Many older clients are more afraid of run­ning out of money than of dy­ing.

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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

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