For many advisers, gearing up to meet more clients’ retirement needs will mean learning new skills and thinking about issues in ways quite different from how they address the accumulation phase.
At the Conexus Financial Post Retirement Conference’s day for financial planners, in Sydney on March 15, attendees heard that the adviser’s task is often complicated by the client’s inability to articulate goals accurately. In the absence of clear goals, the process can start in the wrong place, said Arun Abey, a co-founder of ipac Securities and chairman of Walsh Bay Partners.
“Our industry typically focuses on issues like adequacy, and I don’t think that is the right starting point,” Abey said. “This issue of goals-based advice is more complicated than you think. A person comes in and you say, ‘What are your goals?’ The honest answer – having seen a huge amount of research on this – is that people don’t know. When they’re in the spotlight, they’re like a rabbit and they come up with stuff that is, frankly, complete crap.
They come up with ‘I want to go to Italy’, and ‘I want to do this and do that.’ It’s not really well thought through.
“You need to go through a process of engaging the client, and the good thing now is there’s a variety of behavioural tools that allow you to enable the client to go deep fairly quickly.”
Challenges like this exist quite independently of the technical obstacles that arise not only in superannuation but also, increasingly, in areas such as aged care and estate planning, which are both integral to a comprehensive retirement plan but often missing from a holistic advice offering.
Paul Harding-Davis, principal of Advice IQ, said working with people’s finances and “helping them through three major transitions – work to retirement, independent to assisted living, and through death and estate management – is one of the growth industries. It’s one of the most vital areas for our industry as we go forward.”
Indeed, demand for financial planning services to facilitate a smooth transition from work to retirement will only increase as more people come to realise that the age pension alone simply won’t be enough.
Despite all the change, however, some fundamentals remain.
Dimitri Diamantes, policy manager at the Financial Planning Association (FPA) said that while there are many complex issues in retirement planning, particularly around technical and regulatory changes, it is ultimately always based on the same “traditional four pillars of the retirement income system – the age pension, compulsory superannuation, voluntary super and savings outside super”.
“What we’re seeing now is a positioning of the age pension as a safety net, as provision of something merely basic,” Diamantes said. “It’s not meant to incentivise people not to rely on their own resources; it’s meant to provide a modest standard of living.”
New skills meet new demands
With all the complexity, the task of guiding clients into retirement and beyond should begin with “the human element”, said Wade Matterson, practice leader in Sydney for global consulting firm Milliman.
atterson used the metaphor that advice that’s not truly based on the client’s goals is a pre-Copernican view of financial planning.
“I use this analogy that early views on the planets’ orbits were based on a misconception that the earth was the centre of the universe, [before Copernicus determined the planets orbited the sun],” Matterson said. “In some respects, that’s what happens when we focus on the wrong thing.” He said it produces unnecessarily complex solutions that are often wrong for the client.
“When we focus on risk and return – as the anchor from which we make these challenging decisions and work with clients – you create this hugely complicated web,” he explained. “You introduce complexity into the system by virtue of focusing
on the wrong thing.”
Successful advisers, he continued, would focus on the human elements of retirement. And there are few better guides to understanding what retirees want and need than observing what they do. Doug McBirnie, senior actuary with Accurium, said analysis continues to challenge the perception that when people reach retirement they draw down superannuation and spend large lump sums.
CSIRO and Monash University research released last year, covering 50,000 self-managed super fund members over 10 years to 2014, “really confirmed what other research is showing, and probably what most of you in the room will instinctively already know – that, by and large, those who have been engaged in managing their super aren’t getting to retirement and then blowing it all in one-off purchases or holidays and the like,” McBirnie said. “Those with high balances are starting to withdraw more at younger ages, so perhaps they’re retiring earlier. However, once you get over age 65, this reverses, and those with the lower balances start withdrawing from their funds at a faster rate.
“The data doesn’t tell us why but we can speculate. Those with lower balances perhaps need to withdraw to meet living costs; perhaps those with higher balances have more [assets] outside super. We need to look at a bigger picture to know.”
