Using the same risk-profiling tools for the process of wealth accumulation and drawing a retirement income is a dangerous game. Carmen Reichman finds out how advisers deal with decumulation...
Advisers know the staggering differences between client needs at accumulation and decumulation, but does this always translate to risk-scoring?
To ‘fudge' an attitude to risk score based on an accumulation advice model into a retirement income plan would throw up problems that could be incredibly hard to rectify, according to one stakeholder.
Moody's Analytics head of retail product and advisory Philip Mowbray said that, given the late stage in the investment cycle, the risk-return approach typical of most tools would be inappropriate. Instead, advisers need to be able to focus on clients' income requirements and spending objectives.
The most important decision
Mowbray suggested advisers needed "some kind of model or advice tool that illustrates explicitly, and in simple terms, the trade-off between income, income security and the residual capital".
Defaqto insight analyst Richard Hulbert said the problem begins with existing popular advice tools, because they do not always have an income option, making it difficult to plan based on the client's income needs.
He said relying on things like the maximum 120% GAD capped drawdown limit – reinstated from 100% in last year's Autumn Statement – and critical yield-based insurer quotes created the risk of allowing the client to opt for an income that is probably too high to sustain.
Hulbert also highlighted the threat of a "compounding effect of negativity" – the scenario where capital is drawn out of funds combined with the risk that markets could decrease. He said this made it critical to be aware of the impact any decisions made would have on the future income of the client.
But Ian Thomas, managing director at Pilot Financial Planning, said the right tools to plan a client's move into retirement were already there.
"A good cashflow modelling tool, with all the relevant rules built into it, and used in the right way, will give you exactly what you need in terms of an understanding of the trade-off between your income and whether that capital is likely to last you," he said.
"The key here is having a thought-through process that tries to minimise the risk of selling assets at a time that isn't good and therefore you take account of the income requirements as part of your overall planning," he added.
Other advisers said they would not solely rely on tools to create a plan for their clients approaching retirement anyway, as this part of the advice process was all about making it personal.
Jacksons Wealth Management managing director Pete Matthew said tools were helpful guides but "any competent adviser should be able to sift through those things". Planning for retirement was about "real world conversations, which matter to clients", he said.
"A key part, in my mind, of a financial planner's skill is being able to identify, in real-life terms, what sort of volatility a client is going to be happy with.
"Any system is, at most, half of the job and the other half is, at least, the competence of the adviser to get the necessary points across and to understand [them]. I'm extremely guarded about putting all my faith in systems."
Financial planner at Ark Financial Planning, Phil Perry, said risk ratings and the conversation about the client's personal situation do not always go hand-in-hand as some clients find it hard to understand that they now have to live on the money they have accumulated over the years.
"When you've got a long-term objective or an investment objective, risk questionnaires are important. When you get to retirement, risk questionnaires are also important but it is equally important to have that conversation with the client."
He added: "You can't see the investment goal when you start accumulating but if you then come into retirement – and this is the one and only decision you are making – it's a much more personalised approach. It's more about the clients' feelings towards how they want to approach this."
How we do it
Pilot Financial Planning's Ian Thomas explains his firm's approach to regularly assessing clients' attitude to risk...
"We risk-assess people on an annual basis in terms of their tolerance to risk, using the same questionnaire, to see how the score compares. We then factor in the capacity to take risk and the need to take that risk over time.
As clients approach their chosen retirement date, we de-risk their portfolio, even if they are going to go into drawdown.
"However, you don't want to be all in defensive assets because then you've got an inflation risk. So you need to keep a pot of money for inflation-proofing your portfolio and giving you longer-term growth prospects. But, equally, you don't want to have all your money in growth assets because you don't want to have to start drawing the assets out at the early stage of your retirement because they may be at a low point in their cycle.
"We work out what their required drawings are from their fund – we typically keep around two years of anticipated drawings in cash and a further three years in either cash or other short-dated bonds, so effectively you've got five years of assets in very safe asset classes and your medium to longer-term portfolio is treated similarly to how we treated it in accumulation. That's recalculated on a rolling basis so you always have an amount of money ring-fenced for your short-term needs."
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