A Retirement Income Renaissance?

A Retirement Income Renaissance?

The opinions and views expressed in this article are entirely my own and do not represent the views of my employer or any other third party.

The Retirement Income Review (now forever known as the Callaghan Report) was touted as an objective fact-based assessment of the state of Australia’s leading retirement system. At almost 650 pages long, it’s a behemoth and remains true-to-label with a series of findings and observations without making any explicit recommendations.

In many ways, this is bureaucrat and policy wonk cat-nip – they get to cherry-pick the facts to suit their political and policy-making reform agenda. Having said this, the report is a commendable and important effort to make sense of our highly complex but generally effective compulsory superannuation system. Exploring how it delivers, alongside other important private and public pillars, on the social “retirement” contract for all Australians.

Rather than attempt a chapter and verse summary of the report (by all means, have a crack), I’ve instead channeled my inner-Millennial to provide a “Top 5 list” of things that stood out to me from the report.

1. Half volleys dispatched to cover

Cover drive

While media commentary will undoubtedly focus on the Federal Government’s likely attempts to kill the SG rise off the back of the report, there’s a few no-brainer reforms that the report highlights again as having clear merit:

  • legislating a purpose for superannuation that is clearly oriented towards delivering retirement incomes – in the words of Nike “just do it” and stop worrying about the particular grammar and punctuation; and
  • the retirement covenant which has unfortunately been delayed to 2022 but will require superannuation trustees to specifically formulate a strategy to deliver their members positive outcomes in retirement.

If the report results in nothing else but ensuring these two things finally pass into law, then I would consider the whole exercise a resounding success!

2. Courage, Frydo

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As I read through the denser sections of the report that touch on the imperfect interactions between tax, social security, super and retirement rules – I started to feel a growing sense of excitement (stay with me, here) for true reform on the horizon.

My big bold idea for retirement has always been to means test the family home for Age Pension eligibility purposes. This continues to feel like the easiest and fairest way to address some invidious aspects of the current policy settings, namely:

  • the amount of unproductive capital locked in private property
  • the lack of incentives for retirees to downsize and free up stock for younger buyers
  • difficulties in accessing home equity as a source of retirement income
  • calibrating age pension eligibility to those most in need.

Rather than the Federal Government trying to double down on the Pension Home Loans Scheme (also explored in the report), it would be truly heartening to see Josh Frydenberg make the above a courageous centerpiece of their new retirement policy agenda. The report gives them sufficient ammunition for this and, they have a real live (and well-aligned) example of policy courage in action as the NSW State Government pursues their radical tax reform plan for stamp duty.

3. Biases and best interests

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The report does an excellent job of exploring some of the cognitive biases that effect how we, as humans, often make financial decisions that are against our best interests. In fact, page 159 (biases affecting saving) and 443-446 (biases affecting retirement decisions) are probably my two favourite sections of the report.

That biases affect our decisions shouldn’t come as a surprise to most of us and should be particularly familiar to super trustees who have fought against these biases (on behalf of members) in many recent situations, including:

  • supporting members to “stay the course” rather than switching into defensive assets at the bottom of the market and losing any future growth potential;
  • showing pre-retirees the benefits of maintaining an allocation to growth assets as they approach retirement (even as loss aversion starts to take hold); and
  • helping members understand that accessing their super under “early release” means they miss out on the 8th wonder of the world (compounding) in their retirement.

Where the report really hits the mark, is exploring how trustees have an obligation to support and guide members to overcome these biases. In fact, this is at the heart of their duty to “act in the best interests of members.”

If trustees can objectively prove that lifetime income and longevity protection propositions provide a benefit to some members (whether through a higher age pension entitlement or protecting against the risk they live longer than expected) then the report implies that trustees have an obligation to improve retirement outcomes by helping these members overcome the biases that have been historical barriers to purchasing.

In this regard, the work of the UK Government’s Nudge Unit is instructive. Perhaps if pooled longevity plans were framed as a decision to leave, rather than a decision to join at retirement – this would help address much of the apathy and “sense of loss” that surrounds pooled longevity products that protect against risks that feel too remote.

4. Advice by any other name…

Rose

Coming in as a close runner-up for my favourite section of the report is Box 5A-10 “What is financial advice?”. This lays out in clinical and confronting detail the complex terminology that currently surrounds the advice ecosystem in Australia.

