People with modest pension pots do not want to buy annuities. So what should they buy? A diversified multi-asset fund, of course. Trouble is, there is a hole in this bucket.
Forget the stats saying, over the 15-, 20- or 30-year term, a balanced portfolio (60/40 equity/bond) will do better than a low-risk one. Unless you know the client starting drawdown now is not among the 4 per cent (take any figure for this cohort with a large pinch of salt) that will be ruined by a poor sequence of returns, an adviser should not adopt the multi-asset fund as a default solution.
Why? Because your duty is to minimise the risk of ruin for your client. To quote Warren Buffett: “A small chance of distress or disgrace cannot be offset by a large chance of extra returns”.
As for the stats, the “risk of ruin” may appear low but ruin is like London buses: they bunch. All the clients going into decumulation in 2000 were hammered by the poor three years that followed. I have no better idea than you do about whether a two- to three-year bear market will start tomorrow or in three years’ time, yet that alone will make all the difference to people buying the multi-asset fund.
As for the history, how can you trust stats that cover 30 years or less when we have had a 30-year bull market in bonds? The downside risk in that 60/40 portfolio is higher today than at any time since 1980. Intuitively, I would say at least 25 per cent riskier. And forget 15 years: if it does go wrong, it will go wrong within five years and, if the client is heading for ruin, you should and will lose the case at the Financial Ombudsman Service.
In decumulation, what matters most is whether the client’s investments fall seriously in value in the first three years. If they do, and the client is withdrawing more than the natural income from the portfolio (as most do), there is a serious chance of ruin long before death. On the question of whether this will be any one client’s fate, there is no useful statistical answer: you face unknowable uncertainty, not probabilistically calculable risk. Remember Buffett: “Beware of geeks bearing formulas”.
For those highly dependent on the income from their investments, there are two robust decumulation solutions. One is to use an annuity to generate “fixed” income and a drawdown portfolio for discretionary income. The other is to use a “third way” product with guarantees.
Neither of these solutions offer the flexibility most advisers would normally want in an “income for life” solution, so I think many advisers will adopt “bucketing”. Putting two or three years’ “income” into a low-risk bucket and the rest into a long-term portfolio significantly reduces the risk of ruin. It also plays to clients’ (and advisers’) natural habit of mental accounting: this bucket for this, that bucket for that. You can even include a simple picture in your reports.
If you adopt a cash reserve strategy you can forget Henry’s woe and Liza’s litany of patches and instead join in the merry double-bucketeers’ refrain: “There’s an olé! in my bucket”.
Chris Gilchrist is director of Fiveways Financial Planning, a contributing editor to Taxbriefs Advantage and edits the IRS Report