Safety is as much a part of the human condition as our need for things like food, shelter and friendship, according to Maslow’s hierarchy of needs. So when it comes to our clients making big, hairy decisions this is especially evident in their desire to seek certainty in the choices that are ahead of them. It’s similar to contemplating the pros and cons of something like two competing job opportunities or whether to renovate an existing home or purchase a new one, there’s that feeling of being overwhelmed and wishing there was a roadmap plotting the course and alerting of the obstacles ahead? In the absence of facts our fear of the unknown can rule our decision making.
So when our clients are facing the prospect of retirement, it is quite understandable they could be flooded with fears of what lies ahead and experiencing emotions connected with loss of control. We understand this new phase of life intricately – for the vast majority of our lives we are in control of our income generating capacity, and exchanging decades of skill in return for a regular income. Having decided to stop selling their skills and instead focus their time on the abundance of life that exists outside of a career, what do they have to exchange for a regular income? The answer is their retirement capital – the superannuation, the investment assets, the cash and the equity in their home.
At this point our experience tells us that some of the biggest fears driving decisions could be framed as three simple questions:
1. how can you protect your capital from running out?;
2. how can you derive income to maintain a comfortable lifestyle?; and
3. how can you maintain control and flexibility to adapt through changes?
Let’s have a look at these fears in more depth.
The thought of outliving your retirement capital is a daunting prospect, so wanting to protect it makes a lot of sense. In the world of finance, the act of preserving capital is called capital protection and the risk associated with the fear of outliving your capital is called longevity risk. There are many possibilities that can play into this fear, such as the amount of retirement capital the client has, their spending habits, the current state of investment markets and the level of investment risk they wish to take with their capital.
These two major driving forces of capital protection and longevity can lead retirees down a variety of different paths. Such as, the desire for capital protection could see one retiree deciding to invest in less riskier investments like term deposits and cash and opt to seek advice around budgeting and future capital expenditure to live a frugal lifestyle with some capital depletion. Another retiree may instead focus on combatting longevity risk so seeks advice to shoulder the investment burden of allocating capital to higher risk assets like shares and property with the expectation that capital growth will stretch out the years of being a self-funded retiree.
Tackling longevity risk and capital protection isn’t just solved by seeking advice from a financial adviser about the diversification of shares, property, term deposits or cash that best suits your needs. Many retirees are coming from a world of income consistency into a world of income inconsistency. Shares on the Australian Stock Exchange, which pay some of the highest incomes from all the asset classes, generally pay dividends around twice a year.
This seems predictable enough however, just how much that dividend will be is only made public 3-4 weeks before it is paid. So even though the shareholder could achieve a high income, this approach still does not totally address income uncertainty. And for those holding their investment in cash, the changes in interest rates can either be welcome news or the signal to tighten the lifestyle budget. As far back as 600BCE a man named Aesop was describing the human fear of risk aversion. Fast forward to now and ‘the bird in hand theory’ seems to have just as much traction. That of course refers to investors’ preference for dividends over capital growth because of the uncertainty associated with capital growth. It fundamentally makes sense to prefer a known outcome and forgo the possibility of the price of an asset appreciating.
Being able to control the direction of a retirement journey and possessing the freedom to be flexible are the hallmarks of a fulfilling retirement. It can be very tempting during this new journey for clients to let their control and flexibility be put aside because of the opinion and expectations of others and the fear of not knowing what lies ahead.
Feeling trapped in an investment, a previous decision made and now the parameters have changed, or a set level of income can certainly invoke feelings of hopelessness, loss of control, anxiety and overwhelm. The amount of decisions a retiree could be making during this time are numerous – do we ease our way into retirement? how do we invest our money? what income do we need for our lifestyle? do we use this recommended financial product? do we downsize? how often do we holiday? The clearer they are on what is important to them, and the more they seek advice that still places the control and flexibility in their court, the less room there is for fear to be driving their decision making.
There are many points of stress and fear-invoking elements at play here, so it is understandable if a retiree just prefers to bury their head in the sand and not worry about longevity risk, capital protection, taking on investment risk, income uncertainty, and potential loss of control. The value of certainty is a conundrum in a world where things and people change. The benefit of seeking advice to tackle these obstacles is to provide certainty that no matter what happens, you will be able to find a way through it.
The role of the financial adviser has evolved from something like targeting specific investment returns to meet a client’s income needs toward a more goals-based approach. Financial advisers have an opportunity to deliver certainty by defining an individual’s goals then working backwards to give clients more confidence that they have the means to achieve them. Certainty does need to be balanced with the perpetually changing landscape of legislation and investment markets and does not mean that all of these fears and concerns will be guaranteed with assurances of favourable financial outcomes. However, some disruption to their financial plan, for example, through increased cost of living, will need to be analysed for the specific impact it may have to their capital, income and spending. The strength of the financial adviser is the objective ability to take your goals and ensure they are financially viable.
Find out more about the upcoming wave of client retirement and a new solution available to provide clients with certainty here.