Financial advice reform goes hand-in-hand with any system reform centered on the retirement phase. The reason for this is subtle, but profound. Consider the way super operates today is identical for the vast majority of Australians aged under 60 (and will continue to be due to the Government’s new stapling rules):

  • you start your career and are signed up to a MySuper product
  • you are placed in the default “Balanced” investment option
  • you have one goal: maximise your balance from now to retirement.

Which is to say, in accumulation every member is fairly homogeneous from a financial plan perspective. If trustees help you to maximise your net investment return, 90% of the job is done. But as you approach retirement, things start to get really hairy for members.

Retirement is a personal journey. And for a journey, you need a map. For trustees to help you create this map (aka financial plan), they need to know your “personal goals” and “personal circumstances”.

Unfortunately, as the report makes clear, this is fraught with peril for trustees. Intra-fund advice doesn’t cut it. Personal financial advice is costly, complex and now has an extremely high compliance burden. Everything else isn’t really advice. In the immortal words of Star Wars, we need a “New Hope” for mass-market advice and guidance for retirees.

5. Long term care: back-to-the-future

Hoverboard

Buried in the report first at Box 4A-3 and then later at 5A-7 are some thought-provoking statements about the discordant interactions between the super, insurance, social security and aged care industries. Culminating in this piece of crystal ball gazing:

“If changes are made to encourage greater personal provision for aged care costs following the Aged Care Royal Commission, long-term care insurance may make aged care costs more affordable for people and give them the confidence to draw down their retirement savings.”

A comeback for “Long-Term Care Insurance” in the Australian market has been much speculated about but continues to be a Sisyphean task – beset by challenges on both the supply side and the demand side.

However, there is a scenario I can envisage where the intersection of reform may meet between the Aged Care Royal Commission and the Retirement Income Review – providing an impetus for industry participants to better serve our aging population. It is a risk factor and health burden that is poorly understood by the wider community and grotesquely under-served by both government and the private financial sector alike – the severe impact that increasing levels of cognitive decline and mental illness will have on the retirement well-being of our aging population.

Life insurers (including my own employer) have been highlighting the growing impact of mental illness on our wider community for some time. Alzheimer’s and Dementia will soon grow to be the leading cause of disability, decline and death for individuals over the age of 65. More than this, it is the unique impact that this category of illnesses has on well-being and retirement lifestyle. Among them being that it robs people of their financial literacy right at the time that they need it most – as they are faced with the most dizzying array of complex financial decisions whilst navigating the a bureaucratic range of government/private providers.

If there is a challenge our lucky country should seize upon with gusto to preserve the great Australian dream for all – surely it is this!

I hope you enjoyed this taste of the Retirement Income Report. If you don’t have time to read the report in full, I suggest you focus instead on the key observations and insights. This article was not intended to be a comprehensive summary of the report (or even an incomplete summary) – it is primarily a conversation starter.

I’d love to hear everyone’s thoughts and comments on the report below!

Solving the roboadvice riddle: it’s not the investments, stupid!

Solving the roboadvice riddle: it’s not the investments, stupid!

Roboadvice is many things to many people in many markets, in turn:

  • once the saviour of Silicon Valley’s savings
  • now the darling of the emergent Australian fintech economy
  • the continued whipping boy of alpha seekers, and
  • an already obsolete technology for skeptical venture capitalists.

For the true believers, “roboadvice” is seen as a dirty word that diminishes and ridicules the weighty aspirations of those immersed in the profession. Many prefer to use more cultured phrases like “automated advice” because their more positive connotations don’t evoke images of thousands of human advisers trudging to the Centrelink queues having been replaced by HAL or WALL-E.

Underlying this terminology war is an insecurity which stems from the personality crisis that pervades most roboadvice platforms. Are they true disrupters or the soon-to-be disrupted?

This is the conundrum I will explore in this article whilst surveying the current roboadvice offerings in the Australian market. My contention is that:

the nascent roboadvice profession lies sandwiched between a well-established but much maligned advice community and a barely comprehensible future of true artificial intelligence

Australia’s roboadvice pioneers

“If I have seen further it is by standing on the shoulders of giants” 

When Sir Isaac uttered those famous words, he could very well have been talking about the evolution of the roboadvice industry in Australia. In many ways, it has followed closely in the footsteps of the pioneering Silicon Valley robo houses focusing first on basic multi-sector portfolio solutions and then evolving into more holistic automated advice solutions, as illustrated below:

In the USA, the automated advice solutions of the second generation that have seen the most success have been those with access to existing scale or a captive audience (e.g. Vanguard and Charles Schwab).

