Financially rational individuals are expected to be knowledgeable about financial concepts, conduct regular pension investments throughout their working life, and build a diverse asset portfolio for their retirement. Yet, this assumption of responsible financial behaviour ignores factors outside an individual’s control, such as having to take a break from work due to caring duties or being affected by unemployment or underemployment. Even if individuals are able to behave as expected, there is still uncertainty with regards to future values of financial investments, limiting their ability to plan for the future. In light of these constraints, is behaviour deviating from ‘acceptable’ financial strategies really irrational?
Based on the belief that wider access to financial services and asset ownership gives everyone the possibility to participate in economic growth and creates a more equal society, asset-based welfare policies have been promoted by successive UK governments since the end of the 1970s. People are expected to accumulate assets to provide financial security in the future and mitigate income shortfalls during periods of ill-health, unemployment, and retirement. To support individual asset accumulation, tax reductions for savings and investments as well as indirect subsidies for homeownership have been put in place (1). The most recent example of this approach can be seen in the pause on stamp duty during the COVID-19 pandemic, which in turn has caused housing prices to rise to the highest level since 2014. At the same time, the publicly funded welfare state has been continuously reduced in the past four decades, resulting in the UK having one of the lowest social welfare provisions amongst OECD countries (2,3). And yet, 38% of the working-age population are under-saving for retirement (4).
Explanations of ‘deviant’ financial behaviour
This difference between expected financial behaviour and actual practices has been picked up by research in behavioural economics and financial literacy. Behavioural economics has put forward the notion that people experience cognitive limitations and time constraints and are therefore unable to collect and process all the necessary information to make financially rational decisions (5). To illustrate, when investing in stocks and/or bonds, one is expected to take into consideration market developments, current and potential future interest rates, inflation, and risk levels. This would require both an intensive time investment due to having to search for the appropriate information on different companies, markets, and countries and also necessitate the ability to process it appropriately in order to develop a diversified asset portfolio in line with one’s lifetime income and risk preferences. Instead, people use heuristics or mental shortcuts when making financial decisions, resulting in errors of judgement, as exemplified in the case of present bias (5,6). Present bias means that people tend to prioritise the current standard of living and needs over long-term savings, culminating in insufficient retirement investments. Within financial literacy research, a lack of financial knowledge—reflected in a weaker understanding of key financial concepts such as the impact of interest rates, inflation, and risk-return relationships on future investment values—has been identified as an underlying reasoning for sub-optimal investment choices (5,7).
Corrective policy measures as the solution?
Realizing that individuals are underinvesting with regards to their retirement needs and integrating insights from financial literacy research, a plethora of financial education programmes and money advice websites have emerged in recent years, with even secondary schools offering financial education in the UK (8). Similarly, automatic enrolment into workplace pensions introduced in 2012 originated from insights established within behavioural economics where people are argued to be less likely to opt out of existing agreements than having to opt into these. In other words, automatically signing people up for workplace pensions was based on the assumption that they are then more likely to save regularly (6,9).
There is little evidence, however, to suggest that these initiatives work, as evidenced in the persistent gender and ethnicity wealth gap where pension wealth is lowest amongst women and ethnic groups other than white British. Not only is the median value of women’s pensions currently being paid out half of men’s pensions in payment, but also women’s pension wealth in all still active pension types is lower than men’s pension wealth. Similarly, the lowest participation in private pensions can be found amongst Bangladeshi (48%), Chinese (57%) and Black African headed households. Only 59% of UK households headed by Black Africans participate in private pensions with a median pension wealth of less than £5,000, compared to 82% participation rate and £80,000 median pension value of households headed by White Britons. And while financial debts in excess of financial assets were highest amongst households headed by Black African and Other Asian groups, median wealth for households with a white British ‘head’ was the highest in comparison to other ethnic groups. It thus appears that despite nurturing a ‘free’ ownership society and having promoted prosperity for all, the asset-based welfare approach has failed for large groups of society. Yet, rather than questioning asset-based welfare, responsibility is put onto the individual, and corrective policy measures are introduced, seeking to nudge people to become knowledgeable in financial concepts, to conduct regular pension investments throughout one’s lifetime, and to develop a diversified financial asset portfolio for their retirement.
