Changing landscape of retirement saving opportunities

Thirty years ago, Japanese workers could expect that the Japanese government and their workplace would take reasonable care of their retirement savings. They did not even feel like learning much about the details of the financial products to accumulate their retirement savings. Today, Japanese workers cannot expect the same thing because of the substantial change in the landscape of retirement saving opportunities in Japan. Behind this change over the past twenty years lie the prolonged period of low economic growth, rapid population aging, and low interest rates in Japan. As for the role of the government regarding workers’ retirement savings, low economic growth and rapid population aging lead to the reductions in the ratio of the public pension benefits to workers’ earnings. As for the role of the workplaces, the prolonged period of low interest rate made it difficult to sustain a defined benefit (DB) corporate pension plan, and thus many workplaces instead adopt a defined contribution (DC) corporate pension plan. In the traditional DB plan, it is the responsibility of your workplace to save and accumulate your retirement wealth. In the newly adopted DC plan, the responsibility of decision-making for saving, investing in the financial products, and decumulation is all up to the workers and retirees, rather than the workplaces. The DC plan used to be popular in small and medium sized companies, however, from 2017, more people, including those who do not have a job, employees in a private enterprise which satisfies certain conditions, or employees in the public sector, are eligible to join an individual DC plan. Changing landscape of retirement saving opportunities requires more workers to decide how much to save and where to invest, and more retirees to carefully decide on their spending plans until they die.

The purpose of investment into stocks

Reflecting these changes, Japanese workers today need to learn about the details of the financial products to accumulate their retirement savings. To make things worse, because of the prolonged low interest rate period, they need to learn about the details of complex and risky financial products, such as stocks or stock investment trusts, rather than the conventional simple and safe financial products, such as bank deposit or personal pension products sold by insurance companies. Today, bank deposit and personal pension products account for more than 70% of the financial assets held by the Japanese household. However, the period of sustained low interest rates followed by prolonged deflation and low economic growth has made those two conventional financial products unattractive as means for accumulating retirement savings, and therefore the increase in the share of stocks and the decrease in the share of bank deposit and personal pension products in the financial assets, would be necessary. Let’s take an example of conventional fixed deposit. In October 1990, the interest rate for the fixed postal savings account (whose maturities are longer than three years) sold at the Postal Office was 6.33% per year. If you purchased this product in the amount of one million yen in October 1990, your savings would be doubled about 12 years later. As of October 2017, the interest rate for the same product is 0.01% per year. If you purchased this product in the amount of one million yen, it would take 6,931 years until your savings would be doubled. Let’s take another example of a typical product of a Japanese life-insurance company. Since the adoption of negative interest rate policy by the Bank of Japan in January 2016, by observing the market wide reductions in the long-term interest rates including the yield of the Japanese government bond, many Japanese life-insurance companies stopped selling the personal pension products that were popular with individuals. The reason for this is that the life-insurance companies found it difficult to promise customers a favorable long-term future yield based on the investment results obtained from their investment into safe financial products such as the Japanese government bond. These two examples suggest that more workers should consider the possibility of investing in stocks, instead of a bank deposit and a personal pension for the sake of accumulating their retirement savings. In sum, Japanese workers today not only need to save, invest, and decumulate their financial assets at their own risk (Let’s think about the DC plan.), but also need to invest some of their assets in more complex and risky financial products such as stocks and stock investment trusts, which are likely to yield reasonable earnings in the long run compared with the conventional financial products.

Financial literacy needed to invest into complex financial products

Are the Japanese households ready to purchase risky but high yield financial products? A key to be able to make wise decisions to purchase risky financial products is so called “financial literacy.” By financial literacy, financial economists mean peoples’ ability to process economic information to make informed decisions about financial planning for saving or borrowing. Without a certain level of financial literacy, a person cannot purchase complex financial products, and in the worst case, such a person would be fooled by bad sellers of financial products. The Financial Services Agency (FSA), which regulates the Japanese financial industry, is mindful of this unhappy situation where the households without enough financial literacy would lose their money by investing into stocks, and the FSA is ready to help beginners of investment into stock investment trusts. For a recent example, the FSA announced a new type of Nippon Individual Savings Account (NISA) available from January 2018. The new NISA, nicknamed as “Funded NISA”, will allow individuals to invest up to 400,000 yen per year for the longest 20 years in among about 100 selected investment trust products by the FSA without paying tax. The FSA selects relatively simple investment trust products with minimum sales and trust fees for the beginners so that a young worker can start from a small amount of investment, say, from 10,000 yen per month. However, it is still up to a worker to choose from those selected products by the FSA, and thus a worker should have enough financial literacy for investment decisions.

