Why decumulation needs a different approach to accumulation
Tony Hicks, Head of Sales, Copia Capital
People in retirement face more challenges today than ever before when it comes to planning for retirement. The decline of final salary pension schemes and the rise in market-reliant defined contribution schemes, increased life expectancy and pension freedoms have made retirement planning considerably more complex.
Retirees also face very different risks to those who are still working and building on their wealth. In accumulation, the goal is to provide a real return and beat inflation, within the client’s risk appetite. In decumulation though, we need to consider longevity and sequencing risk and clients want more certainty of outcome.
In just the past few months, those already in the decumulation phase have had a stark reminder of the risks facing their income. Market volatility has meant many have had to sell assets in unfavourable market conditions to continue taking an income, while the cost-of-living crisis is eroding the spending power of retirement savings and increasing the possibility of people running out of money sooner than required. At the same time, central bank efforts to quell inflation through interest rate rises are hitting bond capital values, adding further uncertainty to investment outcomes.
The traditional approach of the 60/40 bond/equity portfolio has fundamentally failed investors in decumulation due to the correlation of bonds and equities in falling markets. We’ve seen examples of clients going into retirement and seeing 20% of their portfolios destroyed in the first year, which is really concerning and fundamentally alters their retirement plans. Yet many advisers continue to use the same portfolio ranges for both objectives.
The difference between the needs of those in accumulation and decumulation and the risks facing investors at different life stages is something the regulator is looking at very closely. The Consumer Duty regulations state that financial services firms must “avoid causing foreseeable harm”, which we believe includes acting to mitigate the known risks facing retirees – sequencing, longevity, inflation and interest rate. We also think the FCA’s thematic review of retirement income advice currently in progress will go further and recommend that a different investment approach is required for those people approaching or already in retirement, compared to people in the accumulation phase. In a recent Copia poll of advisers, more than half (52%) agreed that this should be the result of the review.
Against this backdrop, we think guaranteed income will play a bigger role in the financial plans of many retirees. And we’re not just talking about old-style annuities. Innovative ways of using guaranteed income as an asset in conjunction with a purpose-built managed portfolio can help manage some of the specific risks clients face in decumulation.
Planning an income for retirement has to take into consideration how long an individual expects to live, their health and their own personal circumstances. But as we know, nothing is certain and things can all change during retirement. Therefore, having a flexible retirement strategy which can provide a steady income, taking into consideration the issues of sequencing and longevity risk is vital.
We think the specific risks people face in retirement require a portfolio purpose-built with decumulation in mind. Using guaranteed income assets as part of a decumulation portfolio can help meet this need. The guaranteed income is paid for the life of the client, it won’t fluctuate and it isn’t correlated to anything in the portfolio. Having this secure income offers investors in drawdown some protection against the effects of sequencing risk, or ‘pound cost ravaging’, by reducing the need to sell assets in unfavourable markets to generate income. The regular income from the guaranteed income asset can be used to subsidise withdrawals. And if there’s any surplus income, then some or all of it can be left in the cash account to help manage tax liabilities, be retained for future use, or reallocated back into the portfolio, enhancing the client’s legacy pot.
Using guaranteed income in combination with a complimentary investment proposition, means more of the assets stay invested for longer. In addition, it allows a larger part of the risk budget to be allocated to the investment proposition, for instance through increased exposure to liquid alternatives like infrastructure equity and infrastructure debt and certain hedge fund investments that can all be traded easily. The resulting combined portfolio provides a secure income and increases the opportunity to outperform, without increasing the overall risk for the investor.
To manage the specific risks investors face in decumulation, we recently launched Copia Select Retirement Income Plus (RI+) to provide more certainty of outcome in retirement. The range is purpose-built for people in decumulation, using a guaranteed income solution, which is delivered by Just Group’s Secure Lifetime Income (SLI), with a complimentary investment proposition managed by our expert investment team.
SLI offers attractive rates of income and is 100% uncorrelated to other asset classes, allowing our investment team to use more of the risk budget within the managed portfolio. This supports advisers in delivering improved portfolio value and guaranteed income over time, compared with a traditional 60/40 decumulation portfolio, without increasing the investor’s overall risk. You can find out more about the RI+ portfolios here.
The statements and opinions expressed in this article are those of the author and do not necessarily reflect those of Wealthtime or any of its employees. The company does not take any responsibility for the views of the author.