Wednesday, November 16, 2011

Super is a con, perpetrated by people who con themselves

Wednesday column

Whatever happens in Europe we can take comfort from the knowledge that our money is being handled by professionals - experts who’ll know what to do.

They do, don’t they? It’s about to become more important.

Wilful blindness by the government and spinelessness by the opposition have ensured the amount of compulsory super we are forced to hand over to money managers will climb from 9 per cent to 12 per cent of our salaries by the end of the decade (unless we run self-managed funds and try to make a go of financial markets ourselves, something that won’t happen on a large scale and would unmanageable if it did).

Many of us will have to take out larger mortgages than we would have and hold them for longer in order to feed the money management machine. We won’t have the income we would have to pay them off.

Henry recommended against it. He didn’t buy the fiction that the extra super contributions would come from employers (who would presumably get them from thin air). Neither does anyone else, when pressed. The money will come out of future wage increases, giving us less control of what should be our own money.

And giving fund managers more. Even if we have to borrow to give it to them. The Coalition opposed the move for the right reasons - it is financially reckless, costing the budget more in tax concessions than it will raise from the mining tax intended to funded it, it eats into the income of hard-pressed Australians at the times when they need it, and it is paternalistic on a scale that makes mandatory precommitment for poker machines look inoffensive.

And then the Coalition backed down. It’ll tear apart the carbon tax but according to Abbott “national savings and retirement incomes are a significant issue particularly with an ageing population and that’s why the Coalition has decided that we won’t rescind the legislation should it go through the parliament”.

Which pushes us into the hands of fund managers, and in many cases the union-dominated boards who appoint them. They might just be worth their fees if they could get us a better return than we could get ourselves paying off our homes.

The latest Superratings table shows they can’t, over a sustained period of time...

For the past five years the median “balanced” fund has returned an average of just 0.92 per cent per year. Over each of the past ten years the return has averaged 5.16 per cent. Since compulsory super began back in 1992 the return has averaged 6 per cent. The first is way below below inflation, the other two don’t match the return from paying down a mortgage.

Rewarded with generous fees and a leglislatively-directed (increasing) flow of our money into their hands regardless of performance it would be reasonable to imagine fund managers had something special.

They do. Nobel Prize winning psychologist Daniel Kahneman calls it the “illusion of skill”.

Kahneman won the 2002 economics Nobel for groundbreaking research into the way we make decisions. He saves a special place in his new book Thinking, Fast and Slow for “stock pickers”, who he says attempt to make much of their money buying and selling from each other.

“Most of the buyers and sellers know that they have the same information; they exchange the stocks primarily because they have different opinions. The buyers think the price is too low and likely to rise, while the sellers think the price is high and likely to drop. The puzzle is why buyers and sellers alike think that the current price is wrong. What makes them believe they know more about what the price should be than the market does? For most of them, that belief is an illusion.”

University of California Berkeley professor Terry Odean examined the trading records of 10,000 private investors over a seven-year period, sifting data on more than 160,000 transactions.

On average the shares the private traders sold did better than those they bought by a very wide margin of 3.2 percentage points, an “achievement a dart-throwing chimp could not match”. Private traders feel compelled to lock in gains by selling good stocks and don’t like taking losses by selling bad ones. Men are worse than women because they act “on their useless ideas significantly more often”.

The winners, on the other side of trades, are fund managers who are less likely to make those mistakes because they are less emotionally committed. But that doesn’t mean they are especially skilled.

As Kahneman says: “The diagnostic for the existence of any skill is the consistency of individual differences in achievement. The logic is simple: if individual differences in any one year are due entirely to luck, the ranking of investors and funds will vary erratically and the year-to-year correlation will be zero. Where there is skill the rankings will be more stable. The persistence of individual differences is the measure by which we confirm the existence of skill among golfers, car salespeople, orthodontists, or speedy toll collectors.”

