This article is part of our Guide to Maximising Your Pension, helping investors build up the maximum possible pension pot – and turn it into the maximum possible retirement income.
Investing in retirement is a very different prospect to pre-pension age. Where the focus in your 20s, 30s, 40s and even 50s is on growth assets, once you retire, your portfolio goals become capital preservation and above all, income.
This is not to say more volatile securities, such as emerging market equities and venture capital investments have no place in a post-retirement portfolio. But in retirement, you are more likely to be forced to crystallise losses as you drawdown your pension pot to pay for essential expenditure.
While there are risks to investing at any age, there are four key threats to a post retirement portfolio; market risk, inflation, behavioural risk and longevity risk, which have the potential to erode your capital and in turn, your income.
We explain exactly what these risks are, and how to overcome them.
Market Risk
As they say in the City; what goes up, must come down. It is the law of stock market gravity, which anyone who retired in 2008 will know only too well. Back then, most people were compelled to buy an annuity to provide them with an income for life at retirement, and global stock markets falling significantly meant for many a much smaller pot with which to buy that annuity. Their annual pension statements just 18 months earlier would have predicted an income level which, come March 2008 was simply impossible.
Now, retirees have more options. While not everyone has the luxury of being able to stay invested through the market bad times – household bills must be paid after all – but if you can avoid withdrawing cash at a time when asset prices are depressed, try to ride out the storm until markets stabilise.
Inflation
While we are lucky enough to be currently living in an era of extremely low inflation in the Western world, this will not last forever. The inflation target in the UK is 2%, and will many safe haven assets such as government bonds yielding less than this there is a real risk to an investor’s capital. Many strategic bond fund managers including Nick Hayes, manager of the AXA Global Strategic Bond fund, use inflation linked bonds to hedge against inflation risk. Choosing a good strategic bond manager can offer your portfolio some protection from inflation, as can investing in utility stocks as the revenue streams for these companies are often increased in line with the official measure of inflation, infrastructure investments backed by the government offer protection for similar reasons.
Index-linked annuities pay an income that increases every year in line with inflation. While level annuities pay around 40% more initially than inflation-linked annuities, as you no longer have to annuitise the whole of your pot this may be worth considering for a portion of your pension. Your State Pension is also inflation linked.
Behavioural Risk
When pension freedoms were first announced in the 2014 Budget, many industry experts were concerned that access to cash was the last thing retirees should be given. There were fears that savers would blow all their hard-acquired pot on Lamborghinis and fall back on the State. Although the Lambo generation has not materialised, there are case studies of retirees withdrawing their entire pot to hold wholly in cash – earning next to no interest.
“Taking too much money, too early is a real threat to retirement income,” warns Claire Finn, head of Strategic Partnerships and DC Investments for BlackRock. “Just because you can take the 25% tax-free lump sum doesn’t mean you should.”
One of the best ways to protect yourself from sequencing risk – buying at the top, and selling at the bottom – is to cut down on spending in times of poor market performance. Making large cash withdrawals to fund a holiday or non-essential home improvement when markets are in a multi-month downturn is ill-advised for example. Finn advocates seeking professional advice if you find market judgement difficult.
Longevity Risk
We are all living longer – and are much healthier for longer too. More than 95,000 people aged 65 in 2012 are expected to celebrate their 100th birthday in 2047 according the Office of National Statistics. Your requirements in retirement are no longer basic; profits in the travel industry are funded by the Silver pound. Broadly investors are looking for growth from their portfolio which supports a 4% income for 30 years and only one investment product can explicitly address longevity risk – an annuity.
Finn recommends splitting your portfolio into “needs” and “dreams” and running the two pots separately – a portfolio like approach advocated by Morningstar Investment Management’s Daniel Needham also.
Annuitise essential expenditure; household bills, healthcare and outstanding mortgage debt, and then use the rest of your pension portfolio to fund holidays, home improvements and gifts to family. Finn points out that if you are working into retirement there is no need to immediately annuitise for the needs as these will met by your employment income.
