Podcast: Re-imagining retirement - shifting mindsets and managing risks
Rob Starkey discusses simple, effective risk management in retirement investing, highlighting annuities and the bucket approach for stability.
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The full transcript is available below:
[00:00:09.19] - David Brett
Rob, welcome to podcast HQ. How are you?
[00:00:12.18] - Rob Starkey
I'm good, thanks. It's good to be here.
[00:00:14.15] - David Brett
Yeah, first time up here?
[00:00:15.16] - Rob Starkey
Yeah, first time on the podcast.
[00:00:17.11] - David Brett
Fantastic. Today we're going to talk about... Actually, we're going to talk about something we don't usually talk much about, which is retirement, and in particular, a certain part of retirement, which is decumulation. Let's jump straight in. Can you tell us what you mean by decumulation?
[00:00:30.23] - Rob Starkey
Of course. Decumulation, in a nutshell, is around mindset. Investors spend their entire lives growing their wealth. Sometimes that's as long as 40 years that people take building that wealth until they get to that eventual retirement point. Decumulation is essentially just an investment strategy or a financial planning approach to say, let's change our mindset from growing your wealth to now spending and maintaining this hard-earned wealth throughout the course of retirement. We need to separate a financial plan from an investment plan. A financial plan's components would need to be present. How long do you plan to live for? Do you want to bequeath any of your assets to any charity or family members? Maybe that order might not be what people want to do, but whatever it is that you want to do.
[00:01:23.21] - Rob Starkey
Financial planners also need to assess the willingness and ability of people to accept these risks. So we're going to take all of those as given. But even within that framework, we've got the investment risks, and that's where decumulation or retirement income comes in. It's not the same as just growing your wealth. In addition to inflation risk, longevity risk, making sure these risks at the start of your retirement are controlled properly, such as sequence of returns risk. It's all around the mindset shift to say, can we have a long, healthy runway for the rest of your retirement.
[00:02:00.03] - David Brett
There's a lot to think about in there. There's a lot of risk in there as well. Let's start with the one you just mentioned at the end. What do you mean by a sequence of returns risk?
[00:02:08.17] - Rob Starkey
A complicated topic, but let's make it simple. The order in which returns happen matters in retirement. People often find this to be a surprise because while you grow your wealth and accumulate your wealth, generally, you can have these returns happen in any order, assuming it's from the same pot of numbers. I'll bring it to life with an example. We've got a simple three-year return, 5% in the first year, 5% in the second, and minus 5% in the third. If you invest £100, you'll grow to roughly £104.7 after that period. If you had to move that negative return from the end to the start and then grow throughout the three years, you'd end up with basically the same number.
[00:03:00.18] - Rob Starkey
While you're growing your wealth, the order in which you experience those losses or gains doesn't matter. But as you start to take money out of your retirement pot, if you incur those larger losses towards the start of your retirement, that's the sequence of returns risk that we need to manage. That's the accumulation versus decumulation. When a financial planner generally sits down and plugs a number into their cash flow planning for their investor, you'll use an average. The point I'm trying to convey is that in this world, we need to look past the averages, and this risk, that downside risk, now needs to be managed.
[00:03:38.08] - David Brett
Markets move in different ways at different times. How do you manage that sequence of risk?
[00:03:44.10] - Rob Starkey
I'm going to try and please a lot of people here because it depends on who you speak to. If you speak to an actuary, an insurance company, a financial planner, or an investment manager, you'll get different answers. But before we go down any of these routes, when it comes to financial planning and investment management associated with it, whether it's an insurance product, an investment product, or a general financial plan, I like it to be simple. You're going to have this plan in place for the next 10, 20, 30, 40 years or plus. You're going to need to remember what you did. You're going to need to easily, intuitively or emotionally attach and trust this process. Last but not least, you might not be some big fancy pension fund. You might just be an everyday investor that needs to actually be able to implement this. Granted, there are lots of options on the table, but I want simple and easy.
[00:04:40.08] - Rob Starkey
With that being said, what options do we have? Well, if you want absolute certainty, you can consider an annuity. That means you don't need to worry about any downsides at all. If you want to deal with a well-adopted financial planning approach, you can adopt the bucket approach. Generally, in a nutshell, that means you take cash for the first few years, maybe bonds for the next medium term period, and your growth assets that you don't have to worry about for the long term. It provides the emotional safety that you don't need to tinker with the assets when they do go down, like you said, the gyrations.
[00:05:16.12] - Rob Starkey
My approach that I tend to prefer, maybe we can get into that detail later, is being consistent with asset allocation. We have the same mindset that help you grow that wealth into this point. Asset allocation, you're still diversified across a whole number of asset classes, but we slightly tweak what the asset classes are, want to do, as well as include new products. Some approaches are more common than the other. It depends on what access you have to operational advantages, what complexity you want, how much simplicity there is. But depending on who you are, you might go down one route.
[00:05:56.06] - David Brett
Just for the people that might not know, can you just explain what an annuity is?
