You’ve heard this argument before: “If a client has £1m, and they want take £40,000 a year under the sustainable withdrawal rate framework, then 1 per cent advice fees translates to 25 per cent of the withdrawal from the portfolio.”
Or this “Oh, if the SWR is 4 per cent, once you account for total fees of 2 per cent (funds, platform and adviser), then the SWR becomes 2 per cent”.
It feels intuitive. But the maths is wrong.
One of the great misconceptions about the framework is how adviser fees affect withdrawals from a retirement portfolio. To be clear, fees impact the sustainability of withdrawals, and excessive fees are damaging.
People should be able to make informed decisions about this. That’s why it’s important to avoid misleading people, or to exaggerate the effects.
To demonstrate the impact of fees, I used Timeline software to run a withdrawal strategy for a UK investor. Here is the scenario:
- Initial portfolio of £1m – 60 per cent world equities and 40 per cent global bonds. Rebalanced annually.
- An initial withdrawal of £40,000 a year from the portfolio, adjusted for inflation each year over a 30-year retirement period.
- We test the impact of 1 per cent per annum and 2 per cent per annum of the outstanding portfolio, deducted on a monthly basis, based on the outstanding balance of the portfolio at the start of each month.
- Calculate total fee taken from the portfolio over the entire retirement period, and present this as a percentage of the cumulative income and the terminal balance (or legacy).
- We use actual historical return of asset classes and the corresponding CPI for the UK. The dataset runs from January 1915 to December 2018, giving 888 scenarios each lasting 30 years.
- Given the large dataset, we rank all the scenarios based on how quickly the portfolio was exhausted and/or the terminal balance at the end of the 30-year period. We then select five actual scenarios: the worst, the 25th percentile, median, 75th percentile and best scenarios (see table).
1 per cent pa gives around 6–12 per cent of the client’s overall income and capital, depending on the scenario. A total fee of 2 per cent per annum wipes out around 13–26 per cent of the overall fund, again, depending on the scenario.
Even in the median scenario, a 1 per cent fee translates into 10.2 per cent of the cumulative withdrawal and end balance over 30-year period.
High fees can be damaging to a drawdown investor. You could also think about the impact of fees in terms of how many years the portfolios would have lasted with lower fees. For a UK investor, a 2 per cent fee means the portfolio ran out of money around three years sooner than a 1 per cent fee in the worst and 25th percentile scenarios. In effect, the additional 1 per cent fee wipes out three years of income for the client. This ultimately creates a lose-lose situation for both clients and advisers — excessive fees risk depleting the portfolio too quickly so the client runs out of money and the fees invariably stop.
All this means that having a robust withdrawal strategy in place is not only an issue of client outcome, it also has a direct impact on the long-term profitability of the adviser’s business. It’s crucial to accept that having a robust withdrawal strategy that ensures the portfolio doesn’t run out of money is not only good for the client, it’s good for the adviser’s bottom line.
Abraham Okusanya is director of Finalytiq