Alternative explanations of everyday financial practices
What explanations for deviant financial behaviour ignore is the potential for ‘irresponsible’ financial behaviour being logical reactions within the existing welfare system. Might it be rational under certain circumstances not to invest in workplace pensions? Could it be logical not to trust any form of financial investments?
Systemic constraints within the UK pension system
The UK pension system is based on a three-tiered approach, where the first tier in the form of the state pension is solely aimed at poverty relief (with the full state pension being currently £179.60 per week) while workplace pensions (second tier) and personal pension investments (third tier) are intended to provide adequate retirement income (11). This three-tiered pension system is based on the underlying assumptions of having a full-time job throughout one’s working life, earning a decent salary from one point of employment and being able to conduct extensive private pensions investments. Yet, what happens if you work part-time, are self-employed, or have to take a break from work because of caring for a family member?
In these circumstances, you would not have access to the first two tiers of UK’s pensions system. To be eligible for the full state pension, one needs 35 years of national insurance contributions independent of the partner, and to be automatically enrolled in the workplace pension one needs to earn at least £10,000 per year in one place of work (4). Even when someone has contributed to a workplace pension before taking a break or moving into a ‘non-traditional’ working history, if they have not gained sufficient contributions beforehand, the returns they receive on these pensions tend to be marginal due to administrative costs and management charges. Now, one could argue that the third tier in the form of personal pension products and financial investments could be used to balance out having no access to the full state pension and/or having no workplace pension. However, someone experiencing an interrupted work history, relying on several jobs, or being self-employed often cannot contribute continuously to private pensions and conduct additional financial investments for retirement.
The underlying conditions incorporated in UK’s three-tiered pension system thus constrain individuals with working histories deviating from a full-time job throughout one’s working life.
Caring work, self-employed work, and lower income possibilities are not sufficiently recognized (11,12), yet, particularly women and ethnic minorities are affected by these differential employment paths, as uncovered once again by the current pandemic. Not only have predominantly women taken up the rise in caring duties during the pandemic, meaning less time available for paid work, but also individuals from ethnic minorities have suffered relatively more from the fall in employment (13). Given these systemic constraints, might it be logical to not actively engage with pension products and search for alternative avenues to provide financial security in the future?
Inherent uncertainty in pension investments
Even if one is able to develop a diversified asset portfolio for retirement, financial investments remain inherently uncertain (13,14). One just has to look at the Global Financial Crisis 2009 where stock market values crashed, or the current pandemic and subsequent discussion of university pensions, where values are argued to have substantially declined in 2020 and therefore a call for changes to the pensions has been put forward. Moreover, the UK has experienced numerous pension scandals throughout its process of privatising the pension system with the most recent one emerging in 2017. Workplace pension contributions, which were supposed to be protected, had been misused by companies, and employees were left with no or substantially lower pensions than promised.
Uncertainty does not only relate to uncertain investment values but also to legislative changes in pension provisions. As expressed by the director of the Pensions Policy Institute, the UK pension system lacks an overarching framework with a common goal; as a result, piecemeal reforms are introduced without considering the system as a whole, constructing a complex pensions landscape. To illustrate, up until 2016 married women were able to receive up to 60% of the state pension based on their husband’s national insurance contribution. While this possibility has been abolished, amongst others, with the intention to increase independence of women, caring duties which are still predominantly undertaken by women are not sufficiently recognized within the existing pension system. Moreover, even before abolishing it, the system to apply for recognition of the husband’s contributions has been overly complex, and it has been recently discovered that thousands of women were underpaid for decades.
Due to a distrust in the current pension system, some refuse to actively engage with financial products and workplace pensions and instead search for alternative investments, which appear more controllable, such as property, gold, or investments in one’s own business (1,14). This deviating investment behaviour is often portrayed by government institutions or researchers as a lower level of financial literacy which needs to be corrected (4,8,15). However, given the inherent uncertainty of financial investments, is it really irrational not to trust pension investments and disengage from them?
