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How to address high priority goals in retirement

Date: Jun 12th, 2015

Financial planners are adopting new frameworks as they deepen their understanding of client goals in retirement and implement more targeted investment strategies both pre-and post-retirement. While this trend has been in place for some time, largely driven by changing customer attitudes, interest in new approaches has accelerated in the aftermath of the global financial crisis.

Exploring the two major advice frameworks

  • The traditional approach – characterised by an investment portfolio, specified by its strategic asset allocation, judged to have a high probability of delivering returns to meet a client’s overall needs.

  • An asset-liability management (ALM) approach – starts by focusing on the various goals of a client, segments the goals according to importance or priority and then identifies portfolio strategies whose cash flows and risk characteristics are appropriate for each goal and its priority.

How it works: Traditional versus the ALM approach

Maximising wealth is the central objective in the traditional approach. Fund managers build a series of high quality portfolios along the ’efficient frontier‘, with strategic asset allocations that reflect long-term risk and return forecasts implemented through sector portfolios designed to deliver returns above sector benchmarks.

An adviser will then work with their client to select the product with the optimal risk profile given the client’s risk tolerance, arguably a concept few people find particularly intuitive. The portfolio strategy employed to build up adequate wealth pre-retirement is often the same one used to draw down cash flow in retirement.

In practice, advisers wrap additional behavioural-based strategies around the portfolio to help clients deal with market volatility and resist the temptation to make poor choices at bad times.

A popular strategy, which seeks to insulate clients from short-term volatility, is based on allocating capital into three sub-portfolios:

  • A cash portfolio of a size that covers spending needs for the subsequent three years;

  • A capital stable portfolio to cover the next two years; and

  • A balanced portfolio for the remaining capital.

Clients draw capital from the cash portfolio, which is replenished from the capital stable and balanced portfolios through a re-balancing program.

In the ALM framework, things are done in a different order. It starts with a conversation between adviser and client around needs and goals in retirement. These goals can loosely be considered as liabilities on the client’s household balance sheet. Critically, the various goals can be prioritised. This helps establish the capacity to take risk in pursuing each goal.

The goals with the highest priority centre on the capacity for clients to deal with emergencies and to meet essential living expenses on an ongoing basis, for example food, shelter and transport. The goals with moderate priority can be termed ’discretionary expenses’ such as overseas holidays and new cars. The lowest priority goals might be characterised as ’aspirational’ such as leaving a legacy for subsequent generations. While there is considerable scope to take on short-term investment risk in pursuing low priority goals, there is little capacity to do so for the high priority goals.

The ALM approach can address high, moderate and low priority goals

A key benefit of the ALM approach is that separate strategies can be employed to match different goals. For the goals identified as:

  • High priority: clients want to be confident they will receive a regular income, ideally one that rises with the costs of living over time. Multi-asset income-focused funds come within a strategy that has been developed to meet this goal. While they carry no guarantees, the strategies, properly communicated, can promote confidence among clients that their income expectations will be met. For those looking for guarantees, insurance products such as annuities, especially if they are inflation protected, and variable annuities with a guaranteed income stream for life are also relevant products to meet essential needs in retirement.

  • Moderate priority: resilient growth strategies that seek to increase wealth progressively while limiting the extent of temporary setbacks appear appropriate. The new multi-asset strategies described earlier are well-positioned to support the attainment of these goals.

  • Low priority: it is appropriate to focus on long horizon strategies, which can include illiquid assets, aimed at generating real long-term compound growth. Provided the client is confident in the strategy, they do not need to worry about its short-term risk profile.

As advisers look to improve the confidence of their clients that they are on track to meet their goals, the ALM approach facilitates more effective discussion around risk by framing it in terms of failure to achieve a high priority goal. Under this framework, clients work with their advisers to determine how much to allocate to accounts supporting each goal and then select strategies for each account.

Final thoughts

While the traditional approach remains dominant in practice, there is growing interest in the ALM approach as it is more client-centred and arguably leads to a better experience for both financial planning businesses and their clients.

For more information visit the AMP Capital Goals-based investing microsite.

About the Author

Jeff Rogers, Chief Investment Officer, ipac Investment Management
Jeff Rogers joined AMP Capital in 2011 from ipac Securities and he has over 27 years’ of investment management experience. Jeff holds a Bachelor of Science (Honours) from the University of Melbourne.


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