[00:06:00.12] - Rob Starkey
An annuity is essentially an arrangement where you take your hard-earned pot of money, you exchange that entire lump sum with a third party, generally an insurance company. In return, what they will do is they will guarantee you an income until the date of your death. In some instances, depending on how you structure it, you can also pass that on or have a guaranteed period for anyone you want. Essentially, it's a way to remove all uncertainty. My apologies. It's the private market equivalent of essentially government pension.
[00:06:46.12] - David Brett
It's a bit of insurance.
[00:06:48.22] - Rob Starkey
Exactly.
[00:06:49.23] - David Brett
Is there a common approach that investors take?
[00:06:53.14] - Rob Starkey
In my experience in working with a lot of financial advisors, I've seen the bucket approach being the one that's come to the foremost often, and I see the appeal for it. It's really easy to follow. It provides that certainty in the beginning. Operationally, all you need to do is to create three pots. It's quite good from that perspective. However, just like with anything, including my favourite solution, there are pitfalls. The main aim, just to remind you of what we're trying to get around, is that big, large drawdown right at the start of when you begin in taking a pension.
[00:07:32.05] - Rob Starkey
In a world where you have this bucket approach that needs you to move money from the market to this cash portion right in one go, you actually increase the risk of that being a very sensitive time in the market when assets can be depressed. Counterintuitively, if you don't plan ahead, you actually increase your risk. What else is on the table? We've got a situation where over a number of years in advance, you can begin to increase that cash pot on the side.
[00:08:03.15] - Rob Starkey
However, where I start to find a bit of a flaw in that thinking is in those last few years of retirement. That's when that compound growth does the most for you, and when you want your money to be invested. So I'm not quite sold in having a lazy asset on the side a few years in advance. But bear in mind, if you know the cost of what you're working with, you can build that into your financial plan. Just like if you want to take risk off the table and invest conservatively, you can factor that in.
[00:08:32.12] - Rob Starkey
But ultimately, there are other routes you can take. My route, like I mentioned, is that asset allocation route. Instead of being as aggressive with growth assets, you slightly shift to more fixed income, conservative investments. But even then, the type of investments you buy tweaks a little bit. What you're trying to do over here is to bring in what I call a structured product mindset. What is that for the listeners that aren't familiar? It's essentially an arrangement whereby you can say, I won't experience downside or all of it as long as conditions X and Y happen. The market goes up by 5 or 10%. But in return, I'll cap out how much money I get on the upside.
[00:09:17.13] - Rob Starkey
You're essentially taking your distributions of outcomes, and you're making it more in line with what you want, even if you're leaving some money on the table. But there's also annuities, like I said, and I see a place for this in certain instances. An annuity can serve for that base. If you want that guaranteed level of non-discretionary spending, regardless of how wealthy you are, covered for the rest of your life, you have an annuity. The one thing that I find with annuities, though, is that they don't adapt with the income requirements of a general retiree. But amongst those, those are the main options.
[00:09:55.20] - David Brett
I was going to say about the annuity, if cost of living goes up, for instance, which we've had over the past few years, with annuities, you are stuck with what you purchased at the start. Is that the main issue with them?
[00:10:06.10] - Rob Starkey
Exactly. But there are other factors to consider. You can overcome these. But beyond having your income adapt to your lifestyle, your cash requirements at the start of your retirement may not be the same at the end. You can't double up the first few years when you've got the health or desire to spend your money and then back-end it. You can get very complicated with deciding when annuities are going to kick in, but that's that complexity point. It's there if you want it.
[00:10:36.09] - Rob Starkey
Another aspect as well is what happens when you pass on your wealth? Can you do that if an unfortunate event happens with you passing on? With annuities, you can generally elect to have somebody receive the income, but then you get less today, which means there's less of an element of estate planning that we need to factor in. When you consider all of this, you need to trade off your need for certainty, how healthy you are, and whether there are other more attractive opportunities on the table for you to consider.
[00:11:11.19] - David Brett
Yeah, a lot to think about. Dare I ask what other options are available?
[00:11:18.18] - Rob Starkey
It's a constantly moving target, and that's why I'm going to be talking my own book here. But for the listeners, I've previously been on the advice side of the fence many years ago, so I've been in their shoes. I'm a client myself for financial advice, so I understand. But in talking my own book here, you need flexibility that when the market or the environment shifts, you can adapt. Imagine a world when annuities are less attractive when interest rates are close to zero. You want to be able to move on to something else. If you have a market that is growing quite strongly on a year-to-year basis, that is fundamentally good. You may make more money there that can reduce some of that inflation and longevity risk. Then suddenly investing by yourself or through a financial advisor becomes more attractive compared to that guarantee.
[00:12:12.24] - Rob Starkey
But then there's also either other extra considerations. If you've got good fundamentals and cheap valuations with lower interest rates, compound it up and the choice is yours. Generally, there's always some truth in the middle. Maybe you can have a combination of annuity combined with investments. But ultimately, you need to be nimble to factor in these other opportunities. All I'm trying to say is that when you invest in a solutions mindset, you don't just have to default to that cash approach because there's more out there in a given time.
