25 Jun 2025
The FCA’s thematic review of retirement income advice, published in March 2024, shone a light on several areas where the regulator felt advisers could tighten up their retirement advice approach. The review didn’t explicitly say that firms need to use a different investment approach for retirement from that used in accumulation, though FCA officials have suggested that is their expectation.
Rather, the review highlights that the objectives for, and risks faced by, retirement income clients are different from those facing clients accumulating wealth and that the suitability of products and services should be assessed with the specific requirements of retirement income clients in mind. Taken together these suggest we may need to approach retirement income investment differently from investing during the wealth accumulation phase.
Different strokes for different folks
BNY Investments’ retirement investment framework is built on three principles of how retirement clients are different from those accumulating wealth. The first of these differences is that retirement clients have multiple specific objectives. These usually include an objective to produce a lifetime income but may also include leaving a legacy, being able to fund specific expenses, and perhaps contributing to long-term care. We can, and should, think about risk not just in terms of investment volatility but in terms of whether the client will achieve these objectives and, if they don’t, how far short of them they might fall.
The FCA review echoes this idea. It suggests advisers need to consider how willing and able a client is to withstand a reduction in their retirement income. This is not just in nominal terms but in terms of the client’s purchasing power. That is, their ability to maintain their current standard of living. This points to an approach that thinks about investment risk not in terms of capital value but in terms of the ability of the investments to generate a sustainable income in real terms.
Evaluating risk appetite in retirement
Traditional approaches to assessing a client’s attitude to risk tend to focus on their attitude towards volatility in capital values. While capital values can affect income sustainability, this is not always the case. For example, where clients are taking the income being generated naturally by an investment portfolio, it is perfectly possible for income to be relatively stable while capital values are volatile.
In our recent research report, “Retirement advice in the UK: Time for change?”, we found that 75% of firms1 either already have or are planning to introduce a specific attitude to risk questionnaire for clients taking retirement income. This might be a completely different questionnaire or a supplementary questionnaire to the existing one used for accumulation.
As well as understanding a client’s attitude towards variations in income, this might also consider their attitude towards the trade-offs between income level and its sustainability, between taking income and leaving a legacy, and between income security and income flexibility.
Alongside understanding a client’s attitude towards retirement income risk is the objective calculation of the client’s capacity for income loss. This will usually be ascertained by evaluating the client’s income needs using cashflow planning and classifying these needs between essential and more discretionary expenditure.
Investing for retirement income
It’s easy to overcomplicate how we think about generating income from an investment portfolio. Over the years we have seen many approaches that seek to deliver a balance between generating the income the client needs and ensuring its ongoing sustainability. However, there are only two ways we can generate income from a portfolio of investments.
The first is to use a total return portfolio and generate income through selling down assets from that portfolio. This has been the most common approach in recent years with just over half of firms saying they always or often use this approach. This is perhaps not surprising when we consider that 40%2 of firms are still using the same portfolios for retirement income that they use during accumulation where total return investing is the norm.
The second way of generating income is to take the income that is generated by the underlying investments, often referred to as natural income. Perhaps surprisingly, this is the least often used approach with only a third of advisers saying they always or often use it and 18% of firms saying they never use it3.
The low yields we saw after the global financial crisis did make it harder to generate natural income at a level that would meet many clients’ needs. However, with yields having returned to more “normal” levels, and with total market returns perhaps being less certain than they were pre-Covid, there are signs that firms are looking again at using natural income in retirement versus the total return approach. When we asked firms about their likely use of the different approaches over the next few years, we find a small decline in the expected use of total return and a 7% net increase in the use of natural income4.
A third approach known as “time segmentation” or, more colloquially as “bucketing” divides a client’s assets between short-, medium-, and long-term investments to match their short-, medium-, and long-term income requirements. While this is a popular approach with advisers, it is typically just a different approach to constructing a total return portfolio. A variation of this is to use bonds or structured products to generate fixed cashflows but again this is just a variation of the natural income approach.
Unlocking retirement investment
The investment risks we have to manage for clients differ depending on which of the two approaches is used. Understanding these differences can inform how we construct portfolios that help meet the client’s objective of a sustainable real income.
When running a total return approach, it is the level and pattern of returns from the portfolio that are important. We are agnostic as to whether those returns come from income or capital. This is where sequence of returns is important. Falls in capital value, particularly early in retirement, may be compounded by having to sell investments to meet income needs and so reduce the sustainability of future income.
It is understandable to think that addressing this risk will involve reducing volatility, which usually means reducing equity exposure. While this should reduce uncertainty, it may worsen our ability to be able to generate the returns required to sustain income needs, particularly if we suffer unexpectedly high inflation. Also, some assets appear to have low volatility but can and do suffer sharp falls in value that may take some time to recover from. Examples of this include some fixed income and real estate strategies. Even if we suffer a modest fall, the longer it takes to recover from this, the longer we are having to fund income by selling assets at reduced market prices, eating into capital and reducing income sustainability.
One way of balancing the need to generate returns while managing the risks that this might involve is to ensure we include assets that display “bouncebackability”. That is, assets that although they might fall in value, tend to recover relatively quickly from those losses. An example of this is equity income strategies that have not only tended to have lower volatility and drawdowns compared to other types of equity but have also recovered more quickly after a market fall. This quicker recovery means we are less likely to need to sell assets at depressed prices to generate income so improving income sustainability.
Where a natural income approach is followed, it is the level and pattern of income that is important. Capital value, while not unimportant, may not have a direct bearing on the income generated or its sustainability as we are not having to sell assets to fund income. Under this scenario, we need to consider what assets can be used to generate stable and growing income streams in a range of economic scenarios.
This again leads us to consider equity income strategies which will typically focus on companies that are able to generate growing dividends in a sustainable way over time. However, we may need to supplement these with other assets to provide a stable base of income such as bonds, cash and some alternative assets. A multi-asset approach allows us to vary asset allocation over time to meet the client’s objective of achieving a stable, growing income.
Evolving investment approaches
Retirement clients will each have a different set of circumstances and specific needs. The need to think differently about investment will therefore vary from client to client. Those who have relatively modest income requirements relative to their assets may be able to follow an investment approach that is not too different from that they followed in accumulation.
However, with clients becoming increasingly reliant on their retirement savings to provide the bulk of their income beyond State Pensions, the need to think about investment risk in terms of its effect on stability and sustainability of income will only grow.
1Source: Research conducted by NextWealth for BNY Investments, based on responses to surveys with 208 retirement-focused financial advisers and 254 consumers of retirement advice conducted between 9 September 2024 and 21 September 2024.
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3Source: Research conducted by NextWealth for BNY Investments, based on responses to surveys with 208 retirement-focused financial advisers and 254 consumers of retirement advice conducted between 9 September 2024 and 21 September 2024.
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