Adviser experiences: sequence risk and retirement clients

7 min read 22 Jun 20

The information contained in this page is for professional Financial Adviser use only.

Many clients will worry about running out of money in retirement and this is where you can really showcase the value of your advice.  Walking clients though different scenarios and modelling the impact of particular events can help to reassure them that you’ve considered as many options as possible.

One of the first things you’ll probably consider for each client once you fully understand their goals, attitude to risk and capacity for loss, is how to construct their overall portfolio. You may take a total return, bucket or income approach – or perhaps a blend of all three. And, your investment proposition may be an extension of your CIP or you may choose to take different approach for your retiring clients and construct a distinct centralised retirement proposition.

But however you construct a client’s portfolio, the challenge then is how to manage key risks, so that it delivers the required income.

Sequence risk or cashflow modelling or both?

Just how much does sequence risk impact advice propositions for clients in retirement? That’s the question we asked advisers as part of our recent case study series looking at aspects of retirement planning.

It turns out that sequence risk was one of the topics which the advisers we spoke to disagreed on most frequently. It was described as the ‘one thing’ that’s very different for clients in retirement compared to those in accumulation, according to one adviser, while another told us it ‘doesn’t have a specific impact’ on how they advise retirement clients and was just one of many risks that they factor in.

“Sequence risk doesn’t have a specific impact for us. Most of our retirement clients will make a significant drawdown in their first year of retirement and we will discuss with the client what that may mean for them.”
“Sequencing risk is just one of many systemic risks which might impact people but it’s really different depending on a client’s wider circumstances and individual risks, which can’t be modelled.”
“It’s [sequence risk] probably the one thing that’s very different in retirement because it’s probably very real for anyone in or very near to retirement.”

Where cashflow planning comes in

Despite their differing views, these same advisers agreed that cashflow planning is the way to mitigate against any impact of sequence risk .

Here’s what one said on cashflow modelling:

“For example, someone who is receiving a maintenance from a divorce which may stop if their ex-partner dies. We run these ‘what if’ scenarios through our cashflow modelling rather than using a sequence risk model which only focuses on one particular thing.”

Tackling sequence risk

Cashflow planning wasn’t the only way our adviser case studies look to mitigate sequence risk. Another adviser explained how some investment options can potentially help, in additional to cashflow modelling:

“We use CashCalc and FE Analytics to try to test as well as we can using historic data, but we also look at investment propositions that will minimise sequence risk for clients.
“If it’s a low risk client where we would have gone with an annuity but couldn’t because it wouldn’t give them what they need, then we’ll look at certain products that can give them that smoothing effect. These can be quite expensive, so we do try to limit our use of them.”

And this adviser told us how they create a hedge against sequence risk by setting aside a client’s first few years of income as a capital sum, based upon their sustainable withdrawal rate:

“Essentially, the higher a client’s withdrawal rate, the higher the capital sum will be to serve as a hedge against sequence risk.”

You can read more about the adviser case studies on retirement planning here, including their views on big issues like long-term care, effective cashflow planning and approaches to taking income. Or, take a look at the flexible options for managing client cash on the M&G Wealth platform and why it’s important to our advisers.

But, in terms of sequence risk the main take aways on how you can manage this risk for you clients seem to be:

  • Regular reviews where you update their cash-flow planning forecast. These are the opportunities to make the small adjustments that can keep them on track.
  • Use your retirement investment philosophy (safe withdrawal rates, cash buffers, buckets etc) to demonstrate & reassure your clients that there is a plan to manage this sequence risk in markets like these.
  • Work on a clear client friendly explanation of what sequence risk is (and the other risks you are managing for them in retirement). Without this the value of your service is diminished.

On that last point sequence risk is a topic that can be complicated for investors to get their head around. To help, we’ve created a simple explainer that can be used with clients, which won’t bamboozle them with too many charts and figures.

Understanding sequence risk

Sequencing risk – or sequence of returns risk – can have a huge impact on the value of an investment pot and the amount you can take from it, without running out sooner than you had planned. It’s essentially a timing risk that affects when, and how much, you withdraw from your retirement portfolio. Think of it as being a bit like the difference between fruit crops in a good summer, versus a bad summer:

During a good summer, you’ll be able to pick a large amount of fruit and the plants will continue to grow well, producing more fruit as a result. Similar to a harvest in a good summer, if you take a significant amount of money from your retirement pot when markets are performing well, then this will be replenished to an extent as time goes on, by the growth of your remaining investments.

This factor becomes particularly important during retirement because most people will no longer be earning and so contributing to their retirement pot.

But say it’s a bad summer and you choose to pick the fruit anyway: you’ll get a smaller crop in the first place and the plants won’t be healthy enough to replenish and produce the future crops you had expected. This is what can happen if you take money from your retirement pot at, or around, the same time as a significant fall in its market value. The value of your remaining investments are less likely to replenish, so you might have to reconsider lowering the amounts you take or accept that the pot will run out sooner than you planned.

Sequence risk can become more of a problem if markets are going through a sustained period of poor performance early on in your retirement and you need or want to withdraw large sums of money at this time. This is because if and when markets eventually recover, you will have fewer investments left so any gains these make will also be smaller overall.

Ultimately, however, any impact from sequence risk will depend on the market conditions when you retire, as well as on your individual investments and financial needs. And, the good news is that there are ways to mitigate sequence risk which advisers and clients can discuss together.