It’s seems conservatism is the new black. Everyone is doing it. But is everyone right? Should everyone be doing it? Or is the concept of conservatism fatally misunderstood, a dangerous mis-conception causing long term financial havoc if left unchecked and uncorrected by responsible financial planners?
Take Ethel, a 71 year old divorced retiree. Ethel presented claiming to be ultra-conservative. She has her house, $500,000 to invest and not much more. She is not eligible for an old age pension. Ethel’s worst fear is running out of money in her advanced old age and being finally forced on to the old age pension to survive.
Ethel’s adviser recommends an annuity costing $500,000. Sounds simple enough. Sounds safe enough.
But it’s not safe enough. In fact it’s not safe at all. And it’s not good enough either.
Ethel will lose her capital after 15 years, ie at age 86, and her 4% pa return, or $20,000 a year, will be a miserable miserly pittance in 15 year’s time, almost completely eroded by inflation, it’s purchasing power pathetic. If Ethel only had her home and did not have her $500,000 she would have got an old age pension of about $20,000 a year anyway. So in a sense Ethel’s $500,000 will be wasted, lost, with no real benefits at all.
The only good news is, presumably, the assets test limit for a single person will rise over time and eventually Ethel will get a part pension, and probably, eventually, a full pension. Ethel really will be poor: her worst fear will come to pass.
And her adviser will be to blame. FOS will have a field day.
So called ultra conservative investments like annuities are in fact the most risky of all investments. The investor is virtually guaranteed to lose capital over time. Live long enough and you will be poor. Inflation will catch you eventually. Nothing is more certain.
What should the adviser have done?
Education. Patient explanation. Keep all options open. Don’t commit to an irreversible strategy. Key phrases like this should resonate. It’s because you are an adviser, not a salesman. Acting in your client’s best interests means spending time and energy helping clients understand investment and financial theory.
Vulnerable clients like Ethel need extra tender love and care. And your SOA must show this.
Small steps count. Start with 80% defensive and 20% growth. Let Ethel learn more about growth assets, and why inflation is so dangerous. Spend time with Ethel. Send her extra reading. Meet for a coffee. Encourage Ethel to learn more and better understand investment theory and why inflation is so dangerous.
As Ethel gains confidence increase her exposure to growth assets, ie paradoxically, low risk assets. The ones you have to own if you do not want to be poor.
Give Ethel a copy of The Russell ASX Long Term Investment Report. Page 8 tells us in the 20 years to 31 December 2015 Australian residential property averaged 10.5% and Australian shares averaged 8.7%.
Ethel is a vulnerable client
Ethel is a vulnerable client, in that she is not able to critically examine your advice and relies on you 100%. The trust level is as high as it gets. So meet her trust by involving others in your advice and her decision making process. Talk to Ethel’s adult children. Get them to speak to their mother and help explain how things work.
Ask her accountant, solicitor or other trusted person to attend the meeting, as her advocate.
Give Ethel’s advocate a copy of The Russell ASX Long Term Investment Report, and explain that in the long run Ethel has to be exposed to growth assets. It’s too risky not to be. Invite them to get a second opinion.
And make sure you can prove to FOS you did this.
Who says the answer lies in a financial product?
Who says financial planning has to involve a financial product?
Perhaps the four of you, ie you, Ethel, her solicitor and her daughter, should settle on a strategy to up-grade Ethel’s home, i.e. invest further in residential property, become eligible for the old age pension (about $20,000 a year, effectively tax free) and start a small, controlled reverse mortgage of say $15,000 a year.
Ethel gets $35,000 a year to spend, and is exposed to growth assets. She is protected from inflation.
Do the maths. Study the history. Check the economics. Australian residential property is much less risky than an annuity. Ethel is in control and gets more cash to spend. And her kids inherit more.
Ethel’s risk profile is satisfied and her objective of not being poor in her advanced old age is virtually certain.
That’s a huge improvement over the neo-con-con, which made it virtually certain Ethel will be poor.