Working and thriving in a brave new world of constraints
by Mike McGlothlinMr. McGlothlin is the Executive Vice President of Annuities at Ash Brokerage. Visit ashbrokerage.com.
Recently, Nintendo announced a mobile version of Super Mario Bros., the popular 1980s video game. Developer Shigeru Miyamoto created Super Mario under several constraints: time, money and technology limitations, all of which posed threats to the character’s development.
Delivery time expectations from Nintendo put pressure on developers to find a way to make Super Mario’s hair flip-flop as he jumped, so they added a hat to the plumber to lessen the need to show hair. In addition, pixel technology was not at the same level as it is today – making hands and fingers move meant that more technology and time was needed. Without those resources readily available, Super Mario began his career with bulky gloves. Through all those constraints – time, money, and technology – the greatest and most famous gaming character was created. By turning tight constraints into an opportunity to look at their business differently, the developers established a new mechanism for growth and increased market share by nearly 100 percent in some countries. More than three decades later, Miyamoto is still involved in the Mario brand development.
I share this analogy because our industry faces more constraints than the retirement income planning community has seen in four decades, and many of them are the same as the developers of Super Mario faced: fee compression (money), DOL implementation (time) and Robo-adviser competition (technology). We have to think differently about retirement income planning, just as the developers of Super Mario did to have success in the 1980s. More importantly, we have to recognize the landscape of retirement income planning continues to change rapidly around us. We can no longer ignore the demographic shifts of the American population and their buying tendencies. Looking forward, Boomers have a generational bias and distrust against financial services, especially after the financial crisis of 2008-2009.
Future generations are likely to carry the financial crisis forward with a heavier dependence on digital solutions. Considering all those headwinds, successful retirement income planners that shift their focus to new planning strategies, working efficiently and increasing their value to clients, can expect unprecedented growth in the near future.
Live Long! … And run out of money
Planning strategies will likely take a dramatic shift over the next decade as we continue to see over 10,000 people retire every day through 2029. A lessening reliance on governmental retirement income – combined with the last two-decade shift to defined contribution retirement plans – will force the successful planner to provide an alternative source for guaranteed level of income.
Our clients remain concerned about living too long and running out of money. Longevity multiplies the other risks associated with retirement: healthcare costs, inflation factors, taxes, long-term care funding and legacy issues. The “safe” withdrawal percentage continues to shift downward as life expectancy increases and low interest rates persist. Lowering percentages create the same pressures as a low interest rate environment – an increase in capital needed to maintain a level income … not to mention an inflation-adjusted income. Transitioning to a guaranteed floor from a systematic withdrawal strategy still allows for asset management above the income level. However, retirement income planning should revolve around income – not assets – in the future. The uncertainty and volatility of asset management combined with a systematic withdrawal plan no longer provides the most efficient way to distribute retirement assets.
Sequence of returns risk, while much discussed over the last 24 months, remains a potentially crippling effect on a retiree’s portfolio. Financial literacy in America continues to drop across all income classes. A recent retirement survey identified that less than four in ten Americans understand the relationship between interest rates and bond prices. It’s no surprise that most planners and client begin to utilize bond placements more as the client approaches their retirement date.
The Federal Reserve announced its intention to raise interest rates as many as three times in 2017, thus providing a market accelerator for portfolio depletion. Place a potential for equity volatility on top of rising interest rates, and you have a recipe for large duration changes in a retiree’s portfolio. Study after study illustrates as much as a 13-year differential in portfolio duration when you change the sequence of returns. An often ignored standard in retirement income planning is “stamina.” Having portfolios with stamina will be more important than simple asset allocation. Stamina increases when guarantees exist that take pressure off the remaining portfolio. Asset location – not allocation – along with stability of income creates stamina in a portfolio. Changing tactics and strategies with our clients will create greater stamina in our clients’ portfolios, which will in turn create stamina in our client relationships.
Portfolios With Stamina
The efficiencies that come from building a portfolio with stamina can help easily transition to a different value proposition to our clients. While the Department of Labor’s Fiduciary Rule and Conflicts of Interest Rule serve as accelerants for this change, digital firms, technology platforms and robo-advisers are driving fees lower and faster. Most fiduciaries and asset managers act as though the DOL’s rules will have the least impact on them.
Building a practice around asset allocation alone may only gross 25-40 basis points in the coming years. While the rules may have minimal impact fundamentally, the collateral effects of pricing across the industry, the move toward robo-advisers and the continued fixation on fees (by agencies, regulators and clients) will lead to more fee compression than commission compression for existing asset managers and fiduciaries. It will be necessary to evolve as a planner and include protection and risk mitigation as integral parts of the planning process. Financial planning value propositions that include a protection platform can gain momentum after decades of focus on accumulation. Customers routinely ask their prospective planners, “Are you a fiduciary?” Education and public awareness of best interest standards have never been higher. A fee-conscious public will ask for transparency in fee disclosure.
In the future, it will be important to add valuable services and marketing to your platform to validate your fee structure, even if the fee is just tied to assets under management. A successful planner will be able to define the planning process, include risk management, mitigate longevity risk and plan for charities and legacy-related issues as part of the fee structure.
Asset location (taxable, non-taxable and tax-deferred) will become more important. Collaborating with other professionals should increase as a result of the best interest standards. Developing a better overall client experience will lead to retention versus results which we have become accustomed to in the past. The ability to outpace an index will become less relevant, and the ability to generate income will become paramount. Planners should look at multiple ways to engage with clients through personal contact, social media and video. In the past, we relied on face-to-face meetings to establish and drive value. Today, we need to build up our value prior to even meeting the prospect. In the future, we will likely be the most researched professional from whom our clients seek advice and trust before the first meeting.
The Disruptions of Technology & Regulation
Similar to what Uber has done in the transportation space, our industry is experiencing disruptive forces like regulation and technology. We essentially have to reinvent our practices in a limited amount of time. Our benchmark shouldn’t be a piece of regulation’s implementation date (or delayed implementation date). If we continue waiting for technology companies to enter our business, we will soon be out of business.
We must instead take a hard look at our business models and fix what is broken: poor use of technology with our clients, inefficient ways to build trust with prospects, a bias toward recurring income based on a singular service, and a lack of focus on guaranteed income solutions. These changes need to take place now and improve continually. We have become creatures of habit through asset management and a repeatable process; the repeatable process should focus on the client and less on the product or service solution.
Finally, looking at alternatives to assets under management can mitigate the conflict of interest that exists with an assets under management strategy. Looking at clients through an income lens can show us alternative paths for income sustainability, including the use of fixed income annuities and riders. While this recommendation results in lower assets under management fees, it has been proven to create more leverage in the portfolio by providing income with less capital.
Through research, anywhere from 18-28 percent of the assets in guaranteed income products optimize the portfolio. Social Security, pensions and annuities are all classified as guaranteed income products. We find that this asset “location” mix creates “free” liquidity – cash reserves that are not necessary for inflation-adjusted, after-tax income. This liquidity can be used to add valuable services through risk mitigation and can be part of a larger fee-for-service business model that includes holistic planning.
In 2017 and beyond, the retirement income planning space will become challenging for all parties – carriers, brokerage general agencies, broker-dealers and advisers. Getting a more diversified financial practice that includes asset management, retirement income solutions and risk management creates enormous benefits for clients. For the planner, these conversations can lead to higher client retention rates, easier referrals, better qualified and trusting prospects and more efficient practices.
While margins across all products and services will decrease, successful planners will look to increase revenues more efficiently going forward. Earning more market share from each client will become a priority and a best practice goal for any financial professional.