brokerage account and, if you want a conservative investment choice, buy strip bonds). 

There are two interesting economic questions that arise from financial industry moral hazard.

First, what are the consequences for savings behaviour?

Low-level moral hazard - high mutual funds fees, inferior investment products - reduces the rate of return on investment. Theoretically, a lower rate of return has an ambiguous effect on savings. It might seem obvious that, when returns are low, the rewards to savings are smaller, so people would save less. But if people want to guarantee themselves a minimum post-retirement standard of living, a lower rate of return means that one has to save more to achieve that retirement-ad lifestyle. 

It is surprisingly difficult to find a clear-cut answer to the question "if the interest rate falls by x percent, how much more or less will people choose to save"? One relatively clear piece of evidence comes from the introduction of individual retirement accounts, like Registered Retirement Savings Plans, which caused large reductions in the tax rate on savings, thus increased the net return on savings. The general consensus is that these plans did increase saving rates, but the exact magnitude of that increase is less well established.

So the answer to the first question is: given what we know about the responsiveness of savings to changes in interest rates, moral hazard on the part of financial advisors would be expected to decrease savings, both because people will choose to save less, and because they will achieve a lower net rate of return on their investments. Decreased savings could have further impacts, for example, causing people to delay, postpone, or even forgo retirement.

The second question arising from financial industry moral hazard is: can governments do better?

Governments provide pensions in one of two ways. Pay As You Go (PAYG) plans use current contributions to fund current benefits. The Canada and Quebec Pension Plan were, when they were first introduced, PAYG plans. The moral hazard risk a worker faces with these plans is political: a politician will design the plan so as to maximize his or her chances of re-election.

The design of Canada and Quebec Pension Plan has created large benefits for the first generation of recipients (current voters) and a much lower rate of return for future recipients (future voters). Now those gainers were the generation that entered the labour market in the Great Depresion and fought in World War II, so one could argue that the windfall gain they experienced was merited on equity grounds. The point here is merely that the design of PAYG pension plans reflects the interests of the designers (for re-election) as well as the interests of the contributors and recipients.  

The Canada and Quebec Pension Plans are now transitioning from pure PAYG to partially funded plans. The Canada Pension Plan Investment Board was, as of June 30th 2011, managing $153 billion in assets. Some is managed directly by the board, the rest is managed by "partners" ranging from Istanbul-based Actera Group to New York-based Welsh, Carson, Anderson & Stowe. I suspect that the CPP, roaming the world with billions to invest, is able to negotiate low management fees, and there must be savings associated with economies of scale in investing. But the possibility of moral hazard - someone getting rich by diverting away a tiny percentage of the return on $153 billion, or a politician exerting pressure on the CPP investment board to make electorally-sound investments - remains.

In sum, while private pension markets suffer from moral hazard, it's not clear that governments can solve the problem. 

So what's the answer?

One solution is for an average person to manage his or her assets directly. As Nick Rowe has argued, the most direct form of asset management is looking after stuff: repairing your house, caring for your car, going to the gym to look out for your human capital. But it's costly, you might argue, I don't have time.

And that's true. But it takes a fairly high rate of return on equities to sustain current levels of management and and advising fees. If equities continue to perform poorly, the standard model of retirement - get a job, work hard, save, get someone else to look after your investments - may no longer be sustainable.

There are, as I see it, three possible alternative scenarios. One is that people won't retire. The second is that people will save by becoming capitalists, by investing in their own businesses, homes, other assets. 

Finally, the financial management industry might choose to discipline itself through tighter regulation, monitoring and information disclosure. There have been changes in recent years - discount brokers, for example, have led to large reductions in brokerage fees. Perhaps one positive side-effect of the current equity market situation will be greater scrutiny of the financial management industry. 

Comments

[Stephen Gordon]

Yep. Those fees have the same effect as a tax on the return on saving - and those taxes are typically the most harmful.

[Joseph]

Even worse, fees are often hard to find and instruments can be designed so they stack. So, for example, 401(k) plans may have management fees as might the individual funds permitted by the 401(k). Even more interesting, the 401(k) or 403(b) may dictate a list of investment options -- some of which may not be ideal choices.

[Patrick]

Don't have much to add, so I'll gripe ...

So I do what should be all the right things: get a self directed registered discount brokerage account, make automatic deposits to it, find ETFs and funds with low fees, etc ... and they f'ing charge me $30 every time I buy or sell anything (which isn't very often). It should cost pennies.

