It’s time to spend it. Supporting the client decumulation phase
What changes when our investment objectives transition from accumulating capital through savings, to using our capital to support our lifestyle or fund capital projects in decumulation? Parmenion’s Distribution & Marketing Director, Richard Goodall, looks at some of the factors Advisers may be considering.
2017 was a special year for Advisers. Not only were markets driving up portfolio valuations to record highs, but the opportunities to work with more clients around their long term savings capital increased dramatically. Indeed, over the last five years, balanced portfolios have seen compound returns of 50-60%. When investment is proving so strong, clients will generally find their expectations are being exceeded.
Looking ahead, we see a need to be a little more circumspect. Because growth is looking good at last, interest rates are edging up, here and in the USA. European rates may be following them up next. Given the amount of debt in the system, these baby steps need to be taken with great care and there’s a risk the baby may stumble. What this points to is the vital need to manage expectations, especially with clients who have just stopped saving.
Time horizons change
When we begin to draw on our capital, our investment time horizon changes. We need some of our money today. For this reason it is common practice to raise cash levels. Parmenion’s thinking is technology that supports multi-pot investing, is ideal in this scenario. Strips of capital can be allocated to cash and lower risk and/or higher yield solutions if appropriate, with everything neatly aligned to the precise time horizons for withdrawals and regular spending revealed during the client planning. We believe a great benefit of this approach is that it boosts composure. No one feels happy with all their eggs are in one basket.
Once we have stopped saving capital, and begin to whittle it down, the obvious questions are, what chance is there I will suddenly lose money, and how big could those falls be? As we have mentioned, recent history may not be the best guide. Advisers can review the credible, conservative forecasts investment consultants share with institutional clients as a guide. Parmenion generate analysis for our portfolios using a firm of actuaries. We also show the long term historic numbers for ‘max loss’ in our disclosure documents for the different risk grades in a solution. These are very easy for potential investors to interpret.
|Risk Grade 4||Risk Grade 5||Risk Grade 6|
|Max loss %||-20.05||-24.05||-25.58|
Annualised figure based on 20 year historic data for Guardian portfolios.
The risk/withdrawal rate conundrum
But we also need to dig a little deeper and ask another question. What is the long term impact of withdrawals on my wealth? And what about sequence risk? Here we come up against the risk/withdrawal conundrum. If I reduce the risk level of my portfolio when I start to spend I may feel safer, but as my withdrawal level rises that may make it more likely I will run out of money. If the withdrawals are just a little higher than the income on a portfolio, it’s not such a problem. But when 5% or 5.5% is needed, you have to look at taking risk, for growth, to replace capital. You will not find a diversified asset mix dependably yielding 5.5% in natural income. Investment managers like Parmenion can offer our guidance on these more subtle effects in terms the percentage odds of running out of money for clients of different age, need for income and risk tolerance.
Value and price
Investment Advisers will be looking to interpret value for their clients in the context of price. Passive investment has been leading the way in the ‘liquidity driven’ markets of recent times. Where active funds and professionally managed portfolios can score, for their extra cost, is by offering downside protection and volatility constraint. The difference in projected outcomes in drawdown for portfolios which match the return of tracker baskets at lower variability of return should not be overlooked. Which brings us, finally, to the value of advice. Nowhere is regular professional review more important and more valuable than when assets get redeployed for spending.
“The above article is intended to be a topical commentary and should not be construed as financial advice from either the author or Parmenion Capital Partners LLP. If a client wishes to obtain financial advice as to whether an investment is suitable for their needs, they should consult an authorised Financial Adviser. Past performance is not an indicator of future returns.”
Any news and/or views expressed within this document are intended as general information only and should not be viewed as a form of personal recommendation. All investment carries risk and it is important you understand this. If you are in any doubt about whether an investment is suitable for you, please contact your financial adviser.