Many of the Australian second generation roboadvisers are banking on bringing fresh perspectives to the automated advice game. Some positioning themselves as product-agnostic portfolio construction tools that put the user in control (OwnersAdvisory) and some giving away their talents for free in the hope of entangling the client even further into their product ecosystem (I’m looking at you, Big 4 Banks).

The levers and dials that Australian roboadvisers are playing with form part of a common spectrum. Each offering being a different spectral play on one of the following characteristics:

Despite the active attempts to truly innovate, the cynical side of me suspects the Australian roboadvice platforms that will triumph will share similar characteristics with their USA counterparts (scale and a captive audience).

However, there is another way…

Making roboadvice sticky

Roboadvisers should be catnip to a prospective client like me. I’m young, growing my wealth, financial savvy but don’t currently have a financial adviser. So what could a roboadviser do to make me use them?

Roboadvisers need to know their client-base and solve real advice problems for them.

Risk-appetite based investment portfolios or generating returns through a top-down asset allocation approach are tried and tested formulas. But they are not engaging or relevant concepts for the average joe investor.

To engage effectively, roboadvisers can take a powerful lesson from the development of mobile applications for financial products and accounts. For example, what do you suppose is the most downloaded superannuation app?

The answer is:

Why do you think this has been downloaded by so many Cbus Super’s members?

Because it:

(a) is useful and relevant to its user base (most construction employees work outside, love their footy and can’t wait until their next holiday)

(b) emphasises features that are much more human and customer-focused than the current balance of their superannuation.

In a previous post, I argued that goals-based advice conversations are the beginning of an industry-wide paradigm shift that will make financial advice relevant again to the masses. Perhaps empathy is the missing ingredient for human and robotic advisers alike.

Unifying the advice community

If humans struggle so much with empathy, what hope for a computer? Roboadvisers don’t need to feel or mimic human emotions to become more useful and relevant to their prospective client base. However, roboadvisers do need to reassess their position in the advice spectrum. Are they cold and calculating or warm and fuzzy? Are they the saviours of the advice profession or the destroyers?

I tend towards the view that roboadvisers can become a powerful part of the advice toolkit, helping to serve clients with simpler advice needs and providing full service advisers a reliable way to begin advice conversations with clients who need help achieving their financial goals or meeting their financial needs.

Roboadvisers that understand their place within the advice spectrum and can humanise their value proposition with gamification techniques are well placed for long-term success. Gamification can turn a chore into a challenge and one of the more appealing conceptualisations of this, from an advice perspective, is Melius.

Melius is a lead generation tool for financial advisers. Prospective clients answer a series of personal finances and wealth questions which are translated into a peer-benchmarked financial wellness (Melius) score. Clients are behaviourally incentivised to improve their Melius score by contacting their financial adviser to, for example, increase their insurance coverage, re-weight their investment portfolio or refinance their home loan.

The Melius concept, whilst appealing, isn’t the panacea for roboadvice. Roboadvisers need to become more human. Or rather, they need to seem more human.

Disrupting roboadvice (the 3rd generation)

Imagine, Siri for financial wellness. Lets call her, Robotica. For the same price as your monthly Spotify subscription you can hold your financial future in the palm of your hand:

 Hello, Robotica!

Good morning, Ashton. How can I help you today?

Robotica, how is my investment portfolio performing?

You’re doing OK, Ashton. Your portfolio is currently outperforming the market by 5% which is better than 98% of your peers. However, I recommend that you reduce your allocation to Australian mining stocks by $22,000 as iron ore prices are continuing to soften.

Thanks Robotica, please go ahead and implement that.

All done Ashton, you have incurred $55 of brokerage costs. Have a good day at work. Let me know if you need anything else today. 

The future of roboadvice will be built on natural language processing, machine learning and artificial intelligence. With sufficient processing power to mimic human conversation, roboadvisers will interact with clients fluidly and naturally. Once the uncanny valley is bridged, the floodgates will open and the industry will never be the same again.

This may seem like science fiction now but human advisers would be well advised to make friends with their robotic counterparts. Whilst the current and near future generation of roboadvisers may not be that impressive, a new world of financial advice awaits only a quantum computing heartbeat away.

