Financial planners still don’t fully understand the importance of building a sustainable income stream in retirement, according to industry experts including ASIC deputy chair Peter Kell, Texas Tech University Professor Michael Finke and Dimensional Fund Advisors executive director Nigel Stewart.
Last week Dimensional Fund Advisors hosted a boardroom presentation by Professor Finke, who leads the Texas Tech Financial Planning Graduate Program. The PhD program is regarded as the best financial planning program in the United States.
Finke said current strategies for turning a lump sum of money into an income stream were flawed, citing the widely-accepted 1994 Journal of Financial Planning article by financial planner Bill Bengen which, in summary, stipulates that if retirees spend 4 per cent of their superannuation assets in year one of retirement, and that amount increases annually in line with inflation, their nest egg will last at least 30 years based on historical scenarios.
Bengen’s paper defines failure as not being able to spend that amount of money each year for 30 years.
However, Finke said retirees who applied Bengen’s static 4 per cent rule in today’s low return environment were setting themselves up to fail because it did not adequately consider a retiree’s starting point or address longevity and asset return risk.
He said retirees today needed to adopt a dynamic approach to retirement spending, which facilitated the ability to spend or less in certain years.
“The first five years are the most important five years in a retirement portfolio,” Finke said.
“It matters where you start out and when you begin withdrawing assets from a portfolio. It makes sense to think about asset pricing,”
Finke urged financial advisers to prepare for the wave of baby boomers about to retire, noting that retirement is one of the biggest triggers for seeking advice.
“The peak of the cohort is 57 years old right now so they’re not ready to retire but they will be soon,” he said.
Rice Warner estimates that post-retirement assets will rise to 32.4 per cent of total superannuation assets by June 30, 2016 and 42.1 per cent by June 30, 2026, from its current level of 30.3 per cent.
At the presentation, Kell said the advice industry needed to develop a deeper understanding of post-retirement issues, citing the Australian Securities and Investments Commission’s 2011 report: Shadow shopping study of retirement advice, which revealed glaring shortfalls in the quality of retirement advice.
“When we did work around the value of advice, in particular advice around transition to retirement, we found there are still too many advisers in accumulation mode,” Kell said.
The mystery shopper exercise, which was conducted with Colmar Brunton Social Research, concluded that while the majority of advice examples reviewed were adequate, 39 per cent of advice examples were poor, with just 3 per cent deemed “good quality advice”.
Finke said the process of turning a lump sum of money into an income stream effectively made each individual adviser a pension manager.
“There will effectively be thousands of pension managers in Australia and around the world who are not qualified to be pension managers,” he said.
He warned that while institutional pension managers were able to pool returns across generations to provide employees with a higher average return, advisers and their clients had just “one whack at the cat”.
“You’re stuck with the one sequence of return and risk that you experience when you retire,” he said.
Professor Finke published three papers in 2013 with his most recent, “The Market for Retirement Financial Advice,” published in Oxford University Press.
