Financial Planners and advisers need to improve their approach to retirement income suitability assessments by considering clients' financial personality, such as whether they are spenders or savers.
Traditional decumulation approaches fail to take suitable risk into account, a new whitepaper by behavioural finance experts Oxford Risk has suggested.
It warned that advisers need to be far more rigorous in assessing clients' risk capacity. It pointed out that retirees' 'financial personality' is typically ignored but can substantially affect the right answers.
The launch of the FCA's Consumer Duty has meant Financial Planners and advisers have to demonstrate that they have accounted for the needs, characteristics, and objectives of their customers at every stage of the customer journey. That includes areas of potential vulnerability and considering how investors are likely to behave over time.
Ensuring that clients have both the right level of guaranteed income, and that their investible portfolio is appropriately adjusted to account for that income, will provide better evidence of their delivery of good customer outcomes and how they can be met, Oxford Risk says.
The new whitepaper, ‘Suitable Drawdown: Guaranteed Income and Investment Risk: How Much of Each?’, warns that the traditional industry approach of considering guaranteed income and the remaining investible assets in isolation is not delivering for clients.
The report highlighted the need to assess the suitability of purchasing a guaranteed income and the investment of the remaining investible assets in conjunction with each other, rather than in isolation, as is typically the case.
That is because the suitability of an investment portfolio is about matching the right level of risk for an investor to take right now with the risk of that portfolio, and guaranteed income has a direct impact on that level of risk.
It recommends a scientific suitability methodology to include funding a guaranteed income stream from investible assets. The popular retirement strategy often uses part of a pot of investable assets (typically from a pension) to provide a guaranteed income, leaving the other part exposed to the market.
Dr Greg Davies, head of behavioural finance, Oxford Risk, said: “The decisions that people make at retirement are crucial decisions that will affect their lifelong financial outcomes, and yet typically these ignore vital elements of investors’ financial personality.
“As we see in their thematic review, getting the right answer of how much risk is suitable for both savers and spenders is clearly of concern to the FCA. This right answer cannot be arrived at through number crunching alone but needs to incorporate an understanding of who the investor is.
“An impulsive person needs a different solution than someone who can easily stick to plans, even if their financial circumstances are identical. We’re urging the retirement industry to deploy better strategies to take account of retirees’ financial personalities to avoid poor client outcomes.”