Successfully navigating the retirement maze
‘Advice is judged by results not intentions’. The words of Roman scholar Cicero, which really capture the challenge of providing retirement advice.
There’s a range of inter-related risks that need to continuously be managed carefully, not just at the start of retirement. Ultimately, the success of any retirement strategy isn't likely to be known for many years, which shows the importance of carefully documenting and evidencing recommendations and resulting actions. It’s not surprising the FCA takes a close interest in this area.
The main risks clients face during retirement are outlined below:
How much is too much (or too little)?
Many people worry about withdrawing too much money and running out during retirement, but there’s no right answer to the question “how much is enough?” Research suggests UK retirees should take around 3% to feel confident they won’t run out of money. A variety of factors are taken into account to determine how much income could be taken, making the reality far more nuanced.
What goes up, rarely comes down
An inflation rate of just 3% would mean the value of money more than halves over 25 years. This can have a substantial impact on the purchasing power of income. While it seems sensible to inflation-link income to combat this, is this really the case? Protecting clients’ income against inflation comes at a price: a lower income today, for a higher income later. Is it a good deal? Well, that depends…
Timing is everything
Sequencing risk can have a devastating impact on clients’ retirement income and it describes the impact of poor returns in the early years. Advisers have a number of strategies that can help mitigate sequencing risk, but there’s no holy grail. All solutions come at a price, usually a potential drain on performance or an inflexible approach to income.
Comfortable investments are rarely profitable
Retirees no longer have the cushion of regular earnings, but live off savings built up over many years. That can lead to a conservative attitude to investments, but is this sensible? Data suggests that a high level of exposure to riskier assets usually produces better returns, but raises the prospect of sequencing risk. Behavioural biases can also influence client choices. How can you best manage these conflicting themes and behaviours?
Pearls don’t lie on the seashore
This Chinese proverb reminds us that we have to take risks to build wealth. When people choose drawdown, they expose their wealth to capital risk. They hope the risk will pay off, but this isn’t guaranteed.
The FCA talks about “the risk a customer is willing and able to take”. How much risk a customer is willing to take is their attitude to risk. Whereas their capacity for loss is the ability to take investment risk due to having significant essential spending needs in excess of guaranteed income. This is often categorised as covering the essentials, such as ‘heating and eating’, but are the ‘bare necessities of life’ enough?
The great unknown
Retirement planning would be so much easier if we could plot each client’s life expectancy. The existing data can be misleading. Averages are useful for calculating the life expectancy of large groups, but have little value at an individual level. Probabilities are better, but are still no more than a guide. The issue is compounded by the tendency for people to underestimate how long they might live. And it's not just how long people live that matters, their state of health during retirement is important too.