How financial planners can get into tune with their clients
Mental accounting can help financial planners harmonise their client’s money by acting as their financial conductors, writes Barry Wyatt.
For a while it looked as though the worst was behind us with the global financial crisis. But 2011 saw increased volatility, with markets going up and down like a yo-yo.
So with all this going on, how are retirees feeling? And what does it mean for the financial advice you’re providing to clients in pre-retirement and retirement phase?
Many of your clients are opening the morning paper and scanning the news with a sinking feeling. Headlines like ‘Guess who’s back?’ over a snarling bear don’t make for happy reading, particularly for those with a nervous disposition.
The relentless focus on doom and gloom is starting to take its toll.
Clients who have just retired are entering a whole new world. Their final payday has come and gone.
They’re living off a lump sum and have been told they need to stay invested in the stock market to beat inflation. But they lose money every time the market falls.
The temptation is to give in to their immediate emotional response, to exit the market and take refuge in the relative calm of cash. It may not even be intentional – it turns out that our brains have been built to respond that way.
The limbic dance
Our emotional responses are governed by our limbic system. It’s been around since Homo sapiens emerged on the plains of Africa about 200,000 years ago and means we’re hard-wired to go into survival mode when faced with danger.
Our limbic system is the reason that we feel the pain of a loss more keenly than we feel the pleasure of a win by an estimated factor of two to one.
The limbic system goes into overdrive in retirement, and we become even more loss averse.
Retirees suffer from ‘hyper loss aversion’ – they are up to five times more sensitive to losses than the average person.
Brave new world
Australia’s demography dictates there are about to be a whole lot more retirees.
As baby boomers approach retirement, millions of Australians are moving from accumulating assets to unlocking capital to fund their lifestyle.
But as they march over the hill into retirement, new risks evolve. The old, safe world of defined benefits is gone forever.
The rise of defined contribution plans has shifted the risk from governments and corporations, to individuals.
No matter how carefully clients have planned their retirement, some things will always be out of their control.
Current market volatility, combined with the prediction that a quarter of 65- year olds will live to 100, makes the risk of running out of money in retirement a very real one.
At the very least, it’s a recipe for a nervous retirement.
Shaking the tins
Success comes from tapping into how your clients think. We’ve traditionally thought in terms of lump sums when it comes to retirement planning; now we need to consider individual accounts and income.
People who understand their finances think in a series of mental accounts. One account might be an overseas trip, another might be for school fees, while another might be saving for a new car.
Mental accounting has its roots in past generations when times were tougher.
My grandmother’s pension money came through on Tuesdays and she immediately divided the money between four tins: food, rent, electricity and ‘spoiling the grandkids’.
Whenever I visited, I knew that my tin was the red one at the end of the mantelpiece.
The same way a conductor brings disparate sections of an orchestra together into a symphony, bringing together these mental accounts, or tins, into part of a cohesive financial strategy is central to your client value proposition.
Tomorrow’s world of financial advice
So how does the mental accounting theory work in practice?
Let’s take a typical retired couple. They’re worried about retiring in a volatile period, but know they need to stay invested in growth assets to make their savings last.
They are keen to maintain a comfortable lifestyle without compromising their need to save for the long-term to keep pace with inflation.
After years of hard work, they are planning the trip of a lifetime in 2012.
In the meantime, the grandchildren’s birthdays are coming up and there’s work to do on the house.
After discussing their concerns and aspirations, you create a series of separate accounts (within an allocated pension) for different purposes and distribute their funds between the ‘tins’.
- Guaranteed income account – using a newer-style variable annuity or a traditional lifetime annuity, this account generates a guaranteed monthly income for your client’s lifetime to meet essential living expenses.
- Regular income account – the investment profile of this account would be a moderately defensive strategy, mixing equities and fixed income, seeking to generate a higher income yield. This helps meet your client’s discretionary retirement income needs.
- Cash account – secure term deposits to pay for short-term goals such as celebrations, home improvements and holidays. It can be easier for clients to spend money if they know it’s coming from an account created for that very purpose.
- 4. Future 2018+ account – a higher-growth strategy using managed funds, shares or exchange-traded funds. This account helps to combat inflation and longevity risk over the long-term for goals later in retirement. Earmarking the account with a date helps manage concerns about short-term volatility.
The key to your financial advice proposition is understanding your client’s short-term, medium-term and long-term retirement goals, and allocating the appropriate amount to each account.
The proportion you end up allocating will also depend on your client’s appetite for risk and personal preferences.
Talking in terms of ‘tins’ of money addresses the need for control that many retirees feel. Despite the fear factor, many retirees are unwilling to fully trade off control for protection.
The right financial advice approached in the right way can help them feel in control of their financial future.
Together, the tins generate ongoing income as well as capital growth. Your clients remain exposed to growth assets but have a measure of protection to guard against market downturns.
You’ve implemented a strategy to address key risks of retirement, and you’ve retained the flexibility to adjust money across the various ‘tins’ in response to changing circumstances.
Mastering the baton
As financial planners, we conduct the orchestra for our clients.
The four sections of an orchestra (strings, percussion, brass and woodwind) come together in harmony under the guidance of a conductor. The success or failure of the composition depends on how the conductor brings all the sections together.
The role of the conductor/financial planner comes to life at the annual review. This is where you take stock of the progress in the four tins and decide where next year’s income will come from.
Rather than talking about investment returns, you can help clients focus on their monthly spending and future income needs.
If markets are down at review time, you can still have a more reassuring conversation.
Instead of focusing solely on the bottom line, you can emphasise the underlying value of the different tins, reminding your clients that they still have:
- A guaranteed income account;
- A lower-volatility account that still provides a high level of income;
- A secure cash account as an additional buffer; and
- A longer-term high growth account. While this account will have fallen in value, it’s labelled as a future-dated account, so it can be left alone to recover.
Whether markets are up or down, your client conversation can be a positive one.
You’re able to demonstrate the value that your financial advice has added by adjusting each account, crystallising gains into cash and fulfilling every retiree’s desire to lead a comfortable lifestyle in their golden years.
By being the conductor of your client’s financial situation, you’ve put their limbic system in its shackles, freeing them to think rationally and enjoy peace of mind about the financial aspect of retirement.
Getting closer to the way your clients process financial information and adjusting your approach to financial advice is the key to cultivating the advice business of the future.
Barry Wyatt is the director of sales at AMP.
AUTHOR
Staff Writer
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