Written by Simon Bussy on Wednesday 3 December 2014
Many words – indeed, many thousands of words – have been written about ‘risk’. Client attitude to risk. Investment risk. Interest rate risk. Liquidity risk. Economy risk. Currency risk. Inflation risk.
And it must be said – regardless of whether you’re an advocate of risk profiling tools as part of the investment process or not - huge strides have been taken over the past decade or so by many (though not yet all) to align a client’s attitude to risk, their capacity for risk (loss), their time horizon, and the most appropriate asset mix to help them achieve their pre-retirement (accumulation) investment goals.
With Freedom comes responsibility
Fast forward to today, post Budget 2014. Much has been, is being, and will continue to be written about the new pension freedoms, and the flexibility (and responsibility) that this will give to the man and woman in the street about how they manage their income in retirement.
"Where a firm creates or uses risk-rated portfolios as part of its CIP, it must ensure the portfolios align accurately with the risk descriptions and outputs from any risk profiling tool it employs," FCA Guidance Paper FG12/6
Much less, however, is being written about client attitude to risk in the post-retirement (or, horrible word that only our industry could come up with, decumulation), phase, and the impact this has on the client’s investment strategy. Unlike the accumulation phase, having a target ‘end date’ post retirement is, of course, far more difficult to judge for the majority of clients. As a nation, we tend to like certainty (the main attraction of the much-lambasted annuity). But while the actuaries might say they can predict when you will die……. what if you don’t? What if you live 10 years or more beyond ‘normal life expectancy’? what if you’re one of the millions who don’t have the benefit of a nice inflation-proofed DB pension? what about your income in retirement then?
Living too long
So now, more than ever, longevity risk and inflation risk (or living too long and ever-increasing prices ) are becoming a topic of conversation, the talk of the pub and the dinner party. In this brave new pensions world, these risks are muscling its way up the ‘things to consider’ list. And it won’t be because Middle England decided to splash out on the shiny new Lamborghini in a delayed ‘mid-life crisis. No. Quite simply, it’ll be because their retirement ‘pot’ won’t be able to sustain the required level of income for long enough.
But what to do? Amongst the plethora of new products and funds that are already being developed by clever people locked away in dark rooms with cold towels wrapped round their heads, my challenge to the industry is to develop the tools and communications that really help clients understand what all their options are, that really help explain the transition from pre-retirement into ‘in retirement’, that pinpoint the key critical decisions that need to be made along the way…….. and the impact of making different ones.
A glimpse into the future..?
For instance…….. the risk profiler as part of a process that properly considers the client’s (changing) attitude to (and capacity for) risk as they begin to move from one phase of their life into another, as they start to draw an income from their pension pot and other assets, in full or in part (perhaps to supplement a gradual move to reduced hours or part time working). The lifetime cashflow modeller that can reflect this, and demonstrate the treble-whammy impact of variable (including negative) returns, living too long, and inflation. The tool that considers tax, and how to mitigate it as far as possible. In fact, the tool, the communications and the process that actually does ALL of these things, in an Apple-style integrated, engaging and intuitive fashion, leading to an optimised level of retirement income.
Not just so that Mr & Mrs Sophisticated Investor can understand, but so that Mr & Mrs Average can understand too. And regardless of whether they chose to take advice or not.
As Benjamin Franklin wrote way back in 1789, “Nothing is certain except death and taxes.” As an industry, it’s our responsibility to help those that need our help achieve the retirement they want by planning for both.