Even so, McBirnie said, right across the wealth spectrum, account balances for SMSF members at age 80 are no lower than for those at age 60. Yet only 1 in 5 SMSFs surveyed formally planned to leave money to the next generation.
“Retirees are not spending down their capital rapidly at all,” he said. “Even as they get to their mid-70s. And while it does look like balances are starting to reduce a little bit, perhaps as the pension minimums increase as they get into their 70s, we’re not seeing a huge consumption of capital.”
McBirnie said research Accurium undertook last year with the SMSF Association found that the typical planned spending level in retirement for an SMSF household was $75,000 a year, and about 30 per cent of households were planning to spend $100,000 a year. He said the opportunities for advisers dealing with retirees exist around providing more holistic advice on retirement lifestyles: helping to ensure that retirement plans are sustainable and giving retirees the confidence to spend money to enjoy retirement.
Golden years last longer now
As clients approach retirement, advisers must help them accumulate enough capital to meet their stated goals and give them the confidence to spend money in retirement to achieve those goals, without worrying unnecessarily about running out.
The longevity challenge is real.
Mercer senior partner David Knox said Australia is among the countries whose life expectancy at age 65 has increased by the most over the past 40 years, beaten only by Singapore, Korea, Japan and Chile.
“The Australian life expectancy at age 65 has increased by one year every seven years,” Knox said. “That is material. We continue to expect to live longer. Our life expectancy is continuing to rise – and not only from birth…We need to think about how much longer people aged 65 or 70 are going to live.
“The problem is, we don’t know. There is a significant variation in when we expect to die. When you sit down with a client, you normally don’t ask, ‘When do you expect to die?’ It’s not a very helpful question when you first meet them.”
Knox said that from a cohort of 65-year-old white-collar workers, allowing for expected improvements in mortality, some will die in their late 60s and some will live into their 100s.
“There is great uncertainty,” he said. “I think that explains some of the behaviour we’re seeing in the post-retirement market.”
He said that in accordance with McBirnie’s analysis of SMSF member behaviour, retirees essentially self-insure against longevity risk by not formally planning to leave a bequest and hoarding capital in retirement instead.
He said this self-insuring is more expensive than pooling longevity risk, which is the concept behind products such as the so-called comprehensive income product for retirement, or CIPR.
Pooled solutions allow retirees to pay a lower premium, leaving more capital in retirement to fund lifestyle requirements and goals. In fact, the effect of pooling risk can be to reduce the insurance cost to as little as 15 to 30 per cent of a retiree’s capital. But a pooled solution doesn’t necessarily suit everyone, and Knox warned advisers to examine carefully the product flexibility, possible means-testing of the product, and the risks of dealing with counterparties.
“But what I want to leave you with is that longevity risk has to be on your radar,” Knox said. “It’s important for retirees, and I think the government is going to continue to push it, and as [account] balances rise, our clients are going to want to tackle it.”
Match strategy with behaviour
ipac chief investment officer Jeff Rogers said good solutions arise only from digging deeply into problems. He added that there are multiple risks through which advisers need to guide clients.
“[What] I’d argue is useful is seeing which risks need to be managed but, in particular, the behavioural one is of great importance,” he said.
Just as important as managing any investment risk is making clients feel comfortable about the journey into retirement, Rogers said.
“It’s that match between the strategy and the behaviours of the customer that is important and, in that respect, we’d say anything in the investment strategy that gives investors confidence that they have a sustainable spending strategy – even if they have to change it over time – makes journey management much easier and gets people focused on overall meeting of goals.”
He added that the starting point shouldn’t be on the assets side of the retiree’s personal balance sheet, it should be on the liabilities side.
“Focus on consumption first, because that’s really what the retiree has some visibility on, and then work back to deal with the investment side,” he said, adding that, again, it’s important to find out what the clients truly want first. “Let’s start [with] trying to get people to articulate what their goals are. It’s quite a difficult task, but we do think that, in the future, having visualisation tools of various types [will help]. Big data should come to the aid here, and at least trigger people in terms of our best guess. It can allow us to say, ‘From what we know, people like you are likely to spend this, do you want to use that as a starting point?’