[00:12:59.23] - David Brett
I was going to ask, let's say in a perfect world, inflation is hovering around the ideal target of 2%, so interest rates settle in around about 3%, that's probably where everyone thinks long term, they might end up in the next few years. Why not just take all your money out, whack it into a high interest account, earn that gap, whatever the high interest account might be, 4 or 5%, and you got a 3% difference between, or 2% difference between that and inflation?
[00:13:24.19] - Rob Starkey
This question has been asked quite a bit. What I'm not talking about here is your emergency funds. Just like my emergency fund is in cash, liquidly available, I would think that everyone would want that. But what I am talking about is the long term. This is where things get a bit gray. In the short term, in the scenario you've mentioned, you may have that guaranteed outperformance. But just from an investment management perspective, if interest rates come down, you lose that capital gain and you get a lower interest rate.
[00:13:57.17] - Rob Starkey
Let's separate that. Let's just look some of the statistics over the long term. Over a 10-year rise in the track record of cash to outperform inflation is around 60%. That number may sound good, but we need to think of by how much do you outperform inflation? Because if it's by a tiny fraction, you're right on the edge. We need to factor into account all the other expenses that happen. You may have financial advisor expense, investment management expense, tax bill. These things are a drag that come out of your investment returns. After cash considers these expenses, it's way behind inflation.
[00:14:38.22] - Rob Starkey
The only way from an asset perspective that's been true to grow out inflation in the long term is stock markets. Stock markets over a 20-year period of 100% history or track record of growing above inflation. You don't get that for free. It's not as conservative as cash, but you get the extra returns to get you there. When it comes to investing for retirement and decumulation, we need to make sure that inflation risk, what we call longevity risk, is well-built into it.
[00:15:09.15] - David Brett
I guess what we're saying, if you were to put all your money into a high interest account, you're banking on the fact that inflation is going to stay at a certain level and interest rates are going to stay at a certain level. What is the inflation risk and the longevity risk?
[00:15:22.06] - Rob Starkey
As you highlighted earlier, things never stay in a straight line. These two risks, you need to retirement in one sense. Inflation risk, every single year, the buying power of your money gets eroded. Take a pound 40 years ago, and it could probably buy you a lot more than it can today. That will be the nature of the world going forward as well. Central banks have inflation targets of 2%. For a normal investor that's accumulating their wealth, you can adapt your lifestyle, you can save more out of your next pay cheque.
[00:15:58.07] - Rob Starkey
Whereas if you're a pensioner, you can't do that. You have a few levers to pull. You can drop your living standard, but you haven't worked that hard to do that. You can essentially start to take more from your investments, but then as a percentage, that decreases your chances of having money until the end of your life. The game with the financial plan is to have more money at the end of your life than more life at the end of your money. That's in a very simple way what longevity risk is. Living longer than you expect, outliving your money.
[00:16:32.24] - Rob Starkey
This is where annuities come into play. They essentially make sure that you get money until the day that you die. This is where if you've got a very low draw on your asset base, assuming you're a very wealthy investor, you don't need to worry about it. If you start by taking 1% of your money each year and the stock market halves, you're still only taking 2% of your money each year. You're leaving enough in there each year to grow your income above inflation. Where I'm talking about is the investors where all these small decisions matter, where we really need to make sure that that downside risk is managed, the inflation outcome is managed by growth over the long term, and through a good financial plan, we deliver to financial advisors what we promise them so that longevity risk is managed.
[00:17:22.09] - David Brett
We've chatted about a lot. There's a lot to think about. If you could try and wrap it up, maybe in a top-three conclusions or something about what we've just talked about. I know that's quite difficult.
[00:17:31.02] - Rob Starkey
It is a lot. But let's start with the mindset shift. The tools that got you from where you started to where you are were excellent, and you've put in the hard work. Despite that hard work, you need to put on a different hat now. We need to expand the toolbox, and a good financial plan will do that. Secondly, be careful of the risks. You can't just go out there trying to get the highest return because there's these nasty little surprises that we want to avoid.
[00:18:02.14] - Rob Starkey
To speak to the times recently, the so-called carry trade is one of these examples. You don't want to incrementally bank or make that difference between borrowing in the low currency and investing in the higher currency, and then it blows up just like that. The way in which you approach risk needs to change the second point. Thirdly, you need to be able to trust the process. In order to do that, you need a process that can adapt to the environment. I think that's where a solutions mindset comes into play.
[00:18:34.18] - David Brett
Great. I spoke to William Hague a few weeks ago, and we got onto the subject of pensions and working life. I left the conversation a bit of a shivering nervous wreck, but this has given me a little bit more confidence.
[00:18:45.03] - Rob Starkey
I'm glad.
[00:18:45.15] - David Brett
I'm a little bit calmer.
[00:18:46.02] - Rob Starkey
That's what we're here for.
[00:18:46.24] - David Brett
Yeah, brilliant. Rob Starkey, thank you so much for joining us.
[00:18:49.04] - Rob Starkey
Thank you for having me.
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