Financial plans are often generic and too risky for clients on the cusp of retirement, according to a study by the Centre for International Finance and Regulation (CIFR) which examines current financial planning practice in Australia and whether baby boomers are getting the advice they need as they head into retirement.
This is particularly important with the proportion of Australians aged 65 or over projected to almost double over the next 30 years.
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The study also finds that typical fee structures encourage "closet indexing" by fund managers.
Professor Geoffrey Kingston from Macquarie University who led the CIFR-funded study said the research supported the view that commissions from product providers should be banned and that there had been inadequate disclosure by planners of dollar amounts charged in fees versus percentages.
However, the study dismissed the idea that fee-for-service should supplant asset-based fees.
Professor Kingston said, "Asset-based fees still hold value. The optimal investment strategy allows for both fee structures where income-generating assets are exposed to low risk and the remaining assets incorporate both a fixed fee and a fulcrum-style performance fee to discourage closet indexing."
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By GlobalDataThe allocation split between safe-haven and growth assets raises a potential conflict of interest between a client and their adviser.
Approaching retirement, it stands to reason that an investor should orientate their portfolio towards safe-haven assets, such as term deposits.
However, these typically result in a minimal commission to the adviser, unlike equities, where the potential commission is far greater.
Professor Kingston warned that an excessive exposure to growth assets was risky for those on the verge of retirement.
"Financial plans are fragile around the point of retirement. Specifically, if an investor suffers a major capital loss at this time, it is extremely unlikely that the full extent of the loss will ever be recouped. This becomes even less likely if the capital balance is further eroded by withdrawals for the payment of essential living expenses. Accordingly, an element of flexibility in asset allocation appears warranted in order to manage the vulnerability of a portfolio to capital losses at critical moments," said Kingston.
The study indicated that the Future of Financial Advice reforms should help discourage highly risky allocations and ensure planners offer advice that’s in the best interest of their clients.
However, the study also called for the next review of financial advice to examine ways of requiring financial advisors to disclose and respond to the fragility of financial plans for investors on the cusp of retirement.
Professor Kingston added that a good start would be to require Statements of Advice for clients aged over 55 to disclose the percentage allocation to Australian-dollar-denominated interest-bearing securities rated at least ‘high quality’ by one of the major credit rating agencies.
