How can advisers protect client income during a stock market fall?
By taking steps before and during a market correction, advisers can help shield clients from the worst of it.
1. Explain the impact of different scenarios
Cash flow modelling can give clients additional understanding of associated risks. Clients need to reflect on how much income they require from their savings and what they actually want to do in retirement. Running different scenarios showing the good, the bad and the ugly of market returns provides clients with a more realistic appreciation of how the ups and downs of the market could impact upon their retirement. When markets become volatile, clients will already be prepared for what it could mean for them.
2. Diversify to avoid stretching income
Diversification is essential to protecting a client’s assets in a market crash. As ever, picking a portfolio of non-correlated investments, diversified by geographical region, asset class and sector can help to reduce a portfolio’s overall volatility and create greater stability of returns.
3. Have a safety net
Building up a cash buffer can protect against falling stock markets and means clients might not have to reduce their standard of living while the market corrects. Holding one to two years’ cash means you won’t be forced to sell when prices are falling, thereby locking in losses. Instead of cashing in funds, clients can dip into cash reserves, giving their pot a chance to regain lost ground.
4. Understand the nature of ‘cash’ holdings
Whatever buffer level you decide on, it is important to understand what is being held. For instance, platform cash deposits are very different from fund managers’ cash funds. Most platforms give access to cash accounts that are linked to the bank deposits that are familiar to investors, whereas the price of a fund manager’s cash fund can fluctuate and values can fall – not what an investor might expect.
5. Have a number of buckets
Having a medium-term investment bucket and longer-term investment bucket can help to manage the mood swings of the stock market. The cash bucket is fed by the medium bucket, which is in turn fed from the long-term bucket. There is no getting away from the fact that holding cash will hold back the performance of the investment portfolio, but it’s a discussion to have with clients.
6. Set a range
Whereby a client can accommodate flexibility in the level of their income, guard rails (a minimum and maximum range that income payments can fluctuate between) could be useful. Having guard rails in place will help clients to cope and appreciate the need to curtail spending during a period of reduced returns.
Rebalancing can help to maintain the overall risk of a portfolio in line with a client’s needs. Rebalancing won’t necessarily provide a greater investment return, but it is a protection mechanism against creating undue or unanticipated risk.
8. Set a level of stock market fall
Advisers might want to discuss setting a level of market fall that triggers a conversation earlier than the one in the diary. This can give added reassurance to clients and is likely to be most suitable for ‘lighter touch’ clients, for whom advisers may be using multi-asset funds to provide a ready-made diversified portfolio, eliminating the need to reappraise market sectors and rebalance the portfolio.
9. Review circumstances
Circumstances during retirement can change for clients as much as investment returns. Just because a client can take the agreed level of income doesn’t mean he or she should if they aren’t spending it. Adjusting the level of income to match a client’s current needs will help to improve its future sustainability.
10. Beware sequencing risk
While it’s important to understand the range of outcomes of any investment, it’s also helpful to understand the range of likely risks along the way. If your client suffers losses in the early years, particularly when their fund value is high, it can be much harder for their portfolio to recover. When either encashing units or taking capital to provide the necessary income, early falls can have a catastrophic impact on a portfolio’s ability to provide the future necessary income. If encashing capital outside of a pension, use a client’s capital gains tax allowance to help control or reduce the impact of taxation.
11. Turn off the taps
You can turn off the income taps whenever you like. There may be some clients who have access to other sources of income and are able to stop their drawdown income.
This can be a good idea because selling funds after markets have fallen means there is no chance to make up losses, thereby shrinking a pension fund and reducing its future growth. If clients can afford to, scale back their withdrawals or place them on hold until markets have recovered. Alternatively, limit the level of withdrawal to the natural income from share dividends or bonds. This leaves the underlying investments intact, giving them a better chance to recover when markets rise.
12. Don’t ignore annuities
Short-term annuities could provide the added comfort clients are looking for if stock markets are volatile at the start of their retirement journey, while others could benefit from enhanced annuities if their health deteriorates later on.
13. Control costs
Flexibility in the delivery of income is essential. Whether it is reducing or increasing income, taking an ad hoc withdrawal, setting up a rebalance or carrying out a fund switch, controlling costs in drawdown is important all of the time, not just during a market downturn. Watch out for ad hoc costs that will eat into your client’s income and could even influence the future decision-making process.
14. Offer online access
With the growing role drawdown is playing in delivering retirement income, it is understandable that many people want to know their money is there and working for them. Our analysis of consumers in drawdown found that almost two-thirds (61%) check the performance of their drawdown investments at least once every six months and more than half do so every two to three months. When volatility strikes, a growing number of retirees will want to have online access to check the impact on their savings.
Drawdown has given hundreds of thousands of retirees greater freedom and flexibility in retirement. It has transformed the retirement landscape, with twice as many people now choosing drawdown over an annuity. However, those who fail to adjust for market fluctuations risk burning through their retirement pot too soon. Raising awareness around the risks and promoting sustainable withdrawals is critical to ensuring a decent, lifelong income for clients.
Alistair Wilson is head of retail platform strategy at Zurich