And of course GS et al need to make millions of trades every second for free, or the world as we know will end.

I keep trying to be a capitalist, but they don't make it easy to join the club.

[Rachel]

I manage an RDSP, Registered Disability Savings Account, for a man with significant disabilities. My investment choice would be to do as you suggest, Frances, and put the money into a low fee brokerage account and invest in strip bonds. But I am not allowed to. Instead I must choose from an very limited line up of mutual funds. I chose the market linked one you described and gnash my teeth at paying the management fee. But no one will complain forcefully because the lion's share of the investment money is coming from the government. This program that the government can claim is for the disabled is also a big hand out to the banks.

[Frances Woolley]

Joseph, Patrick - yup, I've had those same experiences too. At one level the point that I'm making in this post - management fees are high, they stack, they're hard to avoid - seems pretty obvious. But you'd be surprised - when you pick up Rosen et al, Public Finance in Canada, which is the textbook with the lion's share of the Canadian public economics market, there's a whole list of possible problems in pension markets, and the potential for moral hazard on the part of financial advisers and managers isn't even mentioned. And that's pretty typical. This is why I wrote this post - to fill that gap.

Patrick - to those that hath shalt be given - if you can consolidate all of your various plans (RESPs, RRSPs, TFSAs, spousal plans etc) with one brokerage you might be able to bring the total up to a point where you're eligible for a lower fee schedule. It's just like with a regular chequing account - there's a big payoff to being able to hold a balance just high enough to eliminate all fees. Though to tell you the truth I'm totally hopeless at all of this financial management stuff too so you shouldn't follow my advice.

Rachel - this is a really excellent point. The same issue arises with Registered Educational Savings Plans and things like the Canada Learning Bond. As you say, these things are a boon for the financial services industry.

[Determinant]

Spot on Frances. I cannot agree more and this issue needs to be talked about. I used to have a life insurance license, I don't anymore. The best I can characterize the industry is that they are pirates. On occasions useful pirates, but pirates none the less. Never for get that. The pay structure on commissions, overrides and trailers forces the players to behave that way.

Looked at another way, for every product there is a small group of people it can genuinely help, a larger group of people who are indifferent to it and a final group to whom the product is downright damaging. As an adivsor you can't make money only dealing with the first group, you are paid to sell to the second group. If you can do this well you can make a living. If you can sell to the third group and not get in trouble for it then you are a "rainmaker".

Further the hefty commission structure embedded in life insurance and retirement products is seen by advisors as compensation for the "convincing" stage; they see their job as motivating people to see the necessity of their products and then to buy them.

This is further compounded by the chronic problem of pension structure in Canada. Everybody in the industry, in the financial education world and in the Department of Finance understands Canada's retirement system as a three-legged stool: Government programs, employer-provided plans and individual savings arrangements. Government programs work and work well, individual programs are OK but really need cheaper fees and a bit more education to implement them properly. Employer-based plans are nothing short of a disaster.

Originally in the 1960's and 70's employer-based plans were defined-benefit and Canada's retirement policy was designed around this. They aimed to provide 60-70% coverage of re-retirement income. However DB coverage in the private sector now hovers at 10% of workers. Defined-Contribution plans can work if they are funded enough, usually at least at 15% of pay, but most employer plans come nowhere near this level.

Classically costs could be contained in employer plans through scale, the financial industry also liked employer-based plans as you can sell them in the daytime and groups are large. It was a nice complement to group health benefits. But employers have backed away from this model.

RRSP's can work well in the presence employer plans, but experience has shown that they fail miserably when tasked to replace all or most of the employer-based contribution space. The fees are high and the advice is frequently terrible. Honestly, a mutual fund rep in Smalltown Canada has no chance of providing a good pick consistently. It just doesn't happen.

However, all is not lost. Look at the Saskatchewan Pension Plan, a non-profit plan set up by the Government of Saskatchewan. It is DC, is fully covered by pension legislation, has an MER of 1% for its only fund, a balanced fund, and provides annuitization in-house. The don't pay commissions. It's the prototype Pooled RPP. For what it is I think it is the best in Canada at providing a good option for employer-based (paycheque-based) pension coverage.

