Chartered Institute for Securities & Investment  

Financial planning literature branded 'naive'

Financial planning literature branded 'naive'

Financial planning literature has been branded "naive" because of its failure to take sequencing risk into account.

Speaking at the Chartered Institute for Securities & Investment (Cisi) financial planning conference on 1 October, Professor Steve Thomas of the Cass Business School said many in the financial services industry completely ignored this risk.

This was despite the fact his research showed addressing sequencing risk could have a bigger effect on a client's portfolio than diversification.

Professor Thomas said: "The sort of work I have been exposed to in the financial planning literature is very naive.

"Sequencing risk is totally missed when you look at the performance sheets from fund managers.

"In the real world you are either in accumulation or you are in decumulation."

He said the issue of sequencing risk was not particularly different between accumulation or decumulation but he said it was most acute in the "critical moment" when an investor switches from the former to the latter.

Professor Thomas said his research indicated the best way to address sequencing risk was by smoothing a portfolio over time.

This should be done by investing in assets which are overperforming their rolling average and withdrawing money from assets which are underperforming their rolling average and putting the money into cash.

He said his research indicated the positive impact this could have on a portfolio could increase a retiree's withdrawal rate by 50 per cent.

Professor Thomas added: "Think less about diversification across asset classes and more about how you can smooth returns in the two main asset classes."

His colleague Professor Andrew Clare, who conducted the research with him, highlighted the importance of sequencing risk by saying that if an investor with a £100,000 pot withdrawing £10,000 a year faced a 20 per cent loss in their first year of retirement, they would run out of money in the ninth year.

Meanwhile, if the same investor faced a 20 per cent loss in the tenth year they would still have almost £26,000 at that point.

He said: "Diversification helps over long periods of time but not necessarily drawing an income from your pot."

Professor Clare added that an event like the global financial crisis of 2009 could leave a pension pot "permanently impaired" if it hit an investor's pot at the wrong time.