Study after study over 50 years - including those done by Kahneman himself - has failed to find any significant year-to-year correlation in the perfomance of US fund managers. Some do well for a while, some do badly - but no more so than would be expected by chance. In Kahneman’s words, “for a large majority of fund managers, the selection of stocks is more like rolling dice than like playing poker. Typically at least two out of every three funds underperform the overall market in any given year. The year-to-year correlation is very small, barely higher than zero. The successful funds in any given year are mostly lucky; they have a good roll of the dice.”

Fund managers don’t see themselves that way. Like most of us, they think we’re better than average. “The subjective experience of traders is that they are making sensible educated guesses in a situation of great uncertainty,” Kahneman writes.

But if the way markets work mean their guesses are no better than blind guesses I don’t feel particularly good about entrusting my financial future to them. I certainly don’t feel good about being forced to entrust them with more.

Published in today's SMH and Age

"There have been many good books on human rationality and irrationality, but only one masterpiece. That masterpiece is Daniel Kahneman’s Thinking, Fast and Slow." - Financial Times

Related Posts

. The great superannuation swindle

. While repudiating Rudd, here's an idea for Gillard -- keep super at 9%

. The stairway to super

. Most forecasts are crap


Anonymous said...

Thank you, Peter. Very interesting. In light of this, I shall continue my frenzied investment on the Dapto dogs.

Anonymous said...

totally agree with your article, my own investments have attracted far greater returns than my super fund..and with far less fees.

Mr Wu said...

Funny I just read youir complete post at Do you own the copyright?

Anthony S said...

Glad to see someone else has seen through the Super myth.

I don't have an issue with Super per-se, but if I was in a business with an assured stream of income and laws that still make it rather inconvenient to change providers... well, the math doesn't add up in favour of the owner of the capital being streamed in.

Given that most of it is invested on the stock market, I'd compare it more to horse racing. Read the guide, see what other people think, then throw the bet on the one with the prettiest colours (read:PR team ) anyway.

dB said...

Is your gripe really with Super, or with managed funds? Most of your arguments are the same ones Bogle etc used to introduce the world to low-cost index funds many years ago.

What if the default fund was a low-cost fund comprised of some mix of share index, bond index, cash index, and property index, so you're not paying any manager to pick winners and losers.

Do you truly think such a fund would under-perform mortgage rates over the next 40 years?

Anonymous said...

A lot of Australian political and economic journalism is gossip or daft. It makes you think that if all the Australian newspapers and broadcasters (including the ABC) were to cease doing anything more than posting links to press releases Australia precious little would be lost.

But then occasionally you read a piece like this that makes you realise a few journalists know what they are talking about.

Great work.

Anonymous said...

This story is silly. Peter, you're trying to make the following case:

1) Fund managers can't outperform the market, and

2) There is no equity market premium, so people would always be better off paying down debt.

There's plenty of evidence to support proposition number one, and you've provided some of it, and it's a pretty uncontrovertial proposition anyway.

Proposition number two is much harder to support. Maybe it's true, but I'd like to see some better evidence than what little you've given here.


Peter Martin said...

SJ It happens to have been true over the entire life of super going back to 1992. I take your point: at some periods within that time frame it has not been true. And in the future, who knows.

robfarago said...

I'm not sure you can simply compare super returns to mortgage interest rates due to tax.

e.g. $100 pretax becomes $85 in super. If super earns 10% in the year, i.e. $8.50, after tax you have made $7.22.

Alternately $100 pretax becomes $51.50 into your mortgage (assuming highest marginal tax rate and medicare levy). If the mortgage rate is 10% you have saved/earned $5.15.

I think this means with a mortgage rate of 10% super only has to return 7.1% to be the same (at least at the highest marginal tax rate).

V said...

Now your beginning to see into the rot.

dB said...

I don't think you can measure "equity market premium" since 1992 simply by looking at the performance of the mean balanced Super fund since 1992.

The ASX300 (and all AllOrds before 2000) has returned 9.9% since 1992.

Ultimately, you get what you choose. If you don't think fund managers add value, choose an index fund. If you think the share market is too risky, choose a balanced fund, or even cash fund.