[Patrick]

On the employer side of things, I'm fortunate enough to work for a firm with a DC pension. It's very modest, but the thing that really bugs me is that the money is stuck with the financial company managing the pension, and we can only buy from a list of about 8 funds - almost all of them high fee losers. My picking strategy was simple: scan the list for the one with the lowest MER. Of course it was a TSX indexed ETF. I figure I'll check it in 30 years or so.

It would be SO much better if they'd just deposit the money in my brokerage account and leave the parasitic financial company (who brings no sunshine to my life) out of it completely.

[Nick Rowe]

I like this post. No useful comments. But did you know there's a debate currently raging in the US econoblogosphere about whether Social Security (which I think is their version of CPP/QPP?) is a Ponzi Scheme (PAYGO)?

[Frances Woolley]

Nick - "But did you know there's a debate currently raging in the US econoblogosphere about whether Social Security (which I think is their version of CPP/QPP?) is a Ponzi Scheme (PAYGO)?"

I thought that it was generally accepted that any pay as you go plan has Ponzi-type elements in it. The example that's always given is the first ever beneficiary of Social Security, Ida May Fuller, who paid into the plan for three years prior to her retirement - and then lived to be 100. According to Wikipedia "By the time of her death, Fuller had collected $22,888.92 from Social Security monthly benefits, compared to her contributions of $24.75 to the system."

It's just a question of how far out of line promises and reality are.

CPP/QPP is much less generous than Social Security on the benefit side, and benefits are lower relative to contributions. Most people don't realize that, even if they've been paying the maximum into the fund for 25 years, i.e combined employer/employee contributions of about $4,000 per year, they'll only get about $10,000 per year in benefits (assuming no divorce).

CPP/QPP projections assume on-going growth in average wage rates of 1% per year and real returns on the CCPIF (canada pension plan investment fund) of 4% and something that I don't remember about employment rates. As long as those hold, CPP will be able to keep its promises, such as they are.

Determinant, thanks for the kind words and the useful insights, those remarks about the three pillars are spot on.

Patrick - and because you have that DC pension, you don't have economies of scale/low fees in your other plans.

[Determinant]

Yes, I know. Please can we leave that sleeping dog where it is? It is an extremely unedifying debate. Plus Canada doesn't use that system for pensions anymore, OAS is a direct obligation of the Consolidated Revenue Fund, it doesn't have a special funding account.

Further to Patrick's comment, I also worked for a while for a firm with a DC pension. The funds weren't bad but it was a call centre. You had to go enroll during your break. And don't be one second late, they deduct your pay for that. There was no chance of getting real financial advice in that situation. I would venture most of my fellow employees may as well have been investing blindfolded.

That's why I like the SPP where there are no investing decisions. DB plans of course do not present investment decisions to employees, this was an attraction for both investment firms and governments as it meant that firms could confine their sales efforts to company directors and governments could count on employees having DB plans to keep them in retirement.

Few people are honest enough to admit how bad they are at investing. I have no mind for it. If I do buy a fund for myself, it would amount to speculation. This is why I really, really like the SPP's format. One balanced fund, a classic pension fund at heart.

Also there is another proto-Pooled RPP in New Brunswick. Assumption Life runs a Multi-Employer Pension Plan for businesses in Moncton. It is an open plan like the SPP and Assumption Life handles everything. Small business owners just have to subscribe and remit deductions. It has a bigger set of options than the SPP but there is the option to check "go with Investment Board decisions" so you do get a real pension manager in that plan.

What can I say, I am an fan the Saskatchewan Pension Plan. It makes sense, a lot of sense, as a concept.

[Determinant]

Cross-posted with Frances:

Before condemning CPP, you have to put it in perspective. Social Security provides more than just the equivalent of CPP benefits, it is also a poverty-relief system like OAS. The true equivalent in Canada to Social Security is OAS+CPP.

In the US they bundle the two programs into one with a single funding base: FICA payroll taxes. They also have a single account, the Social Security Trust Fund.

In Canada, OAS is unfunded, it is a direct obligation of the Consolidated Revenue Fund and is paid for with current tax funds, just like any other government program.

CPP since its reform is managed as a defined-benefit pension plan with compulsory and universal membership. It has an earnings and contributions related benefit formula and a pension fund.

You have to take note of the subtle differences.

Finally, the Three Pillars concept is standard fare in all Canadian financial planning books and policy documents about the retirement system. I didn't invent it, it is the standard theory taught to everyone in the literature.

[SimonC]

Good post - nothing good to add.

