For retirees, certainty trumps portfolio theory

How we manage our clients' retirement income urgently needs a revolutionary shift.

The financial planning profession has long focused on sophisticated investment strategies and dynamic asset allocation because – well, that's where our value lies, right? The reality is that most of our retired clients have a much simpler priority: they want to sleep well at night knowing their income is secure.

This disconnect between our approach to retirement income and what clients actually want isn't just a communication issue; it's fundamentally affecting our ability to serve clients effectively and help more Australians access the quality of retirement advice they want.

The challenge we face

While technically sound, traditional approaches to retirement income management often miss the mark on addressing our clients' core emotional needs.

The evidence is clear: retirees prioritise income certainty over complex investment strategies when given a choice and a proper understanding of their options. They're willing to trade some capital access and theoretical portfolio optimisation for the peace of mind that comes with stable, predictable income, irrespective of what markets are doing.

The "retirement risk zone" is a critical period that often goes overlooked. It refers to the decade before and after retirement when clients are most vulnerable to market fluctuations. During this period, a client's portfolio is typically at its largest and the sequence of returns matters more than at any other time. 

A few years of negative returns during this period can have devastating effects that even strong subsequent performance may not overcome, as retirees draw down capital while trying to recover losses.

A new framework for retirement income innovation

While it's been easy to ignore given everything else going on in advice, the government's move to legislate the Retirement Income Covenant and the introduction of comprehensive income products for retirement (CIPRs) – which are designed to provide a regular income throughout retirement, regardless of market conditions – show a clear message from Australian retirees. 

That message? They want more security than they've had over the past 30 years!

It is, therefore, time to flip our thinking as professionals. Instead of starting with investment strategies and working backwards, we need to begin with the client's minimum income needs and build forward.

Our approach should be built around compartmentalisation: separating clients' money based on its purpose. Proper compartmentalisation is more than traditional bucketing strategies; it means establishing a reserve for short-term needs with zero market risk and creating a lifestyle component that balances immediate income certainty (not just income payments) with long-term growth. 

And, when possible, it means maintaining a future goals portion for excess funds where clients can take on more risk – keeping in mind that being conservative can be just as risky as being aggressive, depending on the time horizon.