The Demographic challenge to adviser income
With the sweeping pension changes of 2015, retirement planning is likely to keep advisers rather busy over the next decade.
Along with the opportunities however, there will be many advice and business challenges that will present themselves.
Having a client bank that is packed with retirees, like I expect many firms have, is likely to create long-term pressure on the income of firms.
I can foresee two very large issues facing advisory firms.
- The pace of income withdrawal.
- Financial market flows.
The pace of income withdrawal
If the income your clients withdraw outpaces the investment returns net of fees, then the remaining fund value and thus the ongoing fee income will decline.
A considerable challenge is a client’s need for reviews and ongoing advice will not correspondingly decline.
Let’s make a few assumptions to help explain my point.
Say you have 100 clients. They all have £100,000 invested and take 5% p.a. as withdrawals. Your ongoing adviser charge is 1%. Total RIY is 2%. Investment returns are the magical number of 7% and inflation is the target of 2%.
So the firm receives total ongoing revenue of £100,000 p.a.
After 10 years however, the picture will look rather different. The investment return of 7%, whilst attractive, will not be sufficient to maintain the real value of the clients’ fund, after you take into account withdrawals, fees and inflation.
In the above scenario, the purchasing power of that £100,000 would only be worth approximately £82,000. Or to put it another way, the real value of client funds and adviser income will decline by 18%.
When viewing the current price of financial assets, particularly the low level of income in bonds to compound your returns, I feel the above scenario is probably a positive outcome.
Let’s say that investment returns over the next 10 years average only 5% per annum. In that scenario, the real value of client funds and adviser income would decline by 33%.
Now let’s assume a scenario that isn’t so positive.
Let’s say investment returns are only 3%, inflation is also 3% and the client takes an income of 6%. (Perhaps they don’t initially take the 6%, but maintain a fixed withdrawal rate despite disappointing investment returns – they do have to eat).
In that scenario the real value of client funds and adviser income will fall by over 50%.
There’s nothing essentially wrong with this scenario. Most retirees do have to spend their capital, however the key issue is related to advisory firm profits.
Although the client’s need for ongoing advice will remain, both their ability and desire to continue paying will come under pressure, as the real value of their funds and their income will be declining.
Financial Market Flows
Retiring baby boomers as a group will have a huge impact on flows of capital.
We should consider how much capital is likely to be gradually taken out of financial markets by those needing to consume it, against how much new money is going to be saved by the younger generation, via auto-enrolment etc. and regular saving.
There’s a possibility that the withdrawals of capital from markets could outweigh the saving of younger generations.
What if, despite how attractive an investment may look based on fundamental analysis, there are fund outflows simply because people need to cash in some stock/bonds to buy food?
Even if capital survives and is passed to younger generations, so many have large debts that surely need to be repaid before any consideration is given to investing the inherited capital.
These aspects are going to affect the flow of capital and I believe it’s going to naturally reduce the amount of capital in financial assets. It’s difficult to predict how much is going to be artificially created by central banks and what will actually happen, but I feel fund outflows from people simply spending their money could weigh heavily on the prices of all assets.
These possibilities raise a few questions.
Many firms have a minimum size of investable assets to provide financial advice.
If your client’s funds decline under that level, do you simply write to your long-standing clients saying you can no longer advise them? Does that dissolve your responsibility in relation to the advice you perhaps provided over 10-20 years, but don’t wish to provide for the next 10? Will dropping clients increase or reduce the risk of poor client outcomes and complaints?
Do you expect regulatory, wages and other business costs to increase or reduce in the future? The trend for costs appears upwards, but looking forwards, I personally feel we need to find ways to considerably reduce the costs within financial services businesses.
If costs are increasing, yet fee income is reducing, how can you continue to provide a bespoke and high level of service to these clients, which the regulations, the level of your fees and your expressly stated service all dictate is necessary?
Does the advice in relation to drawdown become simpler as funds deteriorate in real or even nominal terms? (If anything, the advice is more challenging as the effect of mistakes are more severe from the client’s perspective).
What if half of your clients wish to purchase an annuity in the future, or your advice deems this an appropriate option? You will have a very busy year and then will effectively be out of business?
Where will your future clients come from? Many of the younger generation is either saddled with large debts or on automated investment choices, either via work or the Internet.
If you intend to essentially retire with your clients, how much is your business really worth to other firms? The wealth of your clients is naturally going to dissipate through necessary and unavoidable later-life consumption.
Whilst I feel the demand for financial advice will enhance over the coming years, I feel the ability to pay the fees will come under increasing pressure, simply due to demographics and your clients doing what you have encouraged them to do all their lives.
Save for retirement, so they can use the money to live comfortably in old age.
For most of the population, this will mean consuming at least part of the accumulated capital, and for many, it will mean consuming all of it.
For advisers up and down the country, this simply means a job well done. You’ve encouraged people to save and invest and they will be using the outcome of this advice to support their retirement.
Yet where will that leave your business in the future?
Please let me know your thoughts in the comment section below. It would be great to hear from you directly. Simply email email@example.com and i’ll get back to you shortly.Mark Underdown