Patrick: Is purchasing low fund index mutual funds (TD Bank eFunds come to minds) on a regular basis and selling them only once every year or two to buy the ETFs an option? This might be a way to save on those 30$ fees...

(disclaimer: not a financial advisor)

[Frances Woolley]

Determinant: "I didn't invent it,"

It's standard in econ textbooks also. Interestingly, people differ in what they put in each pillar, but there are never more than three. It might be that three pillars conveys just the right image: it's stable, but if you get rid of one pillar the whole thing will collapse.

[Determinant]

It's also used in a different way to analyze government participation in various retirement provisions.

In this case Pillar 1 is pure government benefits. OAS is a plan, it is based on age, residency in Canada and is funded with current tax revenues.

Pillar 2 is contributory government plans funded through payroll deductions into a dedicated fund. Benefits are proportional to contributions and therefore income. No income, no contributions, no benefits. This is CPP.

Pillar 3 consists of private registered plans which are granted tax relief on contributions, RPP's and RRSP's. These voluntary plans funded through tax expenditures.

Speaking of which, it should be outrageous that the financial industry captures a hefty portion of tax expenditures though high fees. That's skimming the government.

[Determinant]

Good post - nothing good to add.

Patrick: Is purchasing low fund index mutual funds (TD Bank eFunds come to minds) on a regular basis and selling them only once every year or two to buy the ETFs an option? This might be a way to save on those 30$ fees...

(disclaimer: not a financial advisor)

Generally not. Most mutual funds have trailing fees which decline with time. Regular selling after such a short holding period would cost you. "Deferred Sales Charge" or whatever the particular structure used is.

Frequent selling, aka churn will get you nailed with these fees. Plus many RRSP holding institutions will further charge you for making a transfer with registered funds.

My feeling it it wouldn't be worth it because you'd get eaten by the trailing fees. Churn is the enemy of registered investing.

[Declan]

"The Canada and Quebec Pension Plans are now transitioning into fully-funded plans."

Really? My impression was CPP was about 20% funded. Wikipedia suggests it will increase to 30% by 2075, but I wouldn't characterize that as 'transitioning into a fully funded plan.'

"I suspect that the CPP, roaming the world with billions to invest, is able to negotiate low management fees, and there must be savings associated with economies of scale in investing."

There's no need to rely on your suspicions, here's a footnote from an excellent discussion paper on retirement options from the B.C. Ministry of Finance - footnote 31 reads,

"In the Canadian mutual fund industry, MERs in the order of 2.5% of assets under management are common, particularly at the retail level. By comparison, 0.5% is the benchmark for large, expertly managed DC pension plans including administration costs. Investment management costs for a large DB plan are in the order of 0.25% to 0.45% (Jog, 2009, p. 15). MERs for the CPP are approximately1.10% of assets under management for 2008/09, and are expected to decrease with the growth of the fund."

You list three alternative scenarios, but a fourth seems obvious, expand the CPP, maintain oversight to reduce the moral hazard.

"In sum, while private pension markets suffer from moral hazard, it's not clear that governments can solve the problem."

Actually, what seems clear is that the problem is solved as best it can be when people's savings are managed through professional funds that achieve economies of scale and are held to a sufficient level of oversight. Which is pretty much the current system, only as time passes, fewer people are being covered by corporate plans due to increased competition in the marketplace, so there is a role for the government to expand and fill the gap that is being left. It's similar in a way to the need for the U.S. government to expand it's government run health insurance to fill the gap left by their unravelling corporate system.

[JW Mason]

while private pension markets suffer from moral hazard, it's not clear that governments can solve the problem.

*boggles*

This is like saying, "while you can't fly by flapping your arms, it's not clear that airplane wings can work any better."

In every single rich country, and quite a few developing ones, government pensions are the main source of retirement income for the great majority of people. Such programs have operated successfully for many decades now, with no Madoffs, and with a performance that's far superior to any private savings vehicle in terms of overhead costs. Of course the returns aren't as high -- but it's mathematically impossible for society as a whole to have investment returns higher than what can be realized through a PAYGO system. Moreover, public pension programs are enormously popular everywhere they exist. Yes, of course politicians design them to win reelection. That's not a criticism -- it's how democracy is *supposed* to work! What's your alternative? A benevolent dictator who listens to economists, naturally, and ignores public opinion?

