Guaranteed Income and Investment Risk: How Much of Each?

December 1, 2023


Globally recognised expert in applied decision science, behavioural finance, and financial wellbeing, as well as a specialist in both the theory and practice of risk profiling. He started the banking world’s first behavioural finance team as Head of Behavioural-Quant Finance at Barclays, which he built and led for a decade from 2006.

Guaranteed Income and Investment Risk: How Much of Each?

How to assess suitability for the combination of a guaranteed income and an investment portfolio

There are many potential benefits to converting some investible assets into a guaranteed income for life.

There are financial benefits. Swapping part of an investment portfolio for a secure income mitigates both sequencing risk and longevity risk, because of all the future paths those investible assets could take, having a fixed return for part of the pot takes out the worst ones. There’s much less chance of being forced to take money out of a portfolio when markets are down if you’ve got a set income stream covering at least some of your expenditure.

There are psychological and behavioural benefits too. Depending on an investor’s psychological make-up, a guaranteed income can provide comfort over being able to meet future expenditure, comfort over the consequences of suffering poor future market returns, protection against the ‘behaviour gap’ (where a variety of behavioural proclivities can cause an investor to fall short of market returns because of the discomfort caused by the variability of those returns), and protection against impulsive spending.

And, while it shouldn’t be a primary driver of such a strategy relative to the above benefits, depending on the ratio between income rates and expected long-term returns, you can use a significant amount of your investible assets to purchase an income and still (over time) end up with both the security of the income and a higher portfolio value.

For potential benefits to become actual benefits is not merely a matter of mathematics. It’s a matter of suitability. Suitability isn’t an objective measure. Because a strategy (as a whole – not an isolated investment) can be suitable only for a given investor, in all their financial and psychological contextual glory.

Meeting the Suitability Challenge

Using some investible assets to secure an income for life while leaving the rest invested poses a challenge for suitability assessments; a challenge that has typically been ignored.

This can be an irrevocable, lifelong, decision, and yet typically there is no robust, reliable, and repeatable methodology to guide that decision. Widespread adoption of a more purposeful approach is long overdue. Not least because the FCA is undertaking a thematic review into retirement-income provision, driven by concern that the risks clients face when transitioning from accumulation to decumulation are being assessed in an inadequately myopic, fragmented way. There’s no need to adopt a different framework for assessing these risks. What we need is a general framework that can seamlessly transition from accumulation to decumulation, ensuring the answer changes smoothly over the retirement boundary. The essential thing is that the model has to be able to internalise the fact that human capital, the value of future earnings streams, goes from positive to zero to negative through retirement and beyond.

In a basic suitability assessment there is only one question to answer: what is the right level of investment risk for the investor to take with their investible assets, right now, given their financial circumstances and financial personality?

Here, however, there are two questions we need to determine a suitable answer for:

  1. How much guaranteed income should be secured?
  2. How much investment risk should be taken with the part that remains invested?

These questions are typically treated in isolation. Yet the answer to one is affected by the answer to the other. If more of your anticipated future expenditure is covered by a secure income, you are less reliant on your investments to cover that expenditure and can therefore afford to take more investment risk with the balance. But how much more? And how should you decide how much income to take in the first place?

Oxford Risk has recently published a white paper outlining a framework for solving for both ‘How much income?’ and ‘How much risk?’ in a single integrated and comprehensive approach to suitability, that accounts for the interdependence of the answers, and the ways in which those answers are affected by each investor’s behavioural tendencies.

A Methodology for Assessing the Suitability of an Income Combined with an Investment Portfolio

The Initial Trigger

Before we get the calculators out, there should be a trigger, based on current circumstances, for why this strategy may be suitable.

In practice, this is likely to be those investors who:

  1. are more sensitive to sequencing and longevity risks – those that have high withdrawals relative to their investible assets and who wish to plan over a longer time horizon;
  2. have lower relative benefits of remaining invested (i.e. those with lower risk tolerance); and
  3. are more impulsive or anxious, and therefore who benefit from being ‘locked in’ to an income stream that lessens their opportunities for reckless behaviour in response to short-term market falls.
How Much Income?

Once the strategy is deemed broadly suitable, we need to know how much income to purchase right now.

Several factors, related to both a client’s circumstances and their personality, influence the extent to which a guaranteed income would be beneficial. Sometimes these factors work in the same direction, sometimes not. We need a scientific means of quantifying these factors and combining them to indicate how much income to secure.

The main factor is the investor’s ratio of investment withdrawals (both ongoing and one-off cash needs) to investible assets. This ratio determines an investor’s sensitivity to sequencing risk and longevity risk. The higher the ratio, the harder it will be to recover from a bad run of returns at the beginning of the withdrawal period, and therefore the more suitable it will be to secure a higher level of guaranteed income.

The higher the expenditure (for the same amount of investible assets), or the smaller the amount of investible assets (for the same level of expenditure), the greater the need for a guaranteed income. Those with an anticipated rise in expenditure will also have a stronger case for locking in more income upfront than those with an anticipated fall.

The key behavioural factor is an investor’s impulsivity. Impulsivity is an investor's propensity to act quickly and on emotional instinct when making decisions about investments and – often more importantly – spending. Investors who are highly impulsive are less likely to: a) remain steadily invested through changing market circumstances; and b) control their own spending impulses. This means that they are much less likely to stick to plans, and more likely to withdraw beyond their means.

Other behavioural factors are also important here, most notably an investor’s composure (their tendency to get emotional with the present state of their investment journey), their financial comfort (their confidence in and satisfaction with their long-term financial situation), and their risk tolerance. The frequency of adviser-client reviews, and the investor’s age and health have roles to play too.

How Much Risk?

Viewed in conjunction with the suitable level of income, the suitable level of risk to take with remaining investible assets relies on a comprehensive measure of risk capacity.

The guaranteed income affects the investor’s Suitable Risk Level, because it directly changes the investor’s income and net expenditure levels (e.g. if you become less reliant on your investible assets to fund your expenditure, it becomes suitable to take a higher degree of investment risk with those investible assets, and vice versa).

Risk capacity governs this relationship between a guaranteed income and the ability to take greater investment risk with the remaining investible assets because risk capacity not only explains the mathematical mechanism by which a guaranteed income allows an investor to take more investment risk, but allows us to calculate how much more.


The assessment of the suitability of purchasing a guaranteed income needs to account for both the guaranteed income and the investment of the remaining investible assets in conjunction with each other, rather than in isolation, as is typically the case.

The key to a robust, reliable, and repeatable, methodology for doing this is a proper measurement of risk capacity and investor behaviours, particularly impulsivity.

Download the Suitable Drawdown Whitepaper now

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