Many older clients are more afraid of running out of money than of dying.
Many people are more afraid of running out of money than of dying. Advisors need to ensure retired clients act prudently l BY JADE HEMEON
as clients retire and enter the decumulation phase of finances, they’re also undergoing a major life transition. Challenges during this time can be just as daunting as for other milestones, such as marriage, parenthood or leaving school.
The shift into retirement is fraught with emotional and financial considerations. However, you can assist your clients in making a smooth transition and adjusting to changing circumstances as their withdrawal years unfold. This decumulation stage also presents a prime opportunity to illustrate your value and cement relationships with your retiree clients, as well as obtain referrals from them.
“As an advisor, you can’t begin talking about decumulation soon enough,” Daniel Crosby, behavioural finance expert, financial advisor and president of Atlanta-based Nocturne Capital LLC, told a recent meeting of the Investment Management Consultants Association in Toronto. “There’s a powerful positive psychology to getting a head start, and it’s not too soon to start speaking about it with clients who are 50, 40, 30 or even 20 years old. It can be a key differentiator for your practice — if you start early.”
According to Crosby, investor research has shown that although fear of death is common, twice as many people are more afraid of running out of money before they die. This fear motivates them during the accumulation phase of their lives to make the necessary sacrifices to save. But it kicks into higher gear when it comes time to start depleting the nest egg, when many factors — including rate of return and the client’s lifespan — are unknown.
The challenge for you is designing a portfolio for the drawdown years that provides the income necessary for clients to achieve their desired lifestyle, but which also achieves sufficient growth to keep pace with inflation and ensure that the portfolio is not depleted before death. A sustainable withdrawal rate is a key part of the planning, but the portfolio’s value must be monitored regularly and there must be flexibility to adjust withdrawals if the nest egg is being depleted too quickly.
When it comes to withdrawals, it’s advisable for retirees to be conservative to avoid the risk of running out of money. Although a 4% annual withdrawal rate often is used as a guidepost, the rate that you and a client decide on can shorten or lengthen the length of time the client’s assets will last significantly, and the with- drawal rate may need to be adjusted during a lengthy retirement. The withdrawal calculation will depend upon whether the client wants to draw down the principal or leave it intact to pass on as a legacy to heirs or charity.
Financial plans during decumulation also require strategies for managing volatility so that clients can rein in their emotions and stay committed to the asset mix that will help them meet their goals. Moderating client behaviour is a key aspect of your job, as this has proven to be one of the primary determinants of investor success. Crosby cites research that indicates 6% of clients believe managing emotions is important, while a vast 83% of advisors who have learned from ex-
perience with skittish clients said client behaviour is what matters.
David Irwin, certified financial planner and regional director with Investors Group Inc. in Pickering, Ont., says that when clients enter the decumulation phase, they become much more sensitive to market fluctuations.
“It’s a much different mindset, when clients are taking money out versus putting it in, and you can visibly see their reactions,” Irwin says. “Dealing with senior clients requires deeper conversations. They’re relying on their savings, and it’s important to provide reassurance.”
Balancing financial needs and maintaining emotional equilibrium is achieved through an appropriate investment strategy that includes diverse asset classes and products, as well as education, setting realistic expectations and hand-holding.
Reaching an agreement with a client on when the portfolio will be rebalanced is important — whether that’s based on time periods, such as quarterly or annual- ly, or the amount of drift from the original asset allocation as markets rise and fall. Sticking to the financial plan also is key, especially in exciting markets.
“It’s not just a matter of letting this puppy ride,” says Sam Febbraro, executive vice president, advisor services, with Investment Planning Counsel Inc. in Mississauga, Ont. “Regular rebalancing allows the investor to buy low and sell high. It’s the last free lunch, and helps take emotion away from decision-making.”
One of the challenges in building a decumulation portfolio is that the fixed-income investments that once were the bedrock of such portfolios, such as guaranteed investment certificates (GICs) and government bonds, are paying skimpy rates of interest. Many clients are climbing higher up the risk/return ladder to corporate bonds, emergingmarkets bonds and preferred shares to improve yield.
Some advisors are forgoing traditional bonds altogether, turning to strategies that emphasize a higher share of equities in the portfolio, along with a “cash bucket” large enough to supply a few years of the client’s income needs and avoid having to cash out during a bear market.
Moshe Milevsky, professor of finance at the Schulich School of Business at York University, suggests that i nsurance annuities could be a solution for part of the fixed-income component of a portfolio and even could be used to replace bonds or GICs altogether. Annuities can provide a healthier income stream than traditional interest-bearing investments due to tax advantages — and the income will last for the rest of the client’s life, no matter how long that is. Once clients have this security, they often willingly commit a portion of their assets to the more volatile equities investments needed for long-term growth.
On the equities side, stocks are at high valuations in many developed markets, and although stocks traditionally offer superior returns vs other asset classes over the long term, equities markets are characterized by occasional, sometimes severe corrections. In the U.S., the key S&P 500 total return index has roughly quadrupled since the bottom of March 2009 and hasn’t experienced a pullback of more than 20%. Some clients are uneasy about the potential for an imminent downturn, while others are sanguine and have hazy memories of how frightening a crash can be.
Rushing to put a big percentage of your clients’ wealth on the sidelines when markets are overvalued in an attempt miss a downturn could result in those clients missing out on the large gains that often occur i n the late stages of bull markets.
Clients also may miss out on the powerful rallies that often follow bear markets and end up with a portfolio that severely underperforms one that uses a buy-and-hold strategy. Keeping an appropriate amount invested and in a position to reap the superior long-term returns of stocks is best.
“The key is proper coaching of clients,” says Darren Coleman, portfolio manager and senior vice president, private client group with Coleman Wealth in Toronto, which operates under the Raymond James Ltd. banner. His clients have 80% of their portfolios invested in equities, on average. “For us, the risk isn’t that you can lose money in stocks; it’s that you can run out of money if you don’t invest in them.”
To smooth the ride, advisors may want to increase the focus on dividend-paying common stocks or preferred shares, or emphasize low-volatility and defensive companies. Or add protective put and call option strategies to portfolios. Some clients are increasing their exposure to alternative strategies, such as hedging or short-selling.
Others are adding a slice of alternative products, such as private debt and equity that are not exposed to the daily movements of public markets and can dampen the effect on both volatility and emotional reactions.
Many alternative strategies are available through mutual funds and ETFs, making them accessible to all types of clients.
“Diversification is powerful,” Crosby says. “At a time when valuations in traditional asset classes are elevated, people may want to consider alternative asset classes, such as commodities or emerging markets.”
R ushing to stash wealth on the sidelines to avoid a downturn could result in missing out on bull market gains