There's a reason why old-age insurance is handled so consistently by the public sector. And there is a reason why this arrangement enjoys such overwhelming public support. To not recognize old-age provision as a core competence of the state requires ignoring the entire history of pension provision. Yet look at the final paragraph. Of the three possibilities, two are choices by individuals and the third is self-regulation by the financial sector. Evidently the idea that government might perform its largest function can't even be acknowledged as a possibility. It's an unthought.

This post isn't science, even social science. It's religious dogma.

[Determinant]

Right, Delcan. CPP is transitioning into what the QPP always was, an earnings-based government superannuation plan secured by both contributions and investment fund returns in market activities.

Formerly the CPP's investment fund was invested solely in federal and provincial government bonds. It was thus tied to the general economic performance of Canada and was as such a pass-through superannuation plan with a lag in the investment fund.

CPP's new policy allows returns from outside Canada and greater returns than the rates offered on government securities. These higher returns, plus the higher contributions we pay are what allow CPP to meet its forecast actuarial expenses for the next 75 years.

When Frances criticizes the CPP as a poor return, I can't agree with her analysis. DB pensions, and the CPP is a DB pension, carry implicit default risk. A DB pension with lower contributions means it has a higher expected rate of return. It is either taking a higher investment risk profile or promising unfunded benefits. Either way the default risk of the pension increases.

CPP is expensive but it has a very low default risk and not because of its government sponsorship. It is because its assumptions are low, reasonable and its contribution base is broad.

UK pension literature is replete with examples of defaulted DB pensions whose managers took excessive equity risk and lost heavily.

My disagreement with Frances is that her analysis does not consider a pension plan's default risk fully.

[Frances Woolley]

Declan - Yes, your'e right, I should have been clearer on this one.

CPP won't ever be fully funded in the sense that it would pass a liquidation test, i.e. be able to pay out to everyone the value of their contributions.

At the same time, you have to read this stuff carefully. When it says " "MERs for the CPP are approximately1.10% of assets under management for 2008/09, and are expected to decrease with the growth of the fund" you have to remember that the CPPIB has a good chunk of the portfolio invested in bonds, real estate, etc., and these should have much lower MERs. The relevant question is: what's the MER on the assets that are actually actively managed?

As I understand it, the long term story on CPP is basically this:
- the first cohort of CPP beneficiaries collected on the Ponzi element of the plan - getting out far more than they paid in.
- Now CPP is going to gradually accumulate assets until the last of the baby boomers retire, which is in the year 1962+65=2027 (or you can round it up to 2030). Then it will gradually spend down the assets paying for the boomers retirement. So people who are contributing now are paying for both their own future benefits and the benefits received by current retirees.
- eventually the Ponzi element of the plan will disappear and people will basically get a return from CPP that reflect their own contributions. That's what I was trying to say with the fully funded bit.

JW Mason -

It's strange. This post is designed to explain to my students why there are limits to the ability of private markets to provide public pensions. Religious dogma is clearly in the eye of the beholder.

[SimonC]

Determinant: Generally not. Most mutual funds have trailing fees which decline with time. Regular selling after such a short holding period would cost you. "Deferred Sales Charge" or whatever the particular structure used is.

Frequent selling, aka churn will get you nailed with these fees. Plus many RRSP holding institutions will further charge you for making a transfer with registered funds.

My feeling it it wouldn't be worth it because you'd get eaten by the trailing fees. Churn is the enemy of registered investing.

I dont really want to turn this into a personal finance forum, but those eFunds have no buying fee, no selling fees after a 90 days minimum holding and a MER (0.33%) that rivals that of ETFs. That's why I was suggesting to buy those mutual funds every pay (free), sell them once a year (free, because you dont sell the ones bought in the last 90 days) and then buy the ETF (lower MER, but 30$ fee upfront).

(http://www.tdam.com/Download/TDB900E.pdf)

[SimonC]

(again I may also be terribly wrong)

[Kien]

Sorry I haven't had time to read the comments. I think there should be a public option. Also, the issue of excess e management fees has been identified as a major concern in Australia. Alas, the government isn't offering a public option even though Australia has a decent sovereign wealth fund that I (as a taxpayer and citizen) would like to invest in if that were permitted. After all, why pay a management fee to a private mnager when the government already pays a king's ransom to an ex banker for doing not very much?

