Dynamic Planner Proposition Director CHRIS JONES analyses key considerations when creating a Centralised Retirement Proposition for clients at your firm, reflecting on mistakes made during the 2008 financial crisis and concluding by pinpointing three ways to manage sequencing risk.
In retirement planning, there is a moment when the client’s needs and objectives change and you are most likely to recommend a pension switch or transfer – the point of retirement itself when everything pivots.
On one level, you are no longer planning for the future, you are planning for now. A client is no longer putting money in, they are taking it out. A client’s typical day changes and so does their expenditure. And we don’t have to mention pension regulation changes.
You could view PROD and imagine your target market is relatively narrow, defined. You don’t need a myriad of different solutions. And yet it is utterly implausible that you could use the same Centralised Investment Proposition [CIP] before and after retirement, and so the Centralised Retirement Proposition [CRP] was born.
Different factors to consider in a Centralised Retirement Proposition
#1 The pattern and frequency of withdrawals
Does the target client want a fixed monthly income like a salary? Would they withdraw a lump sum each year and spend it sensibly? Can they afford to delay withdrawals? Could they tolerate a variable income?
#2 Sequence of returns risk
If you take a fixed withdrawal of capital each month, then you introduce an additional risk into the portfolio. You may until now have effectively managed the risks in your CIP, but this is extra. Until retirement, the value mattered at annual review. Now, it matters every month when units are sold. This means that the volatility of unit price needs to be managed on a monthly not an annual basis. It isn’t as simple as reducing overall annual risk.
#3 Early loss risk
When we look for past retirement risk, the examples of people’s income halving between retiring in 2007 and 2008 is powerful. However, that was due to a combination of a sudden fall in capital value alongside a fall in annuity rates. There is some important context.
Firstly, the fall hurt people in the run up to retirement as much as those who had retired using pension fund withdrawal, so that is an issue for both a firm’s CIP and CRP.
Second, the compulsion or tendency to buy an annuity in 2008 forced people to lock in the loss. People confused this one early loss with sequence of returns risk, but it is different. The impact for clients who remained invested, particularly if they reacted by adjusting the level of withdrawals taken, was much less. The important factor ultimately to consider is whether the client will buy an annuity in the future when the time is right or whether they will continue to withdraw capital until it is gone, or they die.
Like a CIP, as well as the needs of a target market, the level of work an adviser has to do to maintain it and how the costs of that can be reasonably passed on to the client should also be considered. With a CRP needing to further manage monthly withdrawals and risk, a firm can expect a higher level of maintenance work.
How can you manage sequence of returns risk in a Centralised Retirement Proposition?
#1 Do not take fixed regular withdrawals from a portfolio
From a non-individual, centralised perspective, this means only distributing the interest, rent or dividends to the investor, also known as natural income and leaving units untouched. This can work for clients who can afford to live off a small percentage of their capital that varies.
Important considerations when selecting a Centralised Retirement Proposition for this target cohort are: level of ‘income’, its consistency, risk to remaining capital and total return. This approach works by not spending capital but does nothing to manage out sequence of returns risk. Dynamic Planner offers specialist Income Focused Fund Research that addresses this.
#2 Withdraw from the stable part of a client’s portfolio, typically cash
This works if you have effective and efficient portfolio construction software that helps you provide both initial and ongoing suitability assessments and disclosure. The approach becomes personalised and hands-on, so there are challenges with scale and also greater inflation risk due to the amount held in non-real assets.
#3 Invest in solutions which manage risk on a monthly rather than annual basis
This could be through an asset allocation that is negatively correlated in shorter time frames; it could be through highly active management; or it could be the provider using its own capital to smooth the unit price. In whichever case, due to the mathematic nature of sequence of returns risk, it is a matter of analysing and risk profiling with a monthly rather than annual perspective to identify solutions’ risk profile even when fixed regular withdrawals are taken. In Dynamic Planner, these are Risk Managed Decumulation funds.
While these approaches can deal with any target market in retirement, there is one final difference to the pre-retirement accumulation market. Most accumulating clients, in short, require as much capital as possible, while retiring decumulation clients have personal and varied income requirements, time frames and patterns.
As a result, a good Central Retirement Proposition is seamlessly aligned with – and underpinned by – a powerful cash flow planning tool, which is easy to use from somebody you trust.
“Dynamic Planner Cash flow is based on the volatility of the client’s funds or benchmark asset allocation for their risk profile. That is a superb improvement over assuming a flat growth rate, which takes no account of sequencing risk.”
Read how one advice firm uses Dynamic Planner Cash flow
