More Australians are retiring with higher superannuation balances than at any other time in history – and they have lifestyle expectations to match.
Retirement portfolios have a lot of heavy lifting to do. They must make a lifetime of savings last for an undefined number of years to support an ever-changing retirement lifestyle.
It's a near impossible task that falls at the feet of advisers. There are no easy answers, but there are some common mistakes to avoid that can help advisers deliver what clients want and show their true value.
1. Leading with products, not solutions
The financial services industry has been built around products, but they’re simply one conduit to achieve the type of retirement Australians want. The industry and media remain focused on the best performing funds, when the real question is what actions should people take to achieve their goals?
Only high-quality advice can provide the answer. It takes an adviser with strong IQ and EQ to understand clients' problems, goals and risks, which form the basis of practical, tailored solutions.
Product providers are not well placed to answer these questions – just look at the post-retirement sector, which is littered with failed products, showing just how often they miss the mark.
2. One size (or six) does not fit all
Getting from point A to point B is a lot easier in today's world. We no longer rely on a street map, we turn to technology like Google Maps, which analyses big data with sophisticated algorithms to create a personalised journey.
Retirement should be no different.
However, we often put clients into broad categories defined by their risk profiles. While it can provide important information and is a necessary part of compliance, it fails to capture crucial information.
We need to build portfolios that consider an individual's exposure and preferences for markets (return), longevity (time), inflation (spending) and health (liquidity), which are incorporated with their personal goals. Clients can express these needs in terms of their goals and their level of conviction for each one, creating 'goal profiles'.
Technology and data are helping advisers create unique retirement experiences at scale.
For example, the Milliman Retirement Expectations and Spending Profiles (ESP), based on anonymised bank transaction data, shows that the median retired couple’s expenditure falls by more than one-third (36.7%) as they move from their peak spending years in early retirement (65 to 69 years of age) and into older age (85 years and beyond).
The drop-off is more marked for wealthier retirees, who initially spend more on discretionary items than others.
3. It's not just about fees and returns
The Productivity Commission review of the superannuation sector, as well as the recent Royal Commission, have propelled the industry towards a simplistic fee and return debate.
While fees and returns are important factors to consider, people are ultimately concerned about their ability to meet their expectations.
Risk naturally becomes far more important as clients approach and progress through retirement. This isn't captured in fees or headline returns.
Not all balanced funds are created equal or are actually balanced, as the global financial crisis revealed. Risk, and the levers to manage it, change as retirees age, their goals shift, and as the amount they have invested falls.
4. Risk is poorly quantified, managed or communicated
Risk is difficult to identify, quantify, and manage.
Loss-averse retirees are at particular risk of switching their investments to a lower-risk investment option during a market downturn. The popular bucket strategy is one way to help manage these negative behavioural biases, such as mental accounting.
They can take some comfort knowing they can continue drawing down on the cash bucket while their equities bucket recovers during a market correction.
However, this approach relies heavily on the assumption that equity markets will quickly revert to the mean. However, it took equity markets 4.6 years to recover from the global financial crisis in 2008 and 7.9 years to recover from the 1970 downturn.
Another strategy to manage risk is to run a stochastic analysis to determine the probability of a portfolio achieving its goals. This is useful but often neglects to also measure the shortfall when a portfolio fails. We find more aggressive portfolios often produce a higher probability of success but when they fail, the shortfall is larger, potentially eroding several years of income.
Managed risk overlays offer another lever that advisers can pull to directly protect portfolios from extreme volatility and sharp capital losses by using a replicable process.
5. Failure to allow for behavioural bias
Loss aversion is one of the most damaging behavioural biases for retirees. It refers to the way an average person feels the pain from a loss twice as much as the pleasure they feel from a financial gain. In other words, the pain of losing $1,000 is as strong as the satisfaction of gaining $2,000.
However, retirees can be five times more sensitive to losses, which is an intuitive response given their savings are around their peak and their ability to ride out any losses is not what it was when they were still saving.
Portfolios that fail to acknowledge these tendencies, which are not always captured during the risk profiling process, are leaving their clients at risk.
6. Poor fit with adviser practices and investment approaches
The industry will continue to see a range of new investment solutions that have the potential to fill pieces of the retirement jigsaw – but many will fail because they don't respect the advice industry's processes and the way advisers work.
Solutions must be flexible enough to be tailored to clients’ needs and adapt to their changing circumstances. They must fit into holistic objectives while the benefits must be quantifiable and meet regulatory requirements. Advisers shouldn’t be faced with a choice between demonstrating compliance and delivering strong outcomes for their clients.
Solutions should be implemented in the most efficient way, whether through a platform, managed account, ETF or alternative structure. Similarly, we are now in an era of plug and play where advisers and their clients expect to choose their own best of breed solutions rather than compromise.
The Baby Boomers have consistently forged their own path and challenged the status quo. As they move into retirement, the industry needs to continue this legacy and accelerate our own pace of change. Generations to come will be better off as a result.
You can view a webinar here in which Wade Matterson discusses the concepts in this article in greater detail.
If you have any questions about portfolio construction or the solutions offered by Milliman, please contact your Colonial First State Business Development Manager.
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