Written by Patrick Ingram, Retirement Specialist 23rd October 2019

Over fifteen years ago, a smart and now highly successful adviser, who had been committed to one of our leading modelling tools, told me why he stopped running deterministic cash flow models.

“Your valuation number – it’s just a snap shot in time. It’s wrong tomorrow. And your own assumed growth rate. Who believes it?”

It made me stop and think because I was (and still am) deep into the practice of modelling the numbers. But he was right. Nothing in my model could predict the Financial Crisis or how Quantitative Easing would resurrect the market like a phoenix from the ashes.

Weighing up the odds

Life is full of uncertainty. You can never account for every possibility and permutation. Or can you? This is the challenge that led us to build our Income Manager Tool (IMT).

Using a sophisticated stochastic model, it aims to calculate the odds of a plan’s successful outcome within just a few minutes. The calculation is based on the best available, independently sourced, current data for your client’s longevity and the near, medium and long term expected performance of their investments.

Putting investment strategies with a classic 4% drawdown to the test on the IMT usually delivers a viability score of around 75%.

That means there’s a 25% chance of failing to achieve the plan’s objectives – and a Plan B is urgently needed.

Weighing up the options

The most likely hit to a retirement plan in drawdown is sequence risk. From modest tweaks to extreme measures, there are several Plan Bs to consider in a sequence risk scenario:

  • Adapting discretionary spending
  • Accessing other income
  • Accessing untapped capital, or debt finance
  • Re-assessing risk exposure

The IMT makes it easy to see the impact of these changes on your client's long term plans’ viability, delivered in simple graphs so you can clearly demonstrate the ongoing value you are providing to your clients.

Stress test and adapt

Let’s look at a fairly typical scenario of a 65-year-old man with a £100,000 pension pot in Risk Grade 5…

Drawing 4% a year from his portfolio generates an overall Viability Score of 72% - slightly less than the 75% we mentioned earlier. So there’s a 28% chance of failure. Importantly, looking at the 10th percentile outcome you can see there is 10% confidence of the portfolio being exhausted before his median life expectancy.

As that’s not a risk our hypothetical retiree wants to take, he will talk to his adviser who can make some subtle tweaks to the plan.

In this case, they up the risk of the investment solution to Risk Grade 6 and reduce withdrawals to 3.6% pa in real terms.

The Viability Score for the plan jumps to 82%, a figure he’s much more comfortable with. The 10th percentile is looking more favourable too, lasting until at least his median life expectancy.

On the brighter side, looking at the 50th percentile, the portfolio could now last for over 35 years.

Of course a client’s plan is never static. In an advised relationship it will always be tweaked, updated and modified to adapt to client changing circumstances. While a prudent adviser will always coach their client on the possibility of needing a fallback option, in reality, the best Plan B is to continuously evolve Plan A.

Unexpected? Bring it on

As we get older, our spending tends to decline while our chances of hitting an extreme old age, paradoxically, increase. This slowly but surely increases our risk of running out of money.

After three months of linking a plan to a live portfolio on IMT, Viability alerts will kick in. Should a plan’s viability fall by more than 10%, you’ll receive a message prompting you to take action. You can also keep tabs on the movement in all your Viability Scores from the IMT control panel.

With a strong Plan A and a coherent Plan B, things are looking good from your clients’ point of view. And with the IMT at your fingertips, you have a fast, efficient way to keep their plans on track.

If you’d like to see Parmenion’s IMT in action, please get in touch to arrange a demo.

Alternatively, you can listen again to our recent webinar: IMT - An introduction to our Retirement Income Manager Tool

The above article is intended to be a topical commentary and should not be construed as financial advice from either the author or Parmenion Capital Partners LLP. If a client wishes to obtain financial advice as to whether an investment is suitable for their needs, they should consult an authorised Financial Adviser. Past performance is not an indicator of future returns.”

Any news and/or views expressed within this document are intended as general information only and should not be viewed as a form of personal recommendation. All investment carries risk and it is important you understand this. If you are in any doubt about whether an investment is suitable for you, please contact your financial adviser.