Chris Jones: Challenging retirement income decisions

It's a chicken and the egg scenario in Chris Jones' latest article for RP. Read on to find out how quantitative analysis makes all the difference...

If I was stranded on a remote island. I would be pleased to find that I had some chickens. After a while, though I would have to make some difficult decisions; eventually the chickens will die and so I can’t eat all the eggs but if I don’t eat enough I will die. In any case, I might just fancy some chicken.

I could be leaving the island tomorrow or I could be here until I am over 100. There was me thinking it would at least be a simple life but I have a dilemma and decisions to make.

If I am going to live off chickens I bizarrely have to do some quantitative analysis:

How many do I have?  How often do they lay? Do they always lay? How long do they live? What if they get sick? How long does it take for the chick to become a chicken? What if I can’t get to a chicken? Which is better a skinny chicken that lays lots of eggs or one that doesn’t lay but gets very plump very quickly.

Of course, the free market economy, capital markets and retirement industry is a lot more varied and complex than ‘chicken stock’ but the questions and quantitative analysis remain valid; we just call it; asset value, running yield, PE ratio, investment horizon, yield to redemption, default risk, growth rate, liquidity risk, stock selection, cashflow etc.

What a world

Our present reality is that we live in a world where markets have been driven up by a Tesla stock that has grown by over nine times in a year and whose current earnings would take over a millennium and a half to repay its current capital value. It is also a world where you have to pay the Greek government for the privilege of lending money to them. There is circa $18trn dollars of bonds with a negative yield to redemption.

To continue the metaphor when you get to retirement it is inevitable that you will be eating some of those chickens because they aren’t producing enough eggs. Much more decumulation than income. While it is difficult to come to terms with these numbers retirement planners may have to get used to them and almost certainly rethink the investment solutions that they use in retirement.

We are all familiar with GAD tables for calculating the amount of income you could take from a pension and since pension freedoms GAD interest rates have fallen to a quarter of what they were when pensions freedoms were launched, 2% down to 0.5%.

If I were still bound by GAD limits that would mean only £3,200 pa from £100,000 and at age 65. Similarly, a single annuity would be £3,556 at 55 and 65 £4,674 without any indexation or protection which would reduce it further. Within those payments, the simple 0.5% Gilt yield makes up only £500 pa and the rest is return of capital or mortality subsidy whichever way you look it.

If we accept that spending capital (eating chicken) is inevitable then we could be tempted to use the same growth investments in retirement as we used in pre-retirement and with hindsight a client in drawdown could have got away by investing in Tesla. I doubt any readers would consider doing it now or that I would need to explain why.

But just as an exercise what if I took £500 at the beginning of each month in August 2014 (when the GAD rate was 5.9%) from £100,000 of Tesla shares?

Your statement would have been less than £42,000 in June 2019 as you approached the five years anniversary and around half its value in seven of the 78 months and you wouldn’t be back to £100,000 until this time last year. Yes, you would have around £750,000 now but that’s a lot less than the 12.5 times return during that period and of course, how many of us let alone our clients would have stayed invested?

It may be a silly thing to do but with recent headlines you may have wondered. Of course, you wouldn’t ‘put all your eggs in one basket’ but if you were to blindly use index trackers in retirement you still carry most of the problems of the example above but without the benefit of its astonishing stella performance.

Of course, the reverse pound cost averaging and sequence of returns risk had an effect on the Tesla example but this is a stock that has done well.

These factors affect growth solutions with monthly volatility as they do with the Tesla example. We also need to consider the extent to which Tesla and Amazon etc have driven so much of the market and index returns (see graph) in the last year, they have obfuscated market recent and expected market returns.

Don’t count on these chickens before they hatch. Past performance and headline unit price returns can be unhelpful in suitability at the best of times but in decumulation they are fundamentally detached from the client outcome.

As many of the measures of Retirement Outcomes Review PS19/1 come into play and non-advised retiring clients get investment pathways we need to ensure that advised clients in retirement get something better.

If a non-advised client is not only automatically getting different investments when they retire but four choices of pathway it would seem crazy that an advised client would still get the same solution as they had pre-retirement. The need for a separate centralised retirement proposition is clear, as previously discussed, yet it also needs to be sufficiently varied to address the different pathways or target markets in PROD language.

Option 1: I have no plans to touch my money in the next five years.

Option 2: I plan to use my money to set up a guaranteed income (annuity) within the next five years.

Option 3: I plan to start taking my money as a long-term income within the next five years.

Option 4: I plan to take out all my money within the next five years.

As we can see above, whilst pathway 1 and 4 are straight forward and even 2 is becoming challenging it is 3 that is the most difficult. If you are ‘planning to take your money as a long-term income’ you are going to need something a lot more appropriate than lifestyling gilt and equity tracker mixes. There needs to be more competition in drawdown products yet there is a danger in blindly chasing cost over suitability when it comes to decumulation investment solutions.

For the advised at retirement, in retirement and decumulation market greater management to a decumulation objective is not only worth any additional cost it is essential. It is also essential that we set aside headline unit price returns, like Tesla’s, and look at suitable risk-managed solutions for decumulation.

Chris Jones is proposition director at Dynamic Planner