Advising clients on income in retirement suddenly became even more challenging this year. The coronavirus has influenced not simply the way clients of financial advice firms think about their money, but also their short and long-term health too.

It has been a time for advisers to closely support their clients and ensure they fully understand risk and to plan accordingly.

As of 7 May 2020, the Dynamic Planner MSCI Risk Profile 5 benchmark was essentially flat year-on-year, while the FTSE All Share was down sharply by 17%. In comparison, at its lowest point in 2020, on 18 March, the Dynamic Planner Risk Profile 5 benchmark was down 10.65% year-on-year, while the All Share dropped 30.5%.

Such analysis quickly raises wider questions for clients of advice firms, who are either in or are soon approaching retirement.

Should they continue to withdraw money from their portfolio at a regular ‘safe’ rate? Should they reduce that amount or even pause portfolio withdrawals? But if so, when, how dramatically and for what length of time? It isn’t easy, clearly and the need for professional financial advice has arguably never been more acute.

What does a typical client in Dynamic Planner look like?

The typical client currently having an annual review in Dynamic Planner is aged 62; they are a Risk Profile 5, on Dynamic Planner’s 1-10 scale [where 1 represents the lowest level of risk and 10 the highest]; and they have a portfolio of £242,000 – close to a quarter of a million pounds.

As someone nears retirement, they ideally have a clear understanding of their financial needs, their time horizon and a guaranteed income to meet their expenses. In reality, however, none of this will be true, even in benign circumstances, which of course is the opposite of what we have experienced in 2020.

With a portfolio of £242,000 an index-linked annuity might yield 2.9% or £7,000 annual income for someone in their early 60s, modest in the context of a current average UK household income of £29,400, according to the Office for National Statistics.

An alternative of staying invested at a Risk Profile 5 would, over the long term, be expected to deliver a return 5.1% a year – or £12,000 before charges and inflation – which bolstered by a state pension for a couple of £17,500 totals £29,500, just over that average household income.

At a glance, the case to remain invested appears overwhelming – greater returns alongside an ability to access capital. However, what of those tangible risks we spoke of at the beginning – in particular, investment risk and drawdown risk?

The risk of investing money

For a Dynamic Planner Risk Profile 5, the strategic value at risk (VaR) – in layman’s words, the maximum the benchmark asset allocation will lose annually 95% of the time – is 13%. Therefore, losses can be expected to be greater 5% of the time. And at the time of writing, the Risk Profile 5 benchmark has operated well within expectation so far in 2020.

Of course, losing say 10% from a £240,000 portfolio is significant for someone either in or close to retirement. However, if they remain invested and their level of withdrawal is sustainable (see below), they can expect to recover and still enjoy the average returns.

Our own research further shows that there is a link between clients with lower risk profiles and people who sell in a falling market – underlining the exacting need for an accurate attitude to risk assessment and one which, moving forward, potentially reflects how older clients typically become more risk averse in retirement.

What, notably, is often not being captured here is additional risk created by withdrawing a fixed amount from their portfolio each month, for example. In short, drawdown risk – alongside tactical risks asset or fund managers take when building an income-focused portfolio are equally important to understand. There is no free lunch for investors, to coin a phrase, so being clear about that is key.

The risk of regular withdrawals

There is additional risk faced by the clients of advice firms who are drawing down a fixed amount each month when markets drop suddenly and, particularly, if that drop happens early in their retirement when the value of their portfolio, after potentially a lifelong accumulation phase, is greatest.

In that scenario, which we experienced in March 2020, each withdrawal by the client steepens the fall in value of their portfolio and reduces the ability to recover. The unpalatable risk then arises of the client running out of money. Add longevity risk and that risk becomes only greater.

How do you mitigate that additional risk? Below are three potential solutions:

  1. Understanding your client’s capacity to take risk begins by helping them understand their future financial needs and wants – and talking through the difference between the two. Base ‘needs’ expenditure is what plans should be designed to fund, ideally with some cushion. More discretionary ‘wants’ can be added to illustrate an ideal scenario. Note, if a cushion is not in place, withdrawals may need to be reduced or even paused during times of extreme market volatility like March 2020
  2. Ensuring the client has the capacity to meet their needs and continue to withdraw a regular income – not just at the bottom of a single simulated event like a financial crisis, but throughout the period indefinitely – is fundamental to assessing their capacity for risk. A good stochastic model will do this. Note, deterministic assumptions here – for example, modelling a market recovery within 12 months – can significantly and dangerously underplay drawdown risk as described above.
  3. Fixed monthly withdrawals require a monthly, not annual view of risk. This means fund managers take action to remain within a monthly risk ‘budget’, as opposed to an annual one, to maintain a level of return. If a fixed level of withdrawal is important to the client, Risk Managed Decumulation solutions in Dynamic Planner are a strong option.

In summary, for your clients who are preparing for or are in retirement, the need to understand and robustly test their financial needs – and then build, monitor and manage an investment solution matching those needs is an ongoing process.

Risk-based cash flow planning and risk targeting investment solutions always were important resources in an adviser’s armoury. In today’s world, they are priceless.

If you are not already a Dynamic Planner user – and would like to find out more about how we can help you and your firm – please get in touch.