“Am I going to be all right?”
That is the question running through many clients’ minds as they consider their financial well-being. In a 2018 poll conducted by Leger Marketing Inc., Canadians revealed that outliving their money was one of their top financial fears.
However, allaying that fear by answering the question with a resounding “yes” is challenging for financial advisors, thanks to persistently low interest rates and clients’ anticipated longevity.
Consider that in 1995, when inflation was 1.7%, a five-year GIC returned 7.1% – a real return of more than 5%. That same year, female life expectancy at age 75 was 12.5 years. Fast-forward to 2015, and that same GIC’s real rate of return was -0.4%, while female life expectancy at age 75 had increased by 12% to more than 14 years.
Given these trends, could you come under scrutiny for failing to take on sufficient investment risk for your senior clients?
Regulatory focus on seniors typically highlights the potential dangers of risk – with good reason, considering that suitability is the most common topic of complaint from investors. In 2018, the Mutual Fund Dealers Association of Canada announced a sweep of advisors’ books for issues of high-risk investments and suitability for seniors. Guidance on seniors from the Investment Industry Regulatory Organization of Canada in 2016 stated advisors should be vigilant of seniors assuming too much risk in an effort to generate income.
Yet, growth mandates for part of a senior’s portfolio are becoming necessary because of potential expanded longevity.
“The 65-year-old today could have 30 years left,” says Steven Sofer, partner at Ottawa-based Gowling WLG International Ltd. in Toronto. As a result, “growth needs to be part of the portfolio for most people.”
If it isn’t, you may not be doing your best for your clients.
Mitch Frazer, partner and chair, pension and employment practice, at Torys LLP in Toronto, says that when a client’s investments are too conservative to fund an adequate retirement, a court potentially could find that the advisor wasn’t “prudent” – a key legal consideration.
While Frazer is unaware of any such cases, “it’s inevitable that you’d have litigation dealing with what is an adequate retirement and a prudent portfolio,” given historic low interest rates, he says, referring specifically to pensions with a fiduciary duty and, therefore, with greater obligations.
As this economic cycle winds down, such cases could be around the corner. “As long as stock markets go up, there’s usually not a lot of litigation,” Sofer says. “It’s when markets go down that the litigation arrives.”
However, disappointing portfolio returns aren’t sufficient grounds for litigation, Frazer says. Key is that an advisor’s process for choosing an investment is prudent, he says, which would be reflected by, for example, the benchmark vs absolute returns.
“When you part company with diversification to take advantage of something that’s hot,” Sofer adds, “there will be winners and significant losers.” And potential litigation.
Sofer gives the example of a client who insists on taking a large position in a trendy cannabis stock. You should be clear that you don’t support that investment decision if it doesn’t align with the client’s risk profile and have the client sign a waiver, Sofer says.
Sofer also warns that the risk of litigation increases when you change a client’s investment objectives to fit an unsuitable product. This so-called “repapering” has resulted in several enforcement actions, according to the Investment Industry Association of Canada’s 2014 guidance on protecting seniors.
Determining reasonable risk
While a growth strategy may be sound, you may find implementing such a strategy impractical.
Consider that three options exist to increase assets available in retirement: save earlier, save more or take on more risk (assuming spending less isn’t viable or has already been implemented). By retirement, the first two are off the table, and the third may be too, if your firm endorses a conservative approach (especially as the economic cycle winds down).
However, taking on more risk can be an option when a firm embraces goals-based investing and overcomes conventional wisdom about know-your-client (KYC) requirements. For example, the answer to the standard KYC question of “How much risk are you willing to take?” is “It depends,” says Mark Yamada, president and CEO at PÜR Investing Inc. in Toronto. “You have to prioritize” based on the client’s various goals, he says.
Yet, goals-based investing may not work if clients don’t receive comprehensive financial planning – as is often the case under a regulatory regime focused on products and suitability, says Alan Goldhar, a financial planning instructor at York University. For the average client account, “financial planning isn’t integrated into the investment industry yet,” he says.
Long-term goals, such as those associated with estate planning, could be met through dividend-paying equities, Goldhar says, but you must have the skill set to do a full analysis. You must explain the strategy to clients, ensure they understand the risk and provide accompanying documentation.
Also, suitability should be reassessed regularly, Sofer says, so that a portfolio’s appropriate diversification is maintained.
Another challenge related to risk is lack of fiduciary duty. For example, when only a suitability obligation exists, you can recommend high-cost products, Goldhar says. That’s a problem, because the impact of high costs on a portfolio is staggering during both the accumulation and decumulation phases.
When a client pays 2.5% for 25 years while withdrawing 4%, costs consume 64% of the client’s capital, Yamada says. “The consumer has never been told that fees compound as well as returns,” he says. Implementing a fiduciary duty for advisors serving retirees would be a “good first step” toward addressing regulatory concerns related to seniors’ portfolios, he adds.
Yamada offers a solution for boosting income in retirement portfolios in Autonomous Portfolio: A Decumulation Investment Strategy That Will Get You There, a paper he co-authored with colleague Ioulia Tretiakova. The strategy rebalances to constant risk according to market volatility and spending is linked to portfolio performance, with an estimated withdrawal rate varying between 4% and 6%.
“We’re taking judicious risk” when market volatility is low, Yamada says. The result is a framework of risk that addresses income challenges while minimizing the probability that the client will run out of money before death.
Because an effective decumulation product must incorporate low fees, Yamada forecasts that an online platform, which could automate the strategy, might offer such a product for a flat fee.
Prevention provides the ultimate panacea, which means laying the groundwork early. Ideally, financial education would ensure clients understand the importance of investing small amounts regularly starting when they’re young, Sofer says.
Despite the income challenges that seniors probably will continue to face, one trend is supportive: the number of years spent in retirement isn’t growing because Canadians are opting to work longer. Statistics Canada found that in 2015, one in five Canadians age 65 and older was still in the workforce. IE