In general, smoothed funds sacrifice some element of market return in order to provide a level of price stability; of more concern is the market value adjustment (MVA process), which can allow large price adjustments in specific circumstances.
Principal protected portfolios can provide a similar protection against downward price shocks while allowing upward price fluctuations. This is generally achieved using equity put options and is again at the expense of some element of the market return.
Such techniques are also associated with protecting against price shocks in the period before retirement, as an alternative to increasing fixed income exposure.
Equity release sits within the adviser toolkit as a means of accessing a client’s broader wealth to support retirement income. It can be an expensive form of liquidity, but it allows the continuation of a lifestyle without the need to downsize. It can affect legacy expectations and comes with restrictions that may not suit all clients.
Each path, or combination of paths, is associated with compromise, and the chosen compromise must be understood and fully accepted by the client. Later-life surprises are in no one’s interest.
Risk-led planning
Risk is critical to the retirement planning process, and the human mind is very capable of dismissing or underestimating far-off and poorly understood risks.
The primary risk mitigant is accumulated wealth. If a client’s assets patently dwarf the cost of providing a desired level of retirement income, then the choice of strategy is less critical, and the primary determinant is attitude to risk.
If a client’s assets are broadly capable of supporting the proposed income, then caution is required, with guaranteed income or smoothing being fed into the mix to offset tail risk. If a client’s assets and income expectations are incompatible, then the income expectation must be dialled down.
Assuming there is sufficient accumulated wealth to support the intended income, then wealth can be broken down into three components: the amount required to support subsistence income, the amount required to support discretionary income, and a legacy fund.
Accounting for inflation
Advisers and their clients have become accustomed to low inflation rates, and there is a tendency to focus on nominal expected returns, not real expected returns (and associated tail risk).
But inflation has reared its head in recent years, and although forward-looking inflation rates remain relatively benign, it is essential to understand how a plan is intended to address unexpected inflation.
