What does retirement mean to you? Is it what lies at the end of your working life, or your reward for being successful and planning well? There are so many people the world over who amble towards retirement with no real idea as to whether they will they achieve the retirement lifestyle they desire. Whether or not they do, is down to chance, and therefore essentially gambling!
When I talk of retirement, most new clients tell me they are paying into a pension and are planning to retire at age 65. However, most people don’t consider the detail, which is so important!
Questions to consider are:
1. Exactly when do you want to retire?
2. Will you work part time, or progress straight from full time to retirement immediately?
3. What are your current outgoings and how much will they differ in retirement?
4. Will you have regular capital outlays such as a new car every four years?
5. Now you have the time, will you want to go on safari and visit Australia, or just have regular luxury holidays?
6. Will you want to play more golf, socialise more, visit the theatre more, etc.
Without knowing what you want to achieve, and having a plan to get you there, you leave your retirement income matching your desired lifestyle more down to luck than good judgement.
Once you have a picture of what you want your retirement to look like, you then know what the target is. But how accurate is your target? What effect will inflation have? How much is your desired retirement likely to cost you in 5, 10 or 15 years time? Not only that, but what will it cost 10, 20 or 30 years into retirement? Too many people plan their retirement to their retirement date without thinking about the future beyond that date. The reality is that an investment timeframe for someone at age 60 is no longer five years. It is now closer to 35 years. If the plan is to use the income for retirement but leave the capital to the next generation, the timeframes extend again.
With the knowledge of these required future cash flows, you can begin to analyse your pension provision. The starting point is establishing where your pension provision is currently. What do the various pots add up to? This can include non pension assets if the intention is to use them for retirement planning. For high earners (especially those in danger of exceeding the lifetime allowance), this can mean the analysis includes such structures as ISA’s and offshore bonds. This is your base starting point in developing your retirement strategy.
Once the starting point is established, next look at how much are you contributing to your retirement planning? This includes related thoughts, such as whether this amount will stay static, whether there will be lump sums added at later points, etc. Will this be enough? This is traditionally a very difficult question to answer. In reality, the answer may change from year to year, bringing in the importance of reviewing funding levels regularly as well as investment related issues.
Ok, so now you have an idea of the goal, you have established where you are starting from and how much will be going in each year. However, what about the growth rate generated by the underlying investments?
This has many contributing aspects, the most important of which being the asset allocation. This is the mix of different asset classes within your portfolio. This can generally be made up from equities, fixed interest, property and cash, however, some people now include natural resources, hedge funds and private equity to name a few. It has been proven in various academic studies that asset allocation is the primary driver behind returns so getting this right needs to be a top priority. The asset allocation you use should be based on the growth rate needed to achieve your target and the level of volatility you are comfortable with.
However, it is not quite as simple as that. How do you populate that asset allocation? Do you use an active approach, passive approach or a mixture of the two? There are many academic studies that show the lack of value add from active fund managers, however, there are still fund managers out there who do add value. The question is how to identify these managers in advance. Whilst this article is not investment focused, the investment approach is an essential element to your retirement planning. Whatever your belief, you need to ensure that any fees paid to a fund manager are receiving value for money and that you are happy with the approach they are taking.
The growth rate makes up one side of the equation; the other side is the ongoing charges. This can include the annual management charge levied from the fund manager, additional fund costs that are not disclosed in the annual management charge, the wrapper charge (i.e. the charge for the provider giving access to a pension, ISA or offshore bond wrapper), the adviser charge and any other charges that may be levied. Dependent on the wrapper, these can be bundled together to give a total management charge (tends to be traditional pension structures), or separated into their individual elements (tend to be SIPP like structures). Whichever approach is used, a total cost figure needs to be established. Once this is done, you begin to gain an appreciation for the drag on investment performance.
We have already touched on the fund management charges. Some people believe that by paying more to your fund manager you gain more expertise. However the opposing view to this, is that the higher the charge, the more difficult it is for the fund manager to deliver any value due to the high cost hurdle. Again, whichever approach used, you need to ensure that you do not pay over the odds and that you are comfortable with the strategy you are using. The most important jobs a fund manager can do are not pick stocks or time the market, but give access to a particular asset class in a diversified and cost efficient manner.
One aspect that should be paid attention is the additional costs. As the name suggests, these are in addition to the annual management charge. When added together they produce the total expense ratio, which is often not quoted on fund fact sheets. There can sometimes be a marked difference between the annual management charge and the total expense ratio. Without knowledge of this, you can be fooled to think your fund is charging you a small amount, when in fact the costs are much higher.
The wrapper charge is the charge levied by the provider to give the tax efficiency of the pension (or other structure). There are many different charging structures out there, especially when it comes to pensions. In general the charging structure that delivers the most value for money should be sought out. There is a clear distinction between this and the cheapest. It may be that you need aspects provided by a contract that isn’t the cheapest. However, there is no point in paying for flash advertising or marketing budgets when the main thing you desire from the wrapper is the tax efficiency provided.
One point to make is that none of this takes account of extra aspects such as guarantees attached, or penalties for exit. In this case, weighing up the benefits of value for money and transparency against lost benefits becomes paramount.
Lastly, the contentious issue of adviser value add. For those of you who don’t use an adviser, this is less relevant. For those of you who do, this is arguably the most important service being delivered. An adviser’s job is to ensure that your retirement planning will meet your objectives. As you can see from above, this is so much more than product or fund picking. These are but small aspects of the overall view. A good financial adviser will structure your affairs in the most efficient manner. They will design a strategy to allow you to achieve your financial goals as well as ensure that you remain on track with those goals. They will constantly evaluate the investment strategy being used and address any legislative risks. Essentially, this translates into providing peace of mind that your retirement planning will deliver the level of financial independence you wish for in retirement.
As valuable as this is, not all advisers are created equal. You need your adviser to be delivering value for money for the fees they are charging (and they must be charging fees, not working on a commission basis, no one does anything for free).
Effective retirement planning does not happen by chance, nor is it a simple process. Careful consideration and planning early on will save stress and heartache later on in life. Don’t walk blindly into retirement, look forward to it! Grasp your retirement planning with both hands and take control.
This was written for and appeared in the March/April edition of Barrister magazine.