Younger Canadians can’t get into the housing market, and older Canadians don’t know how to get out. And the emotionally charged predicament of house-rich, cash-poor homeowners near or in retirement presents a changing reality for traditional financial advice.
But new research suggests that financial advisers can exhibit behavioural biases that could lead to sub-optimal advice when factoring in home equity release schemes, or HERS, for retirement planning.
“This is part of a larger research project on leveraging home equity to fund retirement income,” said Dr. Vishaal Baulkaran, associate professor of finance at the University of Lethbridge and one of the authors of the paper published in the Journal of Behavioral Finance earlier this year.
“An aging Canadian population, the mounting pressure on pension systems, the rise of homeownership and the growth in house prices presented a unique opportunity to use home equity to generate retirement income. Or, at the very least, make up any potential shortfall.”
There is a duality to homeownership, in which it represents both a home and an investment. Over time, the incredible returns in home prices have pulled more people toward the investment mindset. But a byproduct of high home prices and dwindling affordability is that the home-as-an-investment ideology has supplanted traditional investments into stocks and bonds.
Perhaps this explosion in home equity justified the cognitive dissonance of not saving for retirement. But as retirement approaches, all of a sudden, the home is a home again, not an investment. And seniors don’t want to leave.
More than 90 per cent of Canadians want to “age in place” in their homes. But a Deloitte report published last year, titled “Running out of time,” suggests that “55% of near-retiree households will have to make lifestyle compromises to avoid outliving their savings.”
This is the country’s wake-up call that we need to make sure financial advice for this growing demographic is serving their interests. Because not only is it an emotionally charged decision for households, but there is the added layer of advice providers injecting sub-optimal advice to the mix.
“Individuals, as well as financial planners, are subjected to cognitive biases. Financial planners can help mitigate these biases when advising clients on retirement planning or investing with education and training,” Dr. Baulkaran said. “However, given that we all suffer from cognitive biases, financial planners should be aware of their biases when providing financial advice.”
While Dr. Baulkaran’s research looked specifically at financial planners in Canada, whose training now includes the study of financial decision making and behavioural biases, it’s not a leap to suggest that non-CFP financial advisers and salespeople with less rigorous training might fare worse.
There were seven different home equity release schemes studied in the broader research:
1. Reverse mortgages
2. Home Equity Lines of Credit (HELOCs)
3. Second mortgages
4. Refinancing
5. Selling to downsize into a smaller owned home
6. Selling to move into a rental home
7. Selling to lease-back the same home
The focus in the paper was to see if financial planners displayed common behavioural biases that affected the recommendations they gave to clients with respect to retirement funding strategies, including the interplay between tapping home equity versus selling investments.
It was found that financial planners exhibited different behavioural biases, and that these were associated with differing levels of comfort and willingness in providing advice about utilizing home equity. For example, planners with an aversion to losses are more comfortable recommending the sale of a home in order to downsize and free up equity for retirement income.
Planners exhibiting a mental accounting bias were less comfortable giving advice about using home equity to fund retirement. These planners may see home equity as separate from retirement planning assets, at least to a greater degree than their peers.
(Mental accounting is the tendency to treat money differently depending on how we mentally categorize it. For example, we may spend bonus money more frivolously than our regular salary even though one dollar of bonus is worth the same as one dollar of salary.)
Dr. Baulkaran suggests that by understanding the biases that exist, the industry can work toward more effective advisory practices through training and education.
But another consideration might be a review of how compensation models or sales quotas affect the incentives of salespeople to lean toward different retirement funding strategies.
For example, do salespeople with quotas on investment assets steer their clients to home equity release schemes more than non-quota advisers? That would preserve the fees or commissions collected on investment portfolios. Good for the firm, but what about the client?
As the role of home equity in retirement planning continues to grow, it is essential we scrutinize not only advice provided, but the environment in which that advice may be encumbered by compensation considerations to ensure that the evolving Canadian retirees’ challenges are being met.
Preet Banerjee is a consultant to the wealth management industry with a focus on commercial applications of behavioural finance research.
Preet Banerjee