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Richards: cashflow modelling is no silver bullet

In the second part of our debate, Keith Richards of the PFS explains why cashflow modelling is not essential for everyone.

Richards: cashflow modelling is no silver bullet

Money is often just a means to an end. So it makes sense that the kind of risks we are prepared to take with money are different, according to what we want to do with it.

Very few people are consciously prepared to take risks with the money they need to pay life’s essentials. However, they may be prepared to see a bit more volatility in the money they have set aside for key goals or pastimes; a windfall can make a dream come true, but poor returns are not the end of the world either.

When it comes to longer-term priorities, such as long-term care or leaving an inheritance, putting some savings into more volatile assets could be a hedge against inflation over several decades. But the typical behaviours of the investment market need to be properly understood by the client.

These ideas around asset-liability matching – minimising risk for shorter-term or less flexible liabilities while taking more risk with longer-term and more manageable liabilities – have been around for a long time.

However, in the UK retirement space, the weighting towards buying an annuity meant it was difficult to put these ideas to work for all but the wealthiest clients when it came to their retirement savings.

Now, with the pension freedoms, many people are holding significant savings well into retirement. The way they access this money can be very complex. This is because they are often drawing a pension income down alongside incomes from state pensions, other savings and investment products, the value of their house and possibly an income from part-time work.

Lack of understanding

Australia is an example of one such market, where this situation has been in place for far longer. Experience shows when people have these freedoms, some spend a lot of their savings straight away, draw down at the wrong time or panic when markets drop. All these things can lead to having very little to live on for the rest of their retirement. There is a challenge for consumers to understand longevity risk and the need to plan for long-term care.

But some do the opposite: hoarding savings well into their late 80s and 90s, depriving themselves of the standard of living they have saved so hard for throughout their lives.

Given the risk of spending too much or too little, it has increasingly made sense for advisers to use cashflow modelling tools. These can help them to track their clients likely spending needs throughout retirement, and gauge the kind of risks they could reasonably take. Equally, this also increases clients’ understanding.

Pinch of salt

Some advisers have argued it is impossible to give good financial advice without using a cashflow modelling tool. But it is important to acknowledge it is simply a tool: one that supports the planning process, but does not give a one-size-fits-all solution.

It is certainly true that good retirement advice must be based on a strong understanding of clients’ long-term income needs, and the sources of income likely to meet those needs.

But it is equally important to remember cashflow modelling is not a silver bullet, producing infallible answers that do not need to be talked through with the client. As with all data services, the old rule of ‘garbage in, garbage out’ still applies. If growth assumptions are ignored, or clients’ attitude to risk is not measured and confirmed back to them, the cashflow modelling may not produce a suitable answer.

The fundamental values of good advice still apply: know your client, recommend a solution that is suitable for their needs, explain it carefully and keep everything under review. Tools can only serve to aid professional advice.

By the same token, any tool that can support those principles is a good thing. For many advisers, using cashflow tools is essential to the effective financial planning process and to ensure their clients’ cash keeps flowing for longer.

Keith Richards is chief executive of the Personal Finance Society

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