Illustrations: 4 ways to mislead your clients

Forget CP11/03 or the Board for Actuarial Standards TM1, let’s take a step back, so we can see the wood for the trees, and ask a disarmingly simple question: what are illustrations for? Most would probably answer (1) to show the effect of charges and (2) to show how the fund might grow – after all, that’s what it says on them. The second answer is distinctly dangerous.

I realise that no one knows what the future holds and so we “assume” various things in order to plan. Well, perhaps the FSA should stop requiring pension providers to make an “ass” out of “u” and “me”, as the old joke goes.

There are 4 ways you can “assume” your clients could be misled.

Adopt the Frightened Rabbit Position

Illustrations assume a constant growth rate, usually 7%, which is totally unvarying. Not even Bank of England base rate is that unerring! Illustrations should not be setting the expectation that funds only go up. Faced with reality, this could turn clients in frightened rabbits, crippled by fear of short-term volatility, timidly avoiding risks. In the early to mid years, with an age to go until retirement, this could be most damaging.

Cash on deposit - scary!

Attempt a Mach 2 Landing

Illustrations assume the same growth rate all the way through to retirement date. Implicitly, they are assuming no change in the investment mix, no reduction in risk, no move into cash, not even for the PCLS. What they are assuming, if a 7% growth rate is used, is that by the wonders of compound interest the fund will double in the ten years running up to retirement! That’s a fairly heroic assumption, with no indication of the risk of not hitting it.

No need to de-risk, you say?

 A Street Fight with Rules

I’m talking about the 2% above and below the central projection. Despite the words of warning – which few read in spite of your instructions – this looks for all the world like a best and worst case scenario. This further warps clients’ impressions of risk, volatility and probability of outcomes. They should be removed entirely. It’s a brawl out there in the markets: they haven’t read the rules and they’re willing to kick you r “ass-umption”!

Queensberry rules, right?

I don't think he likes you ...

220 yards Par 3, Hole-in-One

Or, in other words, your client’s exact retirement age known at the outset – like assuming a hole-in-one. Think about just how many variables we’re dealing with – contributions, investments, returns, bull/bear markets, health, longevity, changes in circumstances and aspirations and so on – and consider how the uncertainty goes exponential adding the variable of time. Unless you are pretty close to retirement (and being able to afford it), the notion of a retirement date is probably a fiction. An auto-enrolled 22-year-old, say, or a 40-year-old starting to think seriously about retirement planning should simply be aiming to land it on the green.

I'm guessing that's nearer the water than the hole

Illustrations can be worse than just useless. High-tech tools can potentially handle the job much better, especially if they help convey volatility, risk, probability and the general lack of precision and certainty about planning. It’s time for the FSA to catch up and help the development of realistic, helpful, modern planning tools.


About sipphound

Chewing over pensions, saving and retirement issues. Sniffing around financial planning, personal finance, investing and behavioural influences. All personal opinions, no company represented and no advice given.
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3 Responses to Illustrations: 4 ways to mislead your clients

  1. Tom Murray says:

    Excellent point, but if illustrations become even more complex, trying to reflect reality, financial products will lose out to more understandable investments such as property. Estate agents are forced to tell you that your house price could collapse or that the buy-to-let apartment might not be that easy to actually rent out. Trying to take the risk out of buying is not possible when ultimately investments are risks. Caveat emptor, but more work is required to educate the “emptors”.

  2. Markets do not behave in a constant manner. Modern Porfolio Theory understands and factors this into its portfolio construction. A standard projection rate of 7% takes no account of a market fall of 30% in any single asset class. Therefore in the “real” world the value of these projections can be open to question. The basis of Modern Portfolio Theory understands that Investments returns “do not” follow a constant increase and that differing assets classes will grow at differing rates and it is only by diversification that returns are made.
    “For their financial planning, consumers can find it useful to have some idea of potential returns but it is important that they appreciate the uncertainties. No-one can predict the future. Projected returns are not promises.”
    Source: Michael Folger, FSA Director, Conduct of Business Standards

  3. Pingback: Failing to Illustrate a Simple Truth | SIPP Hound's blog

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