If you enjoyed this post, please like or comment below. You can read previous articles in this series on ideas transforming Australia’s wealth in 2016 below:

Idea #1 – Goals-based investing

Idea #2 – Blockchain (Part 1, Part 2, Part 3)

Goals-based investing: a new advice conversation

Goals-based investing: a new advice conversation

“How much do you think you will need to retire?”

Tough question. Common question. Meaningful question? Probably not. Increasingly, advice professionals need to consider:

“Am I asking my client the right kind of questions?”

Rather than focusing on absolute performance against an impersonal benchmark, a goals-based investment approach is enabling financial advisers and wealth managers to build a truly personal investment portfolio for their clients.

The typical approach, used by human or robot advisers alike, is to construct a recommended investment mix focused on two metrics:

  • return: an absolute level of income and growth a client wishes to achieve from their investments
  • risk: the volatility or downside a client is willing to tolerate in achieving their desired returns.

This approach measures its success primarily from quantitative factors which can mean very little to clients when compared with their personal or family-oriented goals. In contrast, goals-based investment philosophies can begin a powerful client conversation and allow advisers to make investment recommendations that are meaningfully linked to a personal goal or sense of achievement for the client.

In 2016, momentum will build for advisers to place client goals at the centre of the advice conversation. To understand client goals and build an investment strategy and portfolio mix that is explicitly designed to achieve those goals.

Advisers will need to ask their clients less about savings, rates of return and risk tolerance and more questions like:

“What do you want to do and how do you want to live when you retire?”

Consider, benchmark returns and volatility measures mean very little to clients when compared to their goals, hopes and dreams. Advisers understand the importance of talking the same language as their clients and it can be a small but significant step to also invest clients in a way that they intuitively understand. This is where goals-based investing can be particularly powerful.

Continuing with the retirement theme, the traditional asset allocation approach can underestimate or ignore some key risks of retirement, including:

  • sequencing risk: where lower than average expected returns occur early in the retirement term, and have a detrimental effect on the size and duration of a client’s retirement savings
  • longevity risk: where a client’s lifespan and, therefore, retirement term is longer than anticipated leading to a detrimental effect on the duration of the client’s retirement savings.

Rather than trying to achieve retirement goals with a single investment approach and overall target return, goals-based investing takes each goal, considers them as an individual objective, and builds a tailored investment approach.

Advisers that want to begin a goals-based conversation with their clients should be aware of common client behaviours with goal-setting:

  • needs are more important than wants: clients are generally willing to take on more risk when the goal is to invest to buy a speedboat, rather than investing to protect their retirement savings
  • immediate goals are more obvious than later goals: clients are generally more concerned about their current situation and often don’t focus enough on their longer term goals.

To illustrate this:

Advisers need to consider how much client goals can vary in terms of their priority, timing and level of risk the client is willing to tolerate to achieve each goal. Returning to the retirement theme, a goals-based discussion may highlight that in order to provide clients with an effective retirement strategy, an investment approach should:

  • quantify the income stream level required to support the client’s lifestyle
  • invest to provide this income stream level for the full retirement term
  • include realistic assumptions about the length of the retirement term.

 

Three ways advisers can reframe the advice conversation

There are some simple ways that advisers can orient their advice process towards their clients’ goals:

  1. Start asking different questions: this can be as simple as asking a client ‘what are your most important goals and why?’ or as complex as asking ‘how would you describe your ideal retirement lifestyle?’ Clients have come to expect that advisers understand their circumstances and will provide a personalised service. Don’t be afraid to probe deeper during the client discovery phase.
  2. Identify more soft risks: start building into the asset allocation process an understanding of the key roadblocks that will prevent clients achieving their goals (beyond simple market under-performance). Qualitative risks, like opportunity cost, are often poorly understood by clients. If advisers help their clients understand these risks, they may be able to put forward an investment portfolio that better manages their expectations.
  3. Change the way performance is reported: rather than reporting performance against a market benchmark, advisers can start reporting performance against a goal their client is trying to achieve. It can be a powerful image for a client to see how close they are to achieving their goals. More importantly, it may allow clients to better understand how their investments are helping them to achieve their long-term goals (such as the income they want in retirement).

 

Goals-based investing is just an extension of the knowledge advisers have of their clients and the personal nature of the advice process. Advisers should reflect…are you asking your clients the right questions?