- Germans continue putting their retirement savings into low yield investments with disastrous consequences, particularly for the younger generation of savers
- A new approach is needed, with a focus on return on investment instead of perceived security
- Retirement planning experts confirm that in the long run, stock investments have offered the greatest security and the highest returns
Despite today’s extremely low interest rates, many people here in Germany still cling to their savings accounts and other zero or low interest rate financial products. New studies attempting to shed some light on this behavior have discovered that children tend to adopt the savings habits of their parents. Is this a logical approach?
Olaf Stotz: I think so. People learn by imitating others. You see this in small children learning to talk. They simply repeat what their parents say – without actually knowing what these words mean. Speech comprehension and individual speaking styles are then acquired over time. Savings behavior is also mimicked – but the learning often doesn’t progress beyond this point. One of the reasons is that only one part of the brain is actively being used.
Can you explain what you mean?
Stotz: Quantitative thinking occurs in the brain’s left hemisphere, and intuitive thought is controlled by the brain’s right hemisphere. Quantitative thinking is strenuous, which is why most people tend to make intuitive decisions when it coming to their savings. This is especially true if they haven’t practiced using the left-brain hemisphere – although this is essential for having a successful savings strategy. It’s therefore no surprise that more sophisticated savings behavior goes hand-in-hand with a higher level of education.
Do you think that schools should be responsible for teaching savings competence?
Stotz: Schools surely have a role to play in helping to ensure that the brain is used to its full potential which, in turn, also helps people develop a suitable retirement savings strategy. In my opinion, we don’t need a separate class in financial education, as some people have advocated. Interdisciplinary thinking involving existing subjects such as mathematics or social studies can also be used to teach investment competence. The government could boost the investment competence level by, for example, paying 10 Euros a month into a retirement savings account for each child, beginning at birth. If the child then continues this activity by making deposits to the account throughout their career, possibly even raising the monthly amount deposited, the retirement savings problem would be eliminated.
To return to our initial question, what are the long-term negative economic consequences of continuing to place our savings in low-return investments?
Stotz: If many people have their savings locked into low-return investments, less value is created and less wealth is accumulated. We’ve found that people tend to focus on the short-term risks – primarily, for example, on stock price fluctuations. In the long-term, however, these price fluctuations cancel each other out and stocks offer a comparatively high potential rate of return. These fluctuations actually have a positive effect in that they offer investors a chance to purchase more shares when the share price is temporarily lower. A comparable analogy can be found at a gas station: when the gas price is low, it costs less to fill your tank. Only the few knowledgeable investors who are willing to temporarily accept a higher level of risk, and use the potential offered by real capital such as equities, wind up profiting from the higher returns that these offer. As a result, the gap between the rich and poor in society continues to widen in the economy.
This focus on investment security and guarantees will have an especially devastating effect on younger Germans.
Stotz: Exactly. In the 1980s and 90s, government bonds offered returns significantly greater than five percent. That is no longer the case today, and you might even incur costs. The younger generation bears an even greater burden because lower government pensions mean that they themselves are expected to provide a larger portion of their retirement income. The only way to achieve this is through more lucrative investments.
By that, do you mean stocks?
Stotz: Yes. A 20-year-old, who will probably have to work until age 70, has a 50-year period in which to accumulate savings. To estimate how much savings should be accrued in this time period, this person can look at what was accrued in 50-year periods of the past.
Speaking of the United States: Anglo-Saxon countries, with their shareholder culture, are often viewed as a role model for Germany. Do you share this view?
Stotz: These countries can serve as an example, but I use the term “role model” a bit more judiciously. We can learn from the American approach to simplifying retirement savings. Americans have special retirement accounts, available in different investment forms to reflect individual preferences. This approach is significantly more practical than our system, with its focus on investment products. Some of these products are subsidized through tax incentives, whereas other products – which may be for suitable for specific types of investors – must exist without subsidies. As an analogy, consider this: the government should provide the infrastructure for retirement savings planning just as it does for mobility. The government builds the highways, and private industry builds the cars. Each individual chooses the automobile or other form of transportation best suited to their needs and preferences. Retirement savings could be handled the same way.
These days, the markets are concerned about the trade dispute between the U.S. And China and a slowdown of the economy. In light of these major concerns, would you recommend that people evaluate their investment strategy more frequently?
Stotz: Short-term risks such as those posed by the current trade dispute are simply a fact of life. There’s always some issue or other generating headlines in the media and being viewed as a risk factor – which often leads people to make irrational investment decisions. Let’s take the 9/11 tragedy in 2001 as an example. After the attacks in the U.S. in which planes were used as weapons; the public suddenly thought flying was risky. So, they flew less and drove more. And what happened? The number of traffic deaths went up – in fact, significantly more people died in traffic than would have through air travel, which is a relatively safe mode of travel. The risk of accidental death through travel, therefore, actually went up instead of down. Applying this analogy to investment strategy, it means that if someone with a long-term investment strategy now suddenly decides to switch their investments to low-return investments simply because of the current trade disputes, this could be exactly the wrong thing to do. The risks posed by the trade dispute can also offer the potential for growth. Increasing disagreements between the U.S. and China could foster trade growth between Europe, China and Africa.
So, your motto is: Stay calm?
Stotz: Yes. In general, I recommend making regular investments in real investments using a share savings plan. It’s also prudent to spread your investments worldwide, and not just focus on a single region. Internationalization, regularity, rate of return – these are the three pillars of any long-term investment savings plan.
Comparison of long-term returns: stocks clearly outperform other investments
This graphic shows the returns for investment types since 1871, as calculated by Robert Shiller (2013 Nobel laureate in Economics). Source: Frankfurt School of Finance & Management
Assuming that someone invests 10 dollars a month in the corresponding asset and checks the return on investment after waiting 50 or 65 years. As result, even in the worst-case scenario, the ROI on stock investments beats that of fixed-income investments and gold investments.