Abstract
The frame of reference for this study provides the background for the analyses and statements about individual retirement-specific FPB. It consists of three elements: First, the inter-temporal financial optimization problem that individuals face with regard to financial planning for retirement is introduced. Second, financial planning as the major tool for financial provision in retirement and the study-specific definition of FPB with its two components, FP perspectives and FP actions are discussed. Finally, as a third element, the conceptual approach of the study is presented. It illustrates the overall analytical concept to accomplish the knowledge aim of this study.
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Such a model could also be used for the analysis of how individuals ought to take decisions to solve their financial retirement issues. This research stream, which lies out of scope of this study, is known as “decision theory” and has, among others, been followed by Lindley 1990.
For simplification, a perfect capital market and zero real interest rates are assumed. See Shefrin/Thaler 1988, p. 611.
Thaler/ Benartzi 2004, p. 165.
Browning/ Crossley 2001, p. 4.
Rosenberg 2004 provides a comprehensive definition of saving as the mechanism that allows shifting consumption possibilities between periods: Saving is “the difference between disposable personal income and personal consumption expenditures; [it] includes the changes in cash and deposits, security holdings, indebtedness, reserves of life-insurance companies and mutual savings institutions, the net investment of unincorporated enterprises, and the acquisition of real property net of depreciation.” Rosenberg 2004, p. 311. This definition highlights that an increase in net real estate assets is considered as saving, an aspect that should be kept in mind in comparing saving rates between different countries. Furthermore, it is important to note that an increase in credits leads to a reduction of the saving rate, whereas paying off credits is considered as saving. The saving rate is defined as the ratio of personal saving to disposable personal income. Disposable personal income is specified as personal income less personal tax and non-tax-payments. See Downes/Goodman 1998, p. 534.
The homo economicus is used in traditional economic analyses. He is assumed to be a calculating, unemotional maximizer that is self-interested and rational. Without taking fairness, loyalty or the framing of decisions into consideration, he takes optimal decisions by rationally analyzing only the risk and reward profile. Building on the utility function of Von Neumann/Morgenstern 1947 that assigns different levels of utility to the various possible outcomes, the homo economicus always chooses the action with the highest expected utility. Optimization is thus his most powerful tool, deferral of consumption his sole motive for saving. See Mullainathan/Thaler 2000, p. 1, Thaler 1995, p. 9 or Kahneman et al. 1986, p. 285.
It has been shown that the standard assumptions about the homo economicus do not hold as individuals show deviations from rationality in terms of actions and judgments. For example, research has shown that individuals are not frame-invariant (e.g., the success of automatic enrollment plans for the saving rate shown by Madrian/Shea 2001) or that they are acting on the basis of mental accounts and are not invariant to the self-control problem. See Shefrin/Thaler 1988, p. 610. Also, they do not discount exponentially with a constant discount rate but apply hyperbolic discounting functions. See Laibson 1997. With regard to the specific assumptions of the standard life-cycle theory, it has been shown that post-retirement consumption is lower than pre-retirement consumption and thus households do not manage to smooth consumption across the retirement threshold. See Banks et al. 1998. Furthermore, the assumption that saving rates are “independent of income [...]is completely unsupported by the data, which shows that consumption very closely tracks income over individuals’ life-cycles.” Mullainathan/Thaler 2000, p. 8. Furthermore, it has been shown that deferral of consumption is not the only motive for saving but rather leaving an inheritance is also an important motive.
The idea of the permanent income hypothesis is that individuals will smooth their consumption based on their permanent (i.e., the anticipated, expected) income, which encompasses both the physical and human income streams. If individuals get an unexpected transitory income increase, this will not influence their consumption in the long run. See Friedman 1957.
The finding that the saving rate increases with the income level has also been demonstrated by Diamond/Hausman 1984, Davies 1981 and Mirer 1979.
See Mitchell/Utkus 2006, p. 83.
The distribution of expenses by age cited by Reimann 2006 shows that relative to the expenses in the age groups 34–45, the expense profile for individuals aged 65 and older shows an increase in healthcare costs and hobby-related expenses, while the expenses for transport, education and clothes are reduced. See Reimann 2006, p. 33.
See Eisenberg 2006, p. 35.
Certain individuals have historically even reached income levels that corresponded to their average pre-retirement income levels. An OECD survey has shown that in Germany in the mid 80s the disposable income of individuals aged 65 to 74 was over 80% of the income of the entire adult population (individuals aged 18 and over) and that this ratio increased to over 90% by the mid 90s. See OECD 2001, p. 27.
Evidence for continuing saving activity of retired individuals has been demonstrated by Mirer 1979 and Diamond/Hausman 1984. German evidence can be found at Börsch-Supan et al. 1999.
Höllger/Sobull 2001 emphasize the increase in consumption in retirement as they state that today’s generation of retirees, the so-called “young old”, are part of the “consumption society”: When they still have a good health, they have a lot of time for traveling, cultural and social activities that are quite costly given that they have gotten used to a certain level of comfort and convenience. When the health level decreases, costs will increase due to medications and treatments as well as the use of special care and all kind of services. See Höllger/Sobull 2001, p. 39. The impact of a higher standard of living on an increasing consumption pattern is also confirmed by an empirical survey that states that “higher standards of living mean that what had been a satisfying retirement in the past may be viewed as insufficient in the future.” AXA 2006b, p. 21.
See Börsch-Supan et al. 2005, p. 18. For younger individuals this effect is less pronounced.
Mental accounts stand for cognitive activities that individuals engage in to serve the same function that regular accounting serves in an organization. Mental accounts lead to different propensities to consume certain mental pots of wealth. Shefrin/Thaler 1988 have found that “the elderly appear to spend money from their income account more readily than they draw down their assets, especially their housing wealth. Again this appears to represent voluntary behavior rather than capital market imperfections” as adequate products such as reverse mortgages are available. Shefrin/Thaler 1988, p. 633. See sub-section 4.2.3.3 on mental accounting.
