What advisers should know about the FCA's investment pathway rules

  • Explain the background to the investment pathway rules
  • Identify the implication of the rules for firms
  • Explain how firms can differentiate their service

Furthermore, if the adviser did not give the client a personal recommendation on the transaction to move into drawdown within the last twelve months, the client must be taken through the investment pathway process. 

Advisers, therefore, are going to be under increased scrutiny to demonstrate the value of what they provide, above and beyond what any individual can receive direct.

As ever, this provides a threat or an opportunity, depending on your perspective. Two key areas spring to mind – the fact that the pathways are unlikely to properly assess a customer’s attitude to risk, and secondly the limited nature of the solutions themselves.

So how can advice firms differentiate their service?

Risk and ‘withdrawal profiles’

Leaving aside the inherent risk in providers offering solutions that take no account of an individual’s risk profile, advisers can go much further by properly assessing a client’s ‘withdrawal profile’. 

Put very simply, most accumulating clients require as much capital as possible, while retiring decumulation clients have personal and varied income requirements, time frames and patterns. 

Clients who expect to draw down a fixed amount each month face additional risk when markets drop suddenly, particularly if that drop happens early in their retirement when the value of their portfolio is greatest, as each withdrawal steepens the fall in value of their portfolio and reduces the ability to recover. 

Discussing a proper retirement income plan, underpinned by a powerful cash flow planning tool, will enable advisers and clients to properly map out future spending plans, making it easier and more transparent to pick the right withdrawal rate for different stages of the retirement journey.

Helping clients understand the difference between essential ‘needs’ and discretionary ‘wants’ expenditure is of course fundamental to this. 

Crucially, advisers are in a prime position to help clients navigate decumulation on an ongoing basis. Retirement strategies should be reviewed regularly, and withdrawal rates monitored to reflect changing circumstances and time horizons. 

Assessing the client’s capacity for loss is also a key measure for decumulation.

Understanding factors such as shortfall risk, income preplacement ratio and liability matching is vital, as is managing sequence of returns risk.

As mentioned earlier, any client taking a fixed withdrawal of capital each month introduces an additional risk into the portfolio.

Until retirement, the value mattered at annual review. Now, it matters every month when units are sold, which means that the volatility of unit price needs to be managed on a monthly not an annual basis. 

Solutions and risk-managed decumulation funds

This brings us neatly on to solutions and a further way that advisers can differentiate against the standard investment pathways approach.