Cultural differences in approaching finance
Finally, when identifying responsible financial behaviour, a cross-country life perspective and cultural differences in dealing with financial aspects tend to be missing from the discussion. Yet, ethnic minorities often have strong ties to other countries determined by family relations or having moved themselves to the UK during their lifetime—and cultural norms can influence one’s own perception of finance. Dependent on the life course and cultural background, this can result in remittances, informal financial practices such as community credit and savings arrangements, non-financial investments inside or outside the country, a focus on savings rather than investments, or a rejection of earning interest on savings (16-18). Moreover, cultural norms that put emphasis on the collective rather than on the individual can impact one’s own financial approach (19). A different understanding of providing financial security might be dominant, where family members support each other during retirement. Here, remittances can be a key component in shaping not only the life of the receiver but also one’s own financial approaches, where flexibility and being able to react fast in case family members need help, might be the main decision factor in choosing investment products. For a discussion of some of these points, watch the video below.
Yet, these factors are often marginalized or not even discussed in the general discussion on financial literacy where a presumed ‘irrational’ financial behaviour stands to be corrected. Are these practices really financially irresponsible because they are outside the boundaries of individual approaches to finance? Or might practices deviating from uniform norms of financially responsible behaviour be equally appropriate?
That finding one’s own unique financial approach, as illustrated in the three cases outlined above, is criticised seems rather striking in a pension system promoting individual financial responsibility. However, it is less surprising when taking into consideration the increasing profit opportunities for the financial sector. Financial institutions have benefitted from introducing increasingly complex products, as highlighted in the numerous pension and financial scandals in the past, the most recent example being the mis-selling of payment protection insurance. If even the Chief Economist of the Bank of England admits that “experts and financial advisers […] have no clue” about the pension system and that “more of the risks associated with financial decisions is these days being shouldered, not by the state or companies, but by individuals” then it is time to move on from the privatized system and re-evaluate publicly funded pension systems. Instead of identifying deviant individual behaviour and introducing new policy measures intended to prop up the existing system, we should see financial practices as rational responses to a dysfunctional system. We should challenge the universal benefit of financial products and education programmes that promote one-size-fits-all procedures but which ignore underlying structural constraints and cultural differences in approaching finance.
- Hillig, A., “Everyday Financialization: The case of UK households. Environment and Planning A”, 2019.
- OECD, OECD employment outlook 2015, 2015.
- OECD, Pensions at a Glance 2017, 2018.
- DWP, Automatic Enrolment Review 2017, Maintaining the Momentum, 2017.
- Elliehausen, G., “Behavioral Economics, Financial Literacy, and Consumer’s Financial Decisions”, The Oxford Handbook of Banking, 2019.
- James, H. et al., “How do people think about later life when making workplace pension saving decision?”, Journal of Aging Studies, 2020.
- Mitchell, O.S. and Lusardi, A,M., “Financial Literacy: Implications for Retirement Security and the Financial Marketplace”, 2012.
- Financial Capability Board, “The Financial Capability Strategy for the UK”, 2019.
- Schneider, G., “Microeconomic Principles and Problems: A Pluralist Introduction”, 2019.
- Altman, M., “What behavioural economics has to say about financial literacy”, Applied Finance Letters, 2013.
- Grady, J., “Gendering pensions: Making women visible”, Gender, Work and Organization, 2015.
- Vlachantoni, A., et al., “Ethnicity and occupational pension membership in the UK”, Centre for Research on Aging, 2014.
- Petts, R. et al., “A gendered pandemic: Childcare, homeschooling, and parents’ employment during COVID-19”, Gender, Work and Organization, 2020.
- Agunsoye, A.,”‘Locked in the Rat Race’: Variegated Financial Subjectivities in the United Kingdom”, Environment and Planning A, 2021.
- Bucher-Koenen, T. et al., “Women, Confidence and Financial Literacy”, European Investment Bank Institute, 2016.
- Datta, K., “Migrants and their money – surviving financial exclusion in London”, 2012.
- Hassan, K., Kayed, R.N., and Oseni, U.A., “Introduction to Islamic banking & finance principles and practice”, Pearson Education, 2013.
- Ibrahim, H., “Structured savings and asset ownership: the role of rotating savings andcredit associations among African immigrants in the United States”, Journal of Sociology & Welfare, 2020.
- Guermond, V., “Contesting the financialisation of remittances: Repertoires of reluctance, refusal and dissent in Ghana and Senegal”, Environment and Planning A, 2020.