I make no apologies for revisiting decumulation and challenging the current model. It is risky for clients and advisers.
My comments relate to the process whereby a retirement portfolio is amortised for income. And I am not looking at financial planning for high net worth clients, whose assets will largely go to children and grandchildren. We know most individuals are not so blessed.
According to Royal London’s drawdown governance service, only 47 per cent of customers have a more than 85 per cent chance of their income lasting them for life.
So, there are three strands to my argument:
- Costs are too high and could eliminate 50 per cent of potential income to the client.
- While 100 basis points of a healthy portfolio represents a great income stream to the advice firm initially, it may not do so later.
- The FCA reckons 50 per cent of people are potentially vulnerable. While this estimate is not helpful, as the current cohort reach their 70s, 80s and 90s, a proportion will be, with concomitant concerns.
Costs are too high
It is a few years since consultant Malcolm Kerr said that an adviser charge of 100bps represents 25 per cent of client income at a withdrawal rate of 4 per cent.
A typical platform cost is 25bps; total cost of active management could exceed 150bps. There may be an additional cost for discretionary management or a model portfolio service. Total cost of 275bps and above are not unknown. The equity premium could disappear in charges.
That said, many advisers now employ competitively-priced passive funds, driving diversified portfolio costs down to 50bps and lower.
Some advisers claim their 100bps charge covers financial planning. Sorry guys, financial planning should not be based on assets under management. You cannot expect an income for a piece of advice.
What is good today, may be less good tomorrow
Most retirees will exhaust their retirement savings. While I think the impact of longevity is often exaggerated, many will live into their 80s and 90s.
In our research, we are often told clients will only use pension pots as inheritance tax mitigation tools and that they will live off other capital, most of which will still be left to children and grandchildren. But this is not true for the typical adviser client.
While there are fortunate ones with both defined benefit and defined contribution benefits, as well as a non-pension portfolio, typical adviser clients have wealth of around £150,000 to £250,000, with possibly a bit of DB as well. Some of you will be screaming: “My clients are better off than that!” Of course, it is a distribution curve, with long tails either side.
There is another factor: the next big correction. Markets have been at all-time highs but have fallen more than 10 per cent recently. The world is full of problems from Brexit to Trump and protectionism, not to mention climate change. The bull run has been long.
Corrections create two problems for advisers and clients.
The first is obvious: wealth has shrunk. Clients rightly do not believe the hype that you do not lose money unless you sell. Take that one to the bank. In 2001, dot coms crashed as most were overvalued. It was the pre-crash price that was wrong.
Most clients will want consistency of income and will therefore be decumulating from a smaller portfolio increasing the rate of reduction.
The other factor is fear. What if the market continues to fall? When we ask what advisers will do following a correction, many tell us they will meet with the client and review. That is all very well but it is possibly pointless and expensive.
If the market has fallen by 30 per cent, will it go back up quickly like 1987, or will it continue falling like 1973/4, or 2001/02, with falls of over 70 per cent and recovery taking 15 and 13 years respectively?
Few behave rationally when they see their savings ravaged by markets. They panic. Many experts argue that corrections represent buying opportunities but since you do not know whether a 10 per cent correction will become a 75 per cent correction, that is a matter of timing and we all know where that goes.
So, in summary, most clients starting decumulation today will see their wealth depleted by amortisation and, over the next 10 to 15 years, further damaged by one or more severe corrections.
Most will ride this, as need for income decreases dramatically in old age. Very old people rarely wear the latest fashions, eat in trendy restaurants or drive exotic cars. They stay home and watch TV. But, there is another bear trap out there…
I am concerned the issue of vulnerable clients creates a whole raft of new regulations, cost and paper for little benefit. I suspect the number of vulnerable clients is not increasing as people are better informed and there are more protections in place. High street banks no longer flog investment bonds to 85-year-olds on 8 per cent commission. Sure, few did, but some did.
The problem is subtler. Drawdown is the default for decumulation. Some advisers will annuitise when clients get to a certain age – 75, 80, 85. That said, we see little evidence of that happening today. It means turning a client who pays 1 per cent a year of the fund in fees to one who pays 2 per cent first and final. Not good for the shareholders.
Furthermore, if the fund has dropped too far, annuitisation is probably no longer a serious option. So, there are going to be difficult conversations.
Which brings me to vulnerability. A proportion of those retiring today will become vulnerable in the next five to 15 years.
The nightmare situation is having difficult conversations about income and valuations with an older client who can no longer make difficult decisions – albeit, you may be unaware of this. On top of that, the 100bps on the depleted fund will not begin to cover the difficult meetings and surrounding work involved.
Advisers, providers and regulators should establish processes now. For ideas, have a look at what the Law Society and Solicitors Regulatory Authority have done. We do not have to start from scratch.
Clive Waller is managing director at CWC Research