At one stage, the general rule was to start de-risking your pension portfolio 10 years before retirement, but a significantly different landscape now necessitates a new approach.
In years gone by, the value of a pension pot on the date you hung up your work boots could make or break a comfortable retirement. That is because most people took their 25% tax-free cash entitlement and bought an annuity with the remainder to secure a guaranteed income for life.
If equities had taken a nosedive just before you retired and you hadn’t moved into lower-risk assets, you could see thousands of pounds shaved off your annual income.
Nowadays, many people stay invested throughout retirement due to the pension freedoms, which gave people greater access to their pensions. Going into drawdown offers greater flexibility and control.
People are living longer too, meaning someone who accesses their pension savings at the minimum age of 55 could live for another two or three decades or more.
“Conventional wisdom was to de-risk in the run-up to retirement, but if you’re going to remain invested through a hopefully 30-year retirement that would be bonkers,” says Tim Walsham, a director of Claritas Wealth Management.
How do financial advisers and wealth managers approach retirement planning today? We asked 10 of them for their top tips.
1) Focus on equities
For Amyr Rocha-Lima, a partner of Holland Hahn & Wills, income generation presents a more significant problem for retirement planning than capital preservation.
“After all, you take your income to the supermarket each week, not the value of your portfolio,” he says. “Almost everything you buy at the supermarket – and anywhere else – becomes more expensive over time. In fact, at trendline inflation of the Consumer Price Index over a 30-year two-person retirement, the cost of living has risen nearly two and a half times.”
Rocha-Lima reckons there is only one sensible investment goal for those investing today for a potentially long retirement: income growth. “Bonds can never offer this. Equities in some of the greatest companies in the world can,” he says.
2) Boost natural income
Two years prior to a client’s retirement, Tom Munro, a financial planner at McHardy Private Wealth, re-evaluates income needs and increases exposure to equity income funds.
Munro takes other sources of income into consideration, such as rental income, state pension entitlement and income from investments held outside the pension. And if less income is required from the pension in future, he switches back to growth funds to help preserve the assets for future generations.
“Most clients see their income needs reduce considerably in their late 70s and early 80s as holidays and hobbies become less of a priority due to either health issues or simply wanting a slower pace of life,” he says.
3) Go for growth
An approach recommended by other advisers is to invest on a total return basis where no distinction is made between capital growth and income.
“Investing in equity income funds often means over-concentration in high dividend-paying sectors,” says Walsham. “We want to invest as broadly as possible. Higher dividends aren’t a free lunch; they just give a company less scope for capital growth as there’s less profit to re-invest.”
Focusing on the growth potential of equities can help stave off the effects of inflation. “Even if the pot grows at 5% a year, it’s doing something,” says Victor Sacks, founder of VS Associates in Cambridgeshire.
4) Hold some cash
As opposed to taking natural income a portfolio is generating, Sacks prefers to ‘asset strip’. “Say a client wants £2,000 of income per month for that year, I’d peel off £24,000, place it in a cash fund and roll out the monthly income from that,” explains Sacks.
“If the client has £24,000 in cash already, I’d be looking to use that first before asset-stripping the pension.”
Holding cash is also important for those who take natural income. On a rolling basis, Munro moves clients’ anticipated expenditure for the next two years into a cash fund – to initially cover income requirements for the next 12 months and a buffer, which can be called on in year two, should markets underperform in order to avoid selling down investments to meet income needs as prices fall.
Apex CB Financial Planning moves to higher-yielding funds two years prior to retirement to allow dividends to accrue and looks to build a cash pot to meet income needs for nine to 18 months.
“This protects against sequencing risk – having to sell equities to meet income needs when markets are down,” says managing director Chris Ryan.
5) Build defences – but don’t overdo it
To shore up defences, Claritas Wealth Management invests a portion of retirement portfolios in bonds – funds such as the Vanguard Global Short-Term Corporate Bond Index. A typical client not far off or in retirement may have up to 40% in high-quality bonds, while those five to seven years away from retirement have between zero and 30% depending on their personal circumstances.
Walsham says: “Working out how much to hold in bonds is a maths exercise based on financial capacity – in other words, when the money is required – and what return and therefore how much risk is required to have a viable long-term plan.
“But it’s the stock market element that will deliver most of the growth over time so we keep the bond element as low as we can. We talk to our clients about ‘reckless caution’ whereby a supposedly risk-averse approach can cost their families a fortune.”
6) Diversify your income streams
Kamal Warraich, head of equity fund research at Canaccord Genuity Wealth Management, points out that introducing more stable cash flows to a portfolio could be a good idea ahead of retirement.
“Not all income is created equal however, so investors may wish to ensure a good balance between lower-correlated cash flows, such as bonds, infrastructure, property and listed equities,” he says.
For risk-averse investors approaching or in retirement, Tom Craske, a portfolio manager at Ravenscroft, says an income portfolio made up of short-dated government bonds with some allocation to corporate bonds, property and quality dividend-paying equities should provide some protection and a level of income, while keeping risk to a minimum.
Hannah Owen, head of group communications at Astute Private Wealth, points to the higher yields currently available on government bonds relative to recent history. “They’re potentially useful for clients who would be satisfied with a yield of 3%-4%,” she says.
7) Keep your balance
Investors should be careful not to put too many eggs in the defensive basket, as the difference in returns relative to riskier assets can be material over the longer term.
“Given that retirement could last several decades, it might be prudent for investors to balance their portfolio not only across asset classes but within equities,” says Warraich.
He adds: “Continuing to have some exposure to adventurous allocations makes sense to help generate long-term growth and stay ahead of inflation.”
Apex’s Ryan says there’s still a case to hold higher-risk equity markets like emerging markets provided you won’t run the risk of having to sell exposure to support income payments.
Walsham at Claritas allocates to smaller companies, value stocks, emerging markets and property companies.
8) Do very little
Ben Yearsley, investment committee chair at Shore Financial Planning in Plymouth, cautions against doing anything that would change the growth potential of the portfolio.
“In a nutshell, I’d broadly leave pensions unchanged in the years before and after retirement,” he says. “You could switch your holdings from accumulation to income units but there’s no massive need to unless you want to take the natural income as a pension payment rather than a fixed amount each month.”
Kingswood, a wealth manager, is of a similar mindset. For Paul Surguy, its head of investment management and proposition, significant changes to asset allocation should be avoided.
He says: “Rather, a gradual approach over time should be the preferred option. For those fortunate enough to have other assets outside of a pension, planning how to use these alongside pension assets tax efficiently will also make a significant difference to overall financial stability in later life.”
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