Locking one’s pension in housing as part of retirement funding system, is it sound?

Donald Low shown in the photo by ST during the talk

By Donald Low

I very much enjoyed listening to Deputy Prime Minister (DPM) Tharman's speech at the Economic Society of Singapore (ESS)' s dinner two nights ago. It was, in my mind, the most compelling, comprehensive and articulate defence of our system of retirement funding. Even though I disagree with some points, these do not detract from the fact that it's a darn good speech. (The look of admiration on my face in the picture is not posed, as some people have suggested to me.)

But there's a conceptual point that puzzles me. Early on in the speech, he points out (correctly) that people systematically underperform the market in investing because of behavioral biases. This is one of the main reasons why most people (85 percent) do worse when they take their Central Provident Fund (CPF) monies out to invest themselves under the current Central Provident Fund (CPF) Investment Scheme (the other major reason DPM cited was high fees charged by mutual funds). DPM noted that people get excessively exuberant and buy too much when financial markets are rising, and get too panicky and sell too much when markets are falling.

This point - that most of us are lousy, herd-following, overly emotional, yet still overconfident investors - is well-established in the behavioral economics literature. It is obviously correct and I can't agree more with DPM. As readers of my posts know, I often highlight the cognitive/psychological barriers and social/contextual factors that all of us face when trying to make good decisions in complex and unfamiliar situations.

But later on in his speech, DPM said that a key priority of our retirement funding system is to help people - especially the lower income - unlock the wealth in the housing assets they own. This point is also a compelling one - but one that I don't agree with entirely. The claim here is that the CPF system provides a level of retirement adequacy comparable, if not superior, to other pension systems once you take into account the savings that are locked in one's housing. So for retirees who are cash-strapped, all they need to do is monetize (part of) their housing wealth.

The claim here is that the CPF system provides a level of retirement adequacy comparable, if not superior, to other pension systems once you take into account the savings that are locked in one's housing. So for retirees who are cash-strapped, all they need to do is monetize (part of) their housing wealth.

So far so good. But what I don't understand is why we should think that people who we know make poor decisions, systematically, when it comes to financial investments should now be able to make good decisions when it comes to housing monetisation. If anything, I would think that people are more prone to bad decisions in housing than in financial investments. The former is far less frequent than the latter so the opportunities to learn from our mistakes are far fewer.

In addition, just as there are cognitive biases and social factors (e.g. herding) that get in the way of us making good investment decisions, so too are there significant psychological barriers to us making good housing monetisation decisions, e.g. the endowment effect, the failure to understand discounting or the time value of money, the bequest motive, the affect heuristic, the sunk cost fallacy, and of course social norms around leaving a property for our children. All these non-rational factors suggest that housing monetisation is a hard sell. DPM did acknowledge some of these difficulties when he said that as a society, we should try to make monetisation more 'normal' and accepted. I agree, but I don't think this is possible relative to the scale of the cash adequacy problem faced by older Singaporeans.

A more fundamental objection to being so reliant on housing as a form of retirement security, as I have argued elsewhere before, is that it is subject to the same kind of intergenerational dynamics as the collective pension systems that the DPM highlighted as unsustainable earlier in his speech. After all, it's future generations that have to bear the costs of financing my retirement by buying my flat. A heavy reliance on housing means that our asset-based system of retirement funding may not be all that different from the cash-based, pay-as-you-go pension systems that we commonly criticize as unsustainable.

All this does NOT mean that I'm not in favour of housing monetisation. Of course, we should try to make it possible and attractive for retirees. But it's never going to be a frictionless process free of cognitive biases and social barriers. Lower-income retirees also shouldn't have to rely so heavily on it to fund their retirement. There really is no good substitute for a strong Pillar One basic pension (and my good friend Lam Keong Yeoh has written a very good post on this - please read it as well.)

This post was first published on the Facebook account of Mr Donald Low, who is Associate Dean (Research and Executive Education) at the Lee Kuan Yew School of Public Policy.

This entry was posted in Opinion.