Kien

[Bob Smith]

Patrick,

Simon C is right that the TD E-series funds are a great product. In fact, for small periodic investments they're competitive with most ETFs. Their fees aren't as low as the cheapest and largest ETFs - they're typically in the 30-50 basis point range - but coupled with the absence of brokerage fees, they're competitive (I use them for my kids RESPs). TD does a terrible job of advertizing them (and if you want to invest RESPs in them, you have to jump through no end of hoops), but they're fantastic.

On the other hand, you might also try the Claymore ETFs. Although I haven't used it, I gather they've set up a pre-authorized cash contribution scheme to allow investors (once they acquire initial units) to make additional investments directly without brokerage fees (see http://www.claymoreinvestments.ca/en/investment-options/exchange-traded-funds/etf-drip/investment-services). Their funds are generally slightly more expensive than the bigger Fund families (like Ishares or BMO), although still generally much less than 1% and often more specialized, but arrangements like their PACC scheme (as well as a corresponding systemic withrawal scheme, to get your money-out without selling units) may make those extra fees worthwhile for retail investors.

If your "discount" broker is charging you $30 a trade, it's time to make a move. There are a number of true discount brokers who charge $5-10 per trade (and don't change other fees), no matter how many trades you make or the size of your portfolio (I use questrade, but there are a number of others, check out Rob Carrick's annual ranking of brokers to get a sense of what's out there). While you don't get much in terms of support from true discount brokers, I mostly only invest in ETFs, so what do I really need?

Finally, Determinant is right that the Saskatchewan Pension Plan is a remarkable gem in the financial sector. Anyone can invest in it (it isn't restricted to residents of Saskatchewan) and it offers what is, essentially, a defined contribution pension plan with a relatively respectable long-term track record. The downside is that annual contributions are limited to only $2500 a year. Still, given the savings rate of most Canadians, that restriction isn't likely to bind a lot of people. Its worth thinking about as an option.

[Andrew F]

The alternative is also to use a discount broker that is actually a discount broker. There are plenty of options that charge $10 and under.

As for CPP and management expenses, 1.1% of $150 billion is $1.65 billion for management. That is very substantial. Pension funds do achieve economies of scale, but there is some controversy about the CPP costing more to operate than it ought to for its size. The CPP should be able to operate in the 20 - 30 basis point range. I for one would like a better explanation of what justifies these higher expenses. I'm concerned that we have rent seeking management that are capturing most of the benefit of the economies of scale.

As far as retirement benefits, my preference would be for the CPP to be expanded in terms of income replacement. It should probably be boosted to 50% replacement at least of the first ~$40,000 of income (or perhaps less). The rest of retirement saving should be covered by voluntary plans. I'd support BE-style nudging with a DC plan including auto-enrollment, auto-portfolio allocation and auto-annuitization at retirement with opt-outs. Essentially, help to break people out of analysis paralysis and try to save people who don't really know what they are doing from paying 2.5% MER at their friendly local banking or insurance conglomerate.

[Determinant]

The UK has recently implemented that very idea, Andrew. The plan is called NEST. It has all the features you mention.

[Frances Woolley]

Andrew F: "As far as retirement benefits, my preference would be for the CPP to be expanded in terms of income replacement. It should probably be boosted to 50% replacement at least of the first ~$40,000 of income (or perhaps less)."

If there is something like that, and it's compulsory, I'd like to see something the expanded benefits coming a little closer to actuarial fairness than CPP is at present.

[Patrick]

Thanks Simon C. Agree about TD-e and Claymore.

The "discount" broker is TD Waterhouse - I got the account years ago (when I knew less then I do now). M

Andrew F: Moving is not easy or free ... And those fees you don't sound right for a registered account that can buy/sell mutual funds, stocks, and (optionally) fixed income. Last I checked the options were basically limited to something attached to one of the big banks or Questrade, and they all have about the same fee structure. Are you think about high net worth individuals? That ain't me. I just barely got to the point where the wave my maintenance fees. Anyways ... maybe it's time to have another look around.

BTW those maintenance fees are another travesty that need to be regulated into oblivion. We want people to save, so when they finally get started the broker rewards them by taking $100 a year of their savings! That could easily make them POORER than had they just stuck the money under the mattress!

ARGGH! I really hate the big banks for this kind of crap.

[Bob Smith]

"I'd support BE-style nudging with a DC plan including auto-enrollment, auto-portfolio allocation and auto-annuitization at retirement with opt-outs. Essentially, help to break people out of analysis paralysis and try to save people who don't really know what they are doing from paying 2.5% MER at their friendly local banking or insurance conglomerate."