Value at Risk can be understood “to mean the maximum loss or lowest gain which could occur at a given confidence level over a specified horizon, and it is based on both expected return and standard deviation.” Kritzman 2003, p. 173.
The model of life-cycle investing illustrated in Spremann 1995 explicitly includes an individual’s human capital (future income from work) besides the financial capital (wealth stock and its growth) as part of his total assets and also considers his liabilities to provide for his retirement. See Spremann 1995, p. 120.
See Braun et al. 2002, p. 3f. The fact that an unprecedented amount of wealth is projected to change hands is especially important for the HNWI since the aging in that segment is particularly pronounced.
See for example Stiefermann 2005, p. 8 and Peape 2004, p. 24f.
CFP 2004, p. 1.
CFP 2004, p. 1.
Siegel et al. 1992, p. 230.
Richards 1986, p. 127.
See Tilmes 2001, p. 37.
See Wyder 2002, p. 35f.
Chieffe/ Rakes 1999, p. 263.
See for example Börsch-Supan/Wilke 2004, Börsch-Supan/Essig 2002, Börsch-Supan et al. 2003, Börsch-Supan et al. 2005.
Siegel et al. 1992, p. 230.
Wyder 2002, for example, gives an overview of financial planning from a banking perspective. Richter 2001 focuses on the identification of general rules of guidance for performing financial planning activities. Tilmes 2001 focuses on the determinants of demand for financial services and the corresponding requirements for the offer of financial planning while Gebistorf 2004 analyzes the determinants of different financial planning pricing schemes.
Maginn/ Tuttle 1990, p. 1–3.
See UBS 2005, p. 30. The different steps in the definition of financial planning have been designed to reflect also the different elements described by Tilmes 2001, p. 31 or RICHARDS 1986, p. 127.
SEC 2005, Advisors Act Release No 1092, Supra Note 4.
Diliberto/ Anthony 2004, p. 30.
UBS distinguishes between “risk capability”, the objective ability to bear risk, and “risk tolerance”, an expression used to describe the subjective perspective on risk. See Peijan 2006, p. 28f. Bank Leu also recognizes these two elements and additionally defines a clear rule determining the overall “risk profile” by taking the lower of “risk ability” and “risk capability”. While “risk ability” is driven by wealth, income and expenditures, professional and social environment as well as the investment horizon, the “risk capability” depends on the reaction to risk, maximum acceptable losses, past experiences and the type of investor. See Leu 2006, p. 6.
“Risk aversion implies that if the expected return is held constant, people prefer the prospect with the smaller spread or variance. In particular, people always prefer a sure outcome over a risky prospect with the same expected value.” Tversky 1990, p. 73.
See Anderhub et al. 2001, p. 246f.
Shim/ Siegel 1991, p. 238.
Shefrin 2002, p. 3.
With his paper on portfolio selection Markowitz 1952 examined the optimization of the choice of the individual constituents of a portfolio given a set of beliefs about the future performances of these securities. He did not investigate how these beliefs are formed.
Sharpe 1964 lays the basis for the CAPM.
See for example, Tversky 1990, Maginn/Tuttle 1990, Sharpe 1990 or Kaiser 1990.
Cultural factors encompass the culture, sub-culture and social class. Culture determines the basic behavior of an individual, his attitudes and beliefs. Social factors include the reference group, family, social status and roles as well as the impact of opinion leaders. Social factors determine an individual’s behavior due to the interaction with specific groups and individuals as well as the role the individual plays in the different contexts. These cultural and social factors can be seen as external to the individual. Personal factors encompass observable elements that characterize an individual’s immediate situation, such as socio-demographic or socio-economic attributes (e.g., age and stage in the life-cycle, occupation and economic circumstances). They also include less observable aspects such as lifestyle, personal traits and self-perception. Psychological factors, finally, include activating elements such as motivation, with its sub-constructs, needs, emotions, mood and self-involvement, as well as cognitive elements such as learning and perception and beliefs and attitudes. Personal and psychological factors are internal elements. For a detailed description of the model or individual elements see Kotler/Bliemel 1995, p. 279ff, Kotler 1999, p. 161ff or Meffert 2000, p. 98ff and also Trommsdorff 1998, p. 47ff or Kroeber-Riel/Weinberg 1996, p. 53ff.
Credit Suisse for example distinguishes between individuals who need a balanced portfolio, those needing an income portfolio and finally those needing a capital gains portfolio. See Keating/Tschanz 2006, p. 5. UBS on the other hand speaks about conservative, moderate and aggressive investors. See UBS 2005.
Kritzman 2003 describes a risk averse person as someone who would reject a fair game, a risk neutral person to be indifferent to such a game and a risk seeker to seek a fair game. Absolute risk aversion relates to the amount of wealth one is willing to expose to risk as one’s potential wealth increases. An absolute decreasing risk aversion indicates that this amount will increase with an increase in the overall potential wealth level; the constant absolute risk aversion means the amount will remain unchanged and an increasing absolute risk aversion means that the amount will decrease. Similarly, relative risk aversion refers to the percentage of wealth one is willing to expose to risk as wealth increases. He also states that most investors are indeed risk averse. See Kritzman 2003, p. 21ff.
Lindley 1990, p. 4.
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(2008). Frame of reference and conceptual approach for the analysis of individual retirement-specific financial planning behavior. In: Individual Financial Planning for Retirement. Contributions to Economics. Physica-Verlag HD. https://doi.org/10.1007/978-3-7908-1998-4_2
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