Measuring financial literacy

How do we know whether a worker has enough financial literacy or not? Financial economists have identified three key concepts to make informed saving and investment decisions as the basis for financial literacy: (1) numeracy and capacity to do calculations related to interest rates, such as compound interest; (2) understanding of inflation; and (3) understanding of risk diversification. More precisely, a group of financial economists ask the following three questions in many economies including Japan to measure financial literacy of an individual (See details in Lusardi and Mitchell (2014)).

(1) Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow? : More than $102; Exactly $102; Less than $102; Do not know; Refuse to answer.

(2) Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, how much would you be able to buy with the money in this account? : More than today; Exactly the same or Less than today; Do not know; Refuse to answer.

(3) Do you think that the following statement is true or false? “Buying a single company stock usually provides a safer return than a stock investment trust.” : True; False; Do not know; Refuse to answer.

The first question checks if you understand the growth rate of your assets expressed by the compounded interest calculation. The second question tests if you understand the changes in the purchasing power of money when inflation occurs. The third question examines if you know about “stocks” and “stock investment trusts” and risk diversification, because to answer this question correctly you need to know what a stock is and that an investment trust is composed of many stocks. If you answered all the questions correctly, you would be judged as having a good financial literacy.

By repeatedly asking the same questions above in many economies, the group of financial economists found the following correlations between the level of financial literacy and individual characteristics. First, financial literacy is lowest among the young and the old. Second, women are less likely to answer financial literacy questions correctly than men, and women are also far more likely to say they ‘do not know’ an answer to a question. Third, financial literacy varies by income and employment type, with lower-paid individuals doing less well and employees and the self-employed doing better than the unemployed.

Improve your financial literacy to make a better investment decision

Even knowing these results, one may still wonder to what extent the level of financial literacy can affect his or her retirement savings. In this context, a recent study using U.S. data reported that 30–40% of retirement wealth inequality was accounted for by the difference in financial knowledge alone (See Lusardi, Michaud, Mitchel (2017)). The result was specific to the U.S. data, but the result indicates that the benefits to be gained from financial literacy would be numerous in Japan, especially when a Japanese worker is planning to purchase a stock investment trust as many ordinary American workers do. The changing landscape of the retirement saving opportunities in Japan suggests that a better choice of financial assets for the sake of retirement savings would be stock investment trusts, rather than the conventional bank deposit and personal pension. If you indeed consider starting an investment into stock investment trusts, you might first wish to check your financial literacy to be able to make informed decisions about your investment strategy. There are many public resources available to check and improve your financial literacy, including the website of the FSA at http://www.fsa.go.jp/teach/kyouiku.html, or the website of the Central Council for Financial Services Information at https://www.shiruporuto.jp/public/data/survey/literacy_chosa/ (Japanese version) or at https://www.shiruporuto.jp/e/survey/ (English version).

I hope I have convinced that every Japanese should learn finance now to prepare for his or her retirement savings, unless he or she is very rich. Changing landscape of retirement saving opportunities under the period of slow economic growth, rapid population aging and low interest rates requires more Japanese workers to decide by themselves how much to save and where to invest including the complex financial products such as stock investment trusts. In making a sensible investment decision over some complex financial products, workers need to learn finance to keep a reasonable level of financial literacy.

You should learn finance now to provide for your retirement savings. You will be never too old or too late to start learning finance. You are not studying finance to be a very rich person, but to earn a reasonable return from your investment to make your retirement life enjoyable. At least you will be able to accept the results of your investment decisions, rather than to be offended or dismayed by them after learning finance even if the results turn out to be not as good as you had expected.

References:

• Annamaria Lusardi & Olivia S. Mitchell, 2014. “The Economic Importance of Financial Literacy: Theory and Evidence,” Journal of Economic Literature, American Economic Association, vol. 52(1), pages 5-44, March.
• Annamaria Lusardi & Pierre-Carl Michaud & Olivia S. Mitchell, 2017. “Optimal Financial Knowledge and Wealth Inequality,” Journal of Political Economy, University of Chicago Press, vol. 125(2), pages 431-477.