Written by JB Beckett, Non Exec, expert witness, global speaker, columnist, broadcaster and author of ‘NewFundOrder
Advisers face a hugely inflated challenge to reconnect their drawdown clients’ perception of money in an ever dematerialised economy. Yet the solution is not cash, says JB Beckett, as he uses a ‘big’ birthday to reflect on how modern ways and the erosive power of inflation are raising the risks for investors – especially those in income drawdown.
Having just crossed into my sixth decade I found myself standing in a supermarket recently (on my birthday) to pay for a couple of items. Mostly painkillers to dull the aches both mechanical and cerebral. I like to stand to queue for the human assistant rather than their automated bot counterparts. Not today AI, not today! As I did so, I noted that most people were queued for lottery tickets. Something of a stramash around scratch cards, super ball thingies and all matters of instant gambling gratification ensued.
With the rise of big tech, social media, climate change, indexation, a pandemic, war, stagflation and a massive rates and bond normalisation come big challenges to long run capital models. Far-reaching consequences for ‘drawdown’, or Pension Fund Withdrawal for those of us who have been around long enough to recall its origins, lie ahead. For with these seismic arrivals they have distorted our collective perception of traditional money and worth.
A changing world
In this world then of; increasing latency, ones and zeros, tap
-and-go, I fear investors are becoming ever disenfranchised from money, all the more acute given the cost of living crisis, demise of physical coins in circulation, sluggish multi decade wage inflation and volatile markets.
Yet it seems many are happier to gamble on a set of lottery numbers, which have odds of paying out on the jackpot at roughly 45 million to one, far more so than increasing their pension contribution that will pay out, at one-to-one odds, a future sum in retirement. That sum is of course uncertain but the odds of positive payout far outweigh the odds of the lottery. Of course, there is no instant gratification, the optical cost of the lottery also appears far less than pension contributions because investors do not factor for inflation or time. The baggage of “salary-sacrifice” that comes with auto-enrolment has not helped and U.K. contribution rates lag heavily behind the likes of Australia and Canada.
On inflation, did you know that £100 in 1973 would now be worth almost £1500 (or only 0.05 of a Bitcoin), the Pound having lost 93% of its value? The sense of money perception is itself generational. GenYs are more happy to ‘invest’ in crypto than pay into an old fashioned system.
Meanwhile older generations frequently mutter and grumble about how much things cost now (I am increasingly one of them) but ‘younger’ generations are largely oblivious to past worth. The problem is that inflation continues to erode the purchasing power of your clients’ money every minute of every day. The real cost of £100 (or 0.003 Bitcoin) contributed today is also a fraction of its future cost in years hence in the future but then so is the resulting value of that pension.
Those were the days
Back in the bad old days, advisers would show investors actuarial pension projections and say they could make them millionaires. The consequences of the Pensions Act 1995 was liberalisation and poor pension transfer practices but the notion of making people “millionaires” resonated in a way pensions today do not.
A million pound pension in 1995 would be worth £2.37 million today (or roughly 80 Bitcoins). Recall the first Crypto transaction ever made was for 10,000 Bitcoins to buy two Papa John’s pizzas for a sum today worth about £200 million! A great example of the disparity between money and worth but also time value and inflation.
Even without crypto; in post-pension freedoms we now have a strange combination of flexibility and detachment among investors. Poor engagement leads to poor drawdown outcomes. The challenge is longevity risk and faltering long-term income sustainability. I expect that we will hit a precipice in sequencing risk over the next 5-10 years. Standing accused for this is intransigent models, poor governance and communication from drawdown providers.
It is no surprise that we now observe rising ad hoc drawdowns from pensions, at rates far in excess of the expected sustainability of the underlying allocation. Add to this the trauma of 2022 and what can only be described as a Gilt ‘prolapse’ and there are very real concerns for allocators and advisers at a time when a new Consumer Duty puts pressure upon us to be far more cognisant than ever before.
Allocators are trying to balance between running more risk in drawdown to keep ahead of inflation through equities versus naturalising income around assets like normalised bonds and perennial property to avoid sequencing risk. There is an intellectual urge to change things of course, a very human condition but it does start with pressing questions such as;
1. Is Cash King or Not?
2. What is a sustainable level of income?
3. Should we rethink annuities?
4. Go active management or index drawdown?
5. Could bonds blow up again?
6. Green transition: how does it change drawdown?
7. Are our long term models mostly right, or mostly wrong?
8. Is tactical asset allocation key to flexible income?
9. Do lifestyling Glidepaths still work?
10. How much total risk is right in decumulation?
However, do not assume your allocators will get this balance right. You might better instead lobby for greater communication and adviser support around money tools, a recognition that we have fully exited what was a two-decade long disinflationary stupor, and the reality is sobering. We have to reconnect our clients’ perception of money, value over time and how it changes with inflation.
Cash may have momentarily looked king but it was only for a day, perhaps only a minute. Drawdown may be the solution but reconnecting clients with the value of money is the answer.