In mountaineering, it is often observed that the descent is more dangerous than the ascent. It may take less time and feel like the hard part is out of the way, but it’s when fatigue can take its toll and supplies can run dry. Investing for retirement is not likely to be as dramatic as a climbing expedition, but some of the same principles apply.
During your working life, it is very much one step in front of the other, accumulating your investments and allowing pound cost averaging and the compounding of returns to help propel you to new heights. If you have a ‘set and forget’ portfolio, and allow for a bit of rebalancing at times, then it can also be pretty low maintenance. Managing things for yourself can be relatively straightforward.
At retirement things are different. A feeling of elation and relief that the hard yards are behind you may give way to some doubts. Do you have enough resources at your disposal? What is the best way to maximise them? What if something unexpected happens?
As with any expedition, planning helps
If you are giving up work completely, there is likely to be a significant shift in your overall outlook. It’s psychologically difficult watching your net worth fall as opposed to rise, as it has during your working life. Planning things out in advance will help.
The best place to start is with your goals and how much they will cost. This is likely to relate to what you 'must spend' and what you would 'like to spend'. Matching this probable expenditure against your known income – state and defined benefits pensions, as well as any annuities payable – will then tell you how much your capital, investments and personal pensions need to generate to make up any shortfall.
In your planning, you’ll be dealing with three significant risks – inflation, longevity and markets – and you will need a solution to each.
Inflation is the silent thief, stealthily robbing you of spending power each year as prices increase. That’s come into sharper focus recently as, following a period of quite low inflation, the cost of living has escalated sharply. However, even small rises each year can compound into big increases over the two decades or so the average person might expect to be in retirement.
Many people underestimate their longevity. The average UK life expectancy is 82, but there is a good chance of living longer if you are in good health in your sixties.
Finally, markets are a constant unknown. Those embracing risk are generally rewarded over the long term, but big swings in the value of a retirement portfolio can be unnerving and potentially disastrous if withdrawals are unfortunately timed in the earlier years. Again, the psychology for many people changes from wanting to take risk and accumulate to preserving what they have.
Assess your options
It isn’t all about investing. As a reminder, there are two main pension options at retirement: Continue investing and take out money from your pot as and when needed (also known as pension drawdown), or buy an annuity, an insurance policy that guarantees a regular income for life. This is a complex issue, and any decision to use drawdown must be carefully considered.
Drawdown offers extra flexibility and the potential for better returns and more income from a pension pot – given the relatively low returns on offer from annuities today. However, drawdown is also a risky option. Keeping your pension fund invested means the value can fluctuate according to what markets are doing. You also need to be careful about how much you take out and when to ensure you leave enough for future needs.
An annuity may be a costly way of securing an income stream, but it does come with a guarantee that you won’t outlive it.
Striking a balance
Sourcing 30 or so years of adequate income is, like any expedition, a challenge. There are many pitfalls as well as a number of different ways of getting there.
When you are drawing from an investment portfolio it is not just the long-term average return that matters but the sequence of returns. Bad performance in the early years can be particularly costly, even if it is then followed by good returns. It’s difficult to bounce back from depleting your capital. Imagine, for instance, if you had been forced to sell assets to fund income in March 2020 when markets fell sharply owing to the onset of the Covid-19 pandemic but then bounced back in the following months.
It’s important not to take too little investment risk in drawdown though. The urge to de-risk a portfolio is likely to be the wrong reaction for someone able to draw only modestly on their money and keep most of it invested to generate long-term returns. However, there are still mathematical challenges to overcome. Withdrawing from your pot means that you can’t benefit as much from compounding returns. It’s also less likely that you can shovel some money in to ‘buy the dip’ when markets fall – something every investor has in their armoury during the ‘accumulation’ stage.
Our drawdown calculator may assist you in your planning. It aims to provide an indication of the extra pension contributions needed to fund any shortfall in your required pension income, so you can see if you are on track.
What’s the solution?
It is vital to ensure your pension investments remain appropriate for your needs in the run-up to retirement. It may be prudent to gradually alter the asset mix in order to meet your objectives during retirement. For instance, if you are planning to buy an annuity it is likely to be worth reducing investment risk and locking in on the cost through fixed interest investments. However, if you are primarily going to be drawing on your pensions via drawdown then you will need a completely different strategy that takes sufficient risk to grow your pot but avoids excessively volatility and loss of capital – especially in the early phase of commencing withdrawals.
When investing in a drawdown pension, you’ll need to be involved in choosing and managing your investments, or get financial advice that covers this for you. A portfolio well-diversified across various assets to smooth returns can reduce the likelihood of a poorer outcome. Flexibility also helps, such as reducing income withdrawals in particularly bad years, but it’s important to address the sustainability of withdrawals in the context of risk and overall circumstances at outset.
Ultimately, though, managing a portfolio to provide income effectively can be much more complex and challenging than investing for growth. An appropriate, sustainable withdrawal strategy is as important as a sensible investment strategy – if not more so. If you want to make the most of securing an income from your investments, it may be worth speaking with one of our experts who can talk you through your options.
Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.