Decumulation - when financial advice really counts

10 June 2020

For long term investors history will tell you that statement has generally held true. For clients who have recently decided to draw down cash from their investment pot as a regular income they might be less easily reassured.

It is easy to forget that for those not working in financial services that not having any income from employment or business once retired can be a little unnerving let alone a sudden drop in asset values we have recently witnessed.

I recently had an update from my financial planner we looked at the refreshed cashflow and our plans look to be on track. All good then. Well yes but a day or so later I was discussing the practical consequences of what we will live on when we both stop working. To me it was obvious, we start spending the accumulated cash and investments we have squirreled away over the years.

My wife felt uneasy about this. I was surprised and curious at her reaction when I thought all this was well understood. She explained that the pot of savings and investments she saw as reassuring, to have that ‘in the bank’ as she described meant we didn’t have to worry. But to start spending it, that was a very different matter. Will we have enough, will it run out etc. The kind of questions financial planners deal with day to day.
If that wasn’t enough we have been hit by market volatility we have not seen in a while, that is a cause for concern for clients, especially those who are nervously starting to eat away at their pots of savings. In financial planning circles we talk about decumulation risks as short hand for many well-worn client worries.

These decumulation risks maybe summarised as;

Sequencing risk

This being the unlucky investor who suffers a poor run of returns at the beginning of their drawing of income. Getting off to a bad start is bad news, really bad news. In fact one could say that avoiding the worst excesses of sequencing risk may well be the biggest service a financial planner can do for a client. A bad start is very hard to recover from. An early fall in asset values may lead to a client deciding they want to take less risk in their investment. This would of course exacerbate the situation by selling out of equities near or at the bottom of the market, baking in the losses.
 

Price inflation risk

If the purchasing power of money is eroded the client is less able to afford the lifestyle they would wish. Therefore the investments selected must at least have a reasonable prospect of producing a return in excess of inflation. That tends to mean a healthy dollop of equities. Fund management companies might have you believe they have the alchemy to create equity like returns but without the volatility. The jury isn’t just out on that, it surely must have retired and gone on holiday.
 

Volatility

Volatility itself isn’t harmful. Volatility is an investment risk but it will only harm the investor if it means a persistent or permanent loss of capital. Trying to avoid volatility like the plague leads to ever more complex investment strategies which are hard to understand for professionals let alone clients. Let’s put volatility then in its rightful place, a risk for sure but one we can probably tolerate if contained within a sensible overall financial strategy.
 

Pound cost ravaging

This is a more pernicious risk and all the more dangerous because it is not easy to identify. Management information we can obtain as standard from platforms and data hubs don’t tend to tell us about this risk. Simply it is the reverse of pound cost averaging. When asset values fall the client needs to sell more units/shares to meet their income requirements. This exacerbates volatility risk and when markets recover a client’s portfolio does not rebound as fast as we might have expected due to this ravaging effect. Rather than work hard to measure this effect it might be better to deploy some preventative strategies. Taking withdrawals from the assets in the portfolio that generally exhibit less volatility is one such strategy. To do that one needs to avoid simply selling down all assets proportionately across a portfolio i.e. simply withdrawing 5% per annum across a portfolio is not optimal.
 

Longevity risk

Outliving your money was clearly a worry my wife was alluding to in our conversation. With the number of centenarians climbing every year we know that portfolios have to be durable, they have to be able to finish the race of life. Combined with price inflation risk that suggests investment in equities is a sensible approach.
 

….but my wife will still ask me, is everything ok financially? Of course I don’t know for certain but I can at least have a plan that has fully considered these risks.

Lawrence Cook
Head of UK Intermediary Distribution

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The value of investments and any income from them can fall and you may get back less than you invested.