Not everybody wants individual financial advice and not everybody can afford it. Those who get individual financial advice want comfort that it is robust and reliable. Rules of Thumb are used in some savings and pensions markets to give general advice to retirees. A working definition of a Rule of Thumb is: “A simple principle, generally reliable in the absence of full advice that provides a broad steer on how to achieve a financial goal”.
A recent review of financial advice in the UK by the Financial Conduct Authority and the Treasury recommends the importance of developing a set of Rules of Thumb and encourages their use by agencies offering guidance to persons making financial decisions.
Behavioural economics suggests that because people find financial decisions difficult, and can make mistakes, people generally benefit from being “nudged” towards thinking about their financial position and towards considering taking action. Rules of Thumb can provide this nudge and guide people at this point in their lives. This means that for Rules of Thumb to be successful, they must:
- Steer the person to the relevant knowledge needed for the decision
- Be a reliable steer, that is tested and up to date
- Be normalised, to take some of the fear out of making a decision
- Addresses a specific question
- Is easy to understand and follow
- Can be used as a guide or target, and
- Offers a better course of action than not following it.
It is, however, important to keep in mind that a Rule of Thumb:
- Is not perfect
- May not achieve the best possible outcome for everyone, and
- Cannot be “set and forget”, but needs review over time.
A study by the New Zealand Society of Actuaries (2017) states the Rules of Thumbs can be useful to follow by persons who are to withdraw (the technical term used is deaccumulate) savings from their pension pots because:
- Most retirees have relatively modest savings and often would not choose to purchase financial advice for small funds.
- Calculating how much a person should withdraw from a pension pot is difficult for retirees as a person may live way beyond life expectancy, so a broad steer would be helpful, whether or not financial advice is also accessed.
- Rules of Thumb fit with the search for simpler ways of giving advice to a broad range of people, including robo-advice
The study adds the rules of thumbs relating to withdrawing savings from your pension pot should not be oversimplified. Compared with the savings phase (where it is usually agreed that any saving is better than none), withdrawing money from your pension pot is harder to generalise and there are more risks involved:
- You have limited resources in later life, especially once you have finished working, so it is very hard to recover from a mistake or bad luck.
- Investment and longevity risks are important in later life, but are not well understood
- You and other people have different starting points for their retirement and their objectives, preferences and ambitions for retirement vary.
In a forthcoming series of post the following Rules of Thumbs will be discussed with regard to drawing down savings from your pension pot: