1. Offer positive, achievable options
Achieving financial security in retirement can often seem an impossible task. Put bluntly to a 40 year old with minimal savings; ‘You need to save a million pounds in order to generate an income of £45,000 a year at current annuity rates’, not surprisingly the response would probably be one of shock and despondency, followed by a swift drink!
Put another way however; ‘If you were to save 10% of your income each month into a pension, increasing this by 5% each year in a medium risk investment and retire a little later at State Retirement Age, you could be most of the way towards maintaining your standard of living', you can get an entirely more engaged response.
You don’t need to explain up front the benefits of grossing up, compounding, employer matching, escalating savings rates, state pension and drawdown but focus on simple steps that feel achievable and that the client can say ‘yes’ to: the technical detail is important, but only works if the client feels they can psychologically invest in the end result and it is simple to take action.
The increasingly well recognised field of behavioural finance has a critical role to play in helping engagement with financial planning and framing choices in more positive ways. The authors of Nudge: Improving Decisions About Health, Wealth and Happiness, University of Chicago economist Richard H. Thaler and Harvard Law School Professor Cass R. Sunstein talk about anyone designing a system or a service being a ‘choice architect’ i.e. that the choices you put in front of customers, the options and the way that they are framed will influence the decisions they make. Understanding this and ensuring that all points on the customer journey are considered, benefits both the end client and the advice firm.
Advisers (supported by FinTech services like www.dynamicplanner.com) have the opportunity to help clients save and invest more by ‘nudging’ them in the right direction and making it easy to take the first steps.
2. Use powerful rules of thumb
With Pension Freedoms the flexibility to build sustainable strategies which don’t rely onincreasingly low annuity rates is clearly much greater. The ability to access tax free and taxable lump sums, draw down income for a period and then have a lump sum left in reserve for later life expenses, medical care or passing on to the family becomes much more possible. That said, explaining these choices is complicated!
We recently completed a study looking at the impact of drawing down 4% a year (a number suggested in the Kitces Report) at different risk levels. The study showed over the last 10 years if you use 4% as a rule of thumb clients would have maintained their capital on a total returns basis across all invested risk profiles except Risk Profile 1 (cash). While not right for everyone, if the client has a suitable risk profile helping them understand a historically safe level of withdrawal / income generation will help them understand how much they might access as income.
The FAMR has encouraged the FCA to set up a unit to look at rules of thumb as simple principles which are generally reliable in the absence of full advice, to give broad steers on how to achieve a financial goal.
3. Anchor with helpful defaults
Historically the past performance of stellar investment funds was used to imply that if you too make this investment you will benefit in the same way. No matter how many warnings about past performance not being a reliable guide to the future, the customer’s perception of what is possible has been anchored. Fortunately those days are long gone but the same principle can be used in planning tools, in a positive way.
Showing a customer the range of potential outcomes their investment may experience at a particular risk level based on tried and tested asset and risk model defaults will help them understand not only the level of investment they need to make but also what the journey may be like along the way.
Single deterministic illustration rates as set out in pension statements do not do the same thing. If anything they run the risk of anchoring clients around unrealistic outcomes. Will my equity portfolio really grow at an uninterrupted 7%, from which I can take 4% income as above? No, but giving a client a range around which you can be 90% confident helpfully sets expectations.
4. Frame the future using the negative impact of inflation
15 years ago in 2001 the government asked Ron Sandler to look at the retail investment market and recommend policy responses to ensure that consumers were well served. Sandler concluded that many investors were ‘recklessly conservative’ keeping their money in the building society and not taking enough risk to achieve the long term inflation beating returns they need to achieve financial security in retirement.
Today in a low returns environment where inflation remains a factor asking a client what the price of a pint of beer, loaf of bread or gallon of petrol was 30 or so years ago (73p for a pint in 1982!) helps demonstrate the negative impact of inflation on purchasing power.
Framing the investment decision around risk with a simple interactive model (see below) showing what is likely to happen to the value of your client's money over the next 30 years provides a powerful nudge to discuss a suitable level of investment risk in the pursuit of higher returns needed.
DT has been working with financial advisers and institutions for over a decade to provide digital services which enhance your client engagement. Get in touch to find out how we can help you nudge your clients into taking action.