Those choices will determine whether or not you beat mortgage rates over the long term.

Anonymous said...

Poster "dB" nails it. By now everybody who knows active managers are not worth their salaries. But that doesn't mean a long-term balanced portfolio built using index funds will not outdo all other options. It's the right bet. And super is necessary to avoid being f****d by taxes.

rowdy said...

What con? I do not see the logic in this rant at all. Superannuation is not an asset class but a savings vehicle. If you do not like the performance of an asset class which includes shares choose Fixed Interest, Cash or another variable.

Peter Martin said...

Or pay down your mortgage, if you were permitted to..

Or pay your bills, if you were permitted to.

Either would be better than super in some situations.

David B said...


David Knox from Melbourne University has over the years produced a substantial amount of work on why compulsory superannuation is necessary to boost private saving rates among workers.

The reality is that people will not have to borrow less money or voluntarily pay down their mortgage faster if you give them pay rises instead of superannuation increases. They will use their increased disposable income to pay more for houses and spend every last cent to be entitled for an age pension. Worse, as much as 50% of lump sums on retirement aren't used to fund retirement living costs. If you want a comparison of voluntary versus compulsory compare the superannuation savings in New Zealand (which has no compulsion and offers no tax incentives) to that of Australians.

And the increase in employers superannuation comes partly from decreased tax receipts - reduction from 30% to 28% is proposed. To the extent the rest does come from future wage increases it is still your money, it is concessionally taxed, it doesn't have to be put into the share market and Choice of Funds means you can choose an Industry Fund with minimal fees.

The pension system - you pay taxes during your working life and received a Government payment after retirement - worked well the demographic shape meant there were 10 workers for each retiree. By 2050 there will be 3 workers for every retiree so the burden becomes substantially greater. It isn't necessarily in your best interest to have the Government force you to save when you're trying save for a deposit or pay down a mortgage, but it is in the national interest

Peter Martin said...

"By 2050 there will be 3 workers for every retiree"

I make it 2.7 Australians of working age (15 to 64) for each Australian aged 65 and over.

Right now the ratio is 5.

The point is that putting money away in super won't alter that trajectory.

It could ease the pain for some if only some had it - they could buy preferred access to scarce workers.

It can't ease the pain for everyone. Sorry.

derrida derider said...

David B, the age pension stuff is a complete furphy. We simply do not have an age pension funding problem. Take a proper look at the numbers, not government rhetoric, in Treasury's Intergenerational Report. Even if we did super would be a spectacularly inefficient way to address it.

Firstly, the generosity of the age pension means test means that the great majority of retirees in the future will still be getting the pension anyway. Secondly, what is the difference between a payroll tax going into a social security trust fund and a compulsory payroll levy going into private superannuation funds? Only two - in the second case administration costs are very high, and in the second case the individual investor rather than the society as a whole bears all the investment risk (including the risk of fund manager incompetence or dishonesty, BTW). In both cases real resources are being taken off working people (whether they need the money now or not) and some - only some - of it is given back when they retire (whether they need the money then or not), which may or may not be a good thing to do, but in the second case it is done inefficiently.

Anonymous above has fallen for an illusion - compulsory super IS a tax by which we are already being f***ed.

Dikkii said...

Just a small correction. You wrote:

Which pushes us into the hands of fund managers, and in many cases the union-dominated boards who appoint them.

(my emphasis)

It's quite illegal for the board of super fund to be "union dominated", as you describe it.

I suspect that you might have known that, though.

Peter Martin said...

The board of my fund has eleven members.

Five of them, including the chair, are union representatives.

Dikkii said...

And the other 6 directors are who, exactly?

I suspect that your definition of "dominated" is different from your average mum's or dad's definition, niot to mention, Oxford's. Suggest that you read Part 9, in particular, section 89.


Anonymous said...

Super can't beat my mortgage for one simple reason. With taxes, a dollar saved is more than a dollar earned.

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