“We think the real gain is in getting people to prioritise their goals, getting them to understand what is and isn’t important.”
From there, Rogers said, an ideal investment solution for retirement should be based on a strategy aligned to the goal and its priority in the retiree’s plan. It should provide confidence that future cash flow will be delivered, supporting planned spending patterns. It should also generate strong internal rates of return, provide liquidity, and boast appropriate risk management.
“If [financial and other assets are not sufficient to fund the client’s goals] that’s when an advice discussion happens. But in a good situation, assets are surplus to the discounted value of goals, and that means the plan has a decent chance of success.”
The changing role of advice
Affinia Financial Advisers chair Steve Helmich said advice trends change over time.
“If you think back, you’ll remember when planners thought they were pseudo-fund managers or stock pickers,” Helmich said. “The message in adding value to their clients was: ‘I’ll beat the market for you.’ They believed they could add value by using their skills and knowledge to outperform the market. That wasn’t going to last long, was it? You have just one year of not beating the market and your value proposition is down the drain.
“Then we saw a move to matching investments to suit a risk profile. That’s all great, but do clients’ risk profiles change over time? Are they influenced by the environment they are in? Who wasn’t a bull in 2000 and a bear in 2001? Things change.
“Next in vogue was lifecycle planning. You know the drill there. As you get older, usually in five-year brackets, the investments switch from so-called risky equities to supposedly safe cash and fixed interest. Some super fund options do this automatically. But why does an Australian who will live for 30 years past retirement want to have the majority of their funds in fixed interest? It’s too much of a risk. I’m almost 62 years old…and if [my financial planner] put most of my money in fixed interest at this stage, I’d sack him, because it’s too much of a risk for the longevity side.
“The world has changed, and financial planning, like many other professions, is becoming more client-focused and more client-centric. We’re now in an environment where addressing clients’ life goals, and providing advice driven by a best-interest duty, is the key to future success. The focus on the end client and what’s important to them is stronger than ever and the delivery of advice and investment strategies to match life goals is paramount.”
Dan Miles, co-CIO for Innova Asset Management, said that in this environment, advice is paramount.
“It’s the advice that’s most important,” he said. “A client seeing an adviser, having a decent plan in place, making sure they can manage their behaviours and cash flows and that assets are in appropriate vehicles – that’s by far the most important part.
“Therefore, the investment solutions need to complement advice. They need to facilitate the process, not drive it. We as an industry have…built products and tried to shove them down planners’ throats. We should be providing the solutions.”
Miles said solutions should be focused first and foremost on risk, because this “can help facilitate the advice process, so the product solution bit becomes just background noise, as it should be,” he said. “If you have fixed asset allocation, which is what we’ve done in the past…you get variable risk. But you’ve just figured out with the client what their risk tolerance is, and whilst it changes through time, at the point when you’ve given the advice, it’s relatively static, [so you get a variable risk outcome].
“An alternative approach is flipping that around and saying, ‘Instead of varying the risk and fixing the asset allocation, let’s vary the asset allocation according to the risk that the clients can handle.’ ”
One downside of this is that the return from a portfolio will vary over time, and it will be difficult to predict or forecast with any certainty. However, Miles said stochastic modelling – a term he says is often used to make the speaker sound smart – can show the probability of a portfolio achieving the necessary returns to achieve the client’s goal.
Doubting risk exists is dangerous
The head of sales strategy and implementation for NAB Asset Management, Katie Whiffen, said there’s no shortage of product availability or willingness on the part of asset managers to innovate, but advisers need to have the right conversations with clients first.
“When you’re thinking about risks and how you describe them to your clients, we’re stuck because you’ve got all these great solutions in the market and we’ve got these massive issues that our clients are facing, yet fewer and fewer people are having those conversations because they just don’t see those long-term risks, they can only see the risks right in front of them,” she said. “Many people and many advisers have not experienced them, so they do not believe they are true. That’s dangerous for our industry and incredibly dangerous for our clients.”