One one level, I like this idea, since I think it would induce people to save more.

On the other hand, I worry about the incentives in play with it. After all, the same inertia that discourages people from saving without a "nudge" might also result in poor monitoring of the management of such a DC plan (particularly if everything is done automatically). In the absence of competition, I'd be quite worried about feather-bedding by the plan manager with a large pool of "captive" capital. Granted, there's the same concern with the CPPIB, but at least there is single large investor with skin in the game, namely the federal government (since, if the CPPIB screws up, CPP benefits will either be paid out of general government revenue or else be cut, at significant political cost to the government of the day). In a single large DC plan, the cost of screw-ups would be borne by investors, rather than the government (who can, credibly, claim that they aren't responsble for monitoring it). Also, although the CPPIB has managed pretty well so-far, I have a nagging suspicion that once those funds get big enough, their investment decisions will inevitably be subject to political influence.

In some ways, I think the 2.5% MER is already on the cusp of being a thing of the past. In it's time, the traditional fund industry was a revolutionary "technology" which made the stock market and other relatively sophisticated financial instruments accessible to Joe Q. Public saving $50 a month. While we think of the 2.5% service fees as being hefty, compared to, say, brokerage fees of the late 1970's, they actually made investing quite affordable. But the technology continues to change. With the advent of online brokerages and banking, the days of the traditional mutual fund "advisor" (read: salesman) collecting his 1% service fee (a big chunk of the MER) are numbered, as investors start investing on their own.

I suspect that funds are going to be a lot more aggressive in pushing down costs in the near future, in light of (a) increased competition from ETFs (b) the pending entry of Vanguard into the Canadian market (initially through ETFs, but we'll see), and (c) increased awareness of fees in a slow-growth environment (a 2.5% MER hurts a lot more when you're earning 4% a year than it does when you're earning 10%), . For most funds this will initially take the form of increased use of "F-Class" units. At present, investment in these units is generally restricted to large institutional investors or to investors who hold their funds through fee-for-service advisors, but expanded access to that class of units would be the easier way for Funds to slash their "retail" costs (and it would be borne entirely by advisors, not the Fund manager). The Fund giants are reluctant to go that route out of a (quite reasonable) fear that advisors who rely on service fees would avoid their funds (there may also be regulatory issues, although I doubt those pose an insurmountable barrier), but as it becomes easier for Canadians to invest without an advisor and as low-cost competition becomes more aggressive, they're not going to have a choice.

[Bob Smith]

Patrick,

I agree with you, and it's even more obnoxious when the US brokerage subsidiaries of the same banks who charge us $29 bucks a trade, have flat-fee commissions that are a fraction of that. So much for "National" champions.

Seriously though, shop around. Althought there big full-services brokerages are all more or less the same (although some have become slightly more aggresive on pricing in the last year), the true discount brokers generally don't charge much beyond trading fees (and even those are, literally, pennies a share). At questrade, it's $5 a trade (no minimum number of trades) with no maintenance or administration fees (for both registered and un-registered accounts). You can also hold mutual funds (they charge you $10 a "trade" but reimburse you any service fees they receive) or bonds (at goofy cheap fees, although I have no idea what their bond pricing is like).

[Determinant]

Meh. I'm honest enough with myself about my investing skills that I will satisfy myself with the Saskatchewan Pension Plan if my future plans work out *knocks wood*. I would still live in Ontario, not that that's a barrier. I have a small amount RRSP room from my early jobs I want to fill out and I am not a trader. I have looked at it thoroughly, it really is everything I want in a pension plan.

[Andrew F]

Not to turn this into a discount broker comparison shopping thread, but Questrade also has tighter bid/ask spreads for CAD:USD exchange than most/all of the big bank brokerages. You can trade mutual funds (IIRC at $20/trade), though I'm not sure why you'd want to. Fixed income has the 'fee' for trading the security built into the bid/ask spread. You don't pay any additional commissions at any broker that I am aware of.

[Andrew F]

"The UK has recently implemented that very idea, Andrew. The plan is called NEST. It has all the features you mention."

It sounds like the UK has a solid government at the moment, then. Between this and their post-secondary education reforms, they certainly have me looking forlornly across the pond when I contemplate the populist mess we have here in Canada.

[Determinant]

It was a Labour idea and the British Tories apparently aren't keen on the idea. British pension politics rivals only NHS debates for opacity, fierceness and sheer pig-pigheadedness.