For many years, the widely-held view has been that clients approaching retirement should reduce their investment risk. In the days of limited life expectancy and compulsory annuity purchase, it was logical to reduce risk ahead of ‘purchasing’ a pension income.
However, with the Financial Conduct Authority (FCA) reporting that two-thirds of people are now opting for pension drawdown, is it time to change that approach?
‘De-risking’ could actually reduce your pension income
Now that people have far greater decision-making power over how to spend, save or invest their own pensions, many are choosing drawdown. This allows investors to take money from their pot gradually over the course of their retirement.
In the past, as you approached retirement you would move your pension savings from stock market investments into bonds and cash. Now, though, could you be better staying in stocks and shares?
Six years ago, US expert Robert Arnott questioned the wisdom of ‘de-risking’ as you approached retirement.
Using three different examples and evidence from more than 140 years of historical returns, Arnott discovered that even in the worst-case scenario, the person increasing their risk in later years entered their retirement with a higher fund value.
Research from Professional Adviserhas produced similar results. They took two investors who saved an average of £20,000 a year from the age of 30 to 60, retired and then began withdrawing an annual pension of £60,000 a year.
The first client invested in a moderately cautious portfolio generating 4% a year on average after costs and fees, while her less cautious client generated 5% a year through a balanced portfolio. The moderately cautious investor ran out of money at nearly 86, at which point the balanced investor still had £800,000.
Even using a worst-case scenario (incorporating the 2008/9 crash), the cautious investor ran out of money four years before the balanced investor.
Even a modest change can significantly affect your returns
So why could it be better to continue in stock-market investments as you approach retirement?
The answer partly lies in compound returns. When your pension fund is at its largest – as you approach retirement – it can pay to maintain the risk you are taking to benefit from the returns.
And, Professional Adviserfound that it takes only a modest difference in risk to achieve remarkably different outcomes. It might be as little as a move from a moderately cautious to a balanced profile.
Take advice on your pension funds
A separate FCA report has underlined the need for you to take professional advice regarding your pension savings. As more people stay invested in their pensions for longer they are likely to both take benefits andkeep their fund invested.
The FCA found that one in three non-advised drawdown consumers is wholly holding cash. They concluded that someone drawing down their pot over a 20-year period could increase their expected annual income by 37% by investing in a mix of assets rather than just cash.
What this means is that so-called ‘lifestyling’ is no longer the default option for pension savers.
Indeed, the government-backed Pensions Advisory Service says: “Lifestyling may be suitable for you if you’re intending to purchase an annuity when you retire … It’s unlikely to be suitable if you intend to keep your retirement pot invested and to use income drawdown.”
Perhaps it’s time to think differently. If you’re looking for a Financial Planner or IFA, we offer free consultations in London or Epsom, Surrey.