It's no secret that financial advisers looking to market their services to the self-managed super fund (SMSF) sector should have a unique value proposition that complements, rather than competes with, these clients' view of their own investing prowess.
As experienced advisers will attest, reliably forecasting the long-term sustainability of any retirement financial plan is a significant challenge due mainly to the unknown investment horizon but also due to purportedly competing investment priorities.
Hence while confident in their abilities to strike the right balance, very few SMSF trustees truly possess the skill and tools to properly understand the risks and sustainability of their retirement plans.
The ‘average' plan will fail half of the time by definition
SMSFs with a modicum of financial knowledge, tend to rely on a deterministic approach to evaluating retirement income adequacy, using average or median figures to produce an ‘average' outcome.
Deterministic modelling assigns fixed values to common variables including asset returns, inflation rates and life expectancy.
While deterministic modelling can be a useful guide, it provides a false sense of security and has obvious shortcomings. Market returns fluctuate from year to year and no one knows how long they will live, so there's a limit on the utility of a process which assigns fixed values to uncertain outcomes.
Indeed, the only certainty with deterministic modelling is that it will not be mirrored by retirees' actual experience. For example, no investor has ever experienced 20 years of seven per cent equity returns and they never will. This matters when capital must be consumed in a portfolio in drawdown mode.
By giving no indication of the range of possible outcomes, deterministic modelling can lead to retirees taking on greater risk than intended, making the outcome more of a lottery than a calculated risk.
Good retirement advice eschews the ‘average'
A more rigorous approach to retirement adequacy is to use stochastic or random modelling. Rather than assuming it away and adopting median figures, a stochastic model accommodates the fact that investment returns, inflation rates and individual life expectancy are variable.
Stochastic modelling produces multiple random scenarios by plugging the range of different values for each variable through its algorithm. A household's retirement plan can then be modelled through each random scenario to give a distribution of possible future outcomes. The likelihood of a retirement plan being sustainable can then be assessed.
Outcomes from stochastic modelling give a far more valuable reading for SMSFs than the more commonly used deterministic modelling because they present the bigger picture.
In retirement, having the financial capacity to sustain a desired standard of living for the client's life is the key goal.
Stochastic modelling can assess with how much confidence income can be delivered. For example an 80 per cent plus confidence of maintaining spending for life might be considered relatively high to some — but viewed by others as an unacceptably high 20 per cent chance of failure.
Do SMSFs have enough super to retire in comfort?
The industry benchmark for retirement spending is based on the Association of Superannuation Funds of Australia's (ASFA) Retirement Standard. According to the standard a couple require $58,128 of annual income to sustain a comfortable lifestyle.
A recent insights report by SMSF retirement specialist, Accurium, used stochastic modelling to identify how varying confidence levels affect the level of retirement savings needed to achieve a given spending level in retirement.
As you'd expect, the less certainty you require that your retirement plans are sustainable, the less capital you "need" to retire on.
Similarly, if more certainty is needed then higher savings are required.
A client's required level of certainty in the adequacy of their plan has a major influence on the capital they'll need to achieve it:
In many cases SMSF members may want to spend more than the ASFA comfortable standard throughout their retirement.
In such cases they will need to assess the level of income required and factor in the confidence level needed to achieve the annual income.
The chart below reflects how a higher income and higher certainty alter the required assets.
Of course, SMSF balances may only tell part of any retirement savings story. In a compulsory super system that's only 22 years old, it's likely many SMSFs members will have investment assets outside their SMSF.
These assets can be combined with those held within the SMSF for the purpose of stochastic modelling, once tax implications are understood.
Adviser value proposition is clear
By using a more sophisticated modelling approach, SMSF members can make informed decisions on retirement outcomes based on accurately calculated probabilities, rather than simplistic or fixed assumptions that are bound by their very nature to be inaccurate most of the time.
Because very few, if any, SMSF trustees will have access to this technology, the opportunity is ripe for financial advisers equipped with such tools to provide retirement adequacy consulting services to the SMSF sector.
Tracy Williams is CEO at Accurium.