Whiffen said advisers need to be sure they are managing the right risks and that those they are managing are genuinely present in clients’ lives.
To illustrate the point, she said about 80 per cent of people in Australia have car insurance – and that figure includes people who do not own cars – but no one does stochastic modelling before they buy it.
“Everyone just takes it,” Whiffen said. “But very few of us have any longevity insurance. And when you discuss the risks, there are 4.8 million registered cars in NSW and last year there were 40,000 accidents. That’s less than a 1 per cent chance of an accident, yet you all have that insurance and you never question it, because it’s so present.
“But [if your clients are drawing out the Superannuation Industry Supervision] minimum, there’s a 30 per cent chance they will run out of money by the time they’re 25 years into retirement.
“That’s a big risk, and it’s not being covered. Why? Because it’s a long time into the future.
One of the big challenges is making those big, far away risks present in today’s conversations.”
Meanwhile, on the product front…
Michael Furey, managing director of Delta Research & Advisory, said the biggest investment challenge facing financial planners is “the drawdown portfolio”.
“Our world, financial planning, has very much been focused on the accumulation side of things [and that’s been done] with the non-liability approach to investing. That’s created quite a few challenges [now that we’re being asked to manage to a liability] – i.e., someone’s lifestyle in retirement.
“When the liability is not an insurance payout down the track but someone’s lifestyle, it carries a massive emotional risk. And, as we know, emotion and investment don’t go well together. So planners have it really, really tough in managing that.”
Nevertheless, Furey said, planners must face the challenge of moving from being asset managers to asset/liability managers and, as a result, there will be increased demand for solutions from fund managers to help them do that.
The managing director, Asia-Pacific, for Colombia Threadneedle Investments, Jon Allen, said “frugality is no longer a fashionable option in the maintenance of income”, and that it was up to asset managers to develop new solutions.
Allen said capital allocation and risk allocation are two different starting points and produce two different outcomes. But risk allocation is what matters more for individuals in retirement, and financial planners and fund managers need to develop solutions that recognise this.
“The asset allocation matrix has to be one that’s cognisant of being dynamic across risk, and when you need to take it and when you don’t,” he said.
The CIO for Legg Mason, Reece Birtles, said the best solutions require “advice, and you need to be thinking about individual circumstances, but you need the right product set”.
“Clearly, the industry is going to take time to respond,” Birtles said. “We think it’s important to think about not just the strategies but also the delivery of the products. How do they distribute, for example, income versus capital gains? It’s clearly in its infancy in terms of the total products you’ll see.”
Much of the talk about retirement solutions focuses on goals-based advice, but that’s different from goals-based investing, said the head of product and distribution for Schroders, Graeme Mather.
“I like the idea of goals-based advice,” he said. “I think the industry as a whole has to move in that direction and stop looking at risk profiling as the first port of call for assessing what type of investments an investor should be in.
“We need to sit down and think about what investors, and retirees in particular, want from a portfolio, then build based on those objectives.
“It’s not hard for us as product providers to do that, but it does require engagement with the individual and the users of the investment products, and with the financial planners. We’ll see more of those types of solutions being developed in the next few years.”
TOPICS: Accurium, Advice IQ, Affinia Financial Advisers, Arun Abey, Colombia Threadneedle Investments, Conexus Financial Post Retirement Conference, Dan Miles, David Knox, Delta Research & Advisory, Dimitri Diamantes, Doug McBirnie, drawdown phase, Financial Planning Association, Graeme Mather, Innova Asset Management, ipac, Jeff Rogers, Jon Allen, Katie Whiffen, Legg Mason, mercer, Michael Furey, Milliman, NAB Asset Management, Paul Harding-Davis, Reece Birtles, retirement income, Retirement planning, Schroders, Steve Helmich, Wade Matterson, Walsh Bay Partners
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