Once you have made the transition to retirement and key considerations such as your income requirements and lifestyle objectives have been explored in detail; the focus quickly moves to how and where your accumulated pension funds should be invested.
There are clearly risks when you are funding a pension, in the ‘fund accumulation’ stage. There are also risks when you move to retirement, or the ‘decumulation’ stage, but they are very different. The risks specific to you as a post-retirement investor should be reflected in the investment portfolio within your post retirement pension fund.
For example, when you are making regular withdrawals from an investment – as you will be doing in retirement – your selected investment portfolio should be constructed with Sequencing Risk in mind. Sequencing Risk is created by the particular sequence in which investment returns are generated, and the timing of withdrawals from the fund.
To understand the effect of sequence of investment returns, consider the below two scenarios of five-year market returns:
|Scenario A Returns||Scenario B Returns|
The returns are identical in both the above scenarios, but in reverse order. In a ‘decumulating’ fund where you are making withdrawals, the order of the returns makes a significant impact on the value at the end of the five-year period.
In Scenario A, €100,000 invested with €10,000 withdrawals each year would leave residual capital value of €70,000.
In Scenario B, the same investment amount and withdrawals would leave a residual capital value of €47,000.
So, if you experience a poor initial sequence of returns immediately after retirement and make withdrawals during this period (as you may be obliged to do in a post-retirement pension); you effectively crystallise some losses. This can be difficult to recover from as you will continue to make withdrawals each year in retirement.
An important tool in trying to reduce the fund volatility you experience is to invest in a wide range of assets, known as diversification. Your portfolio should benefit from an appropriate level of diversification, both across assets classes, like shares, property and bonds, and within each asset class. You can also diversify geographically and across industries, and between different fund managers – reducing the risk of overreliance on any one fund manager.
Another common strategy for post-retirement clients is to invest in a portfolio with a clear focus on income producing assets. In general terms income paying assets tend to be more stable than the average when markets are volatile. In addition to this, the ability to take some or all of your pension withdrawals from income generated within the fund means that the investments themselves can left mainly intact. This allows you to minimise the degree to which you crystallise losses when the fund falls in any particular year.
Finally, when considering a fund on which you are somewhat dependent on for income in retirement, inflation risk should also be considered.
A hypothetical inflation rate of 2% per annum, coupled with a negative interest rate of 1%, would lead to a 25% reduction in purchasing power over a ten-year period. Unfortunately, we are all by now very familiar with the concept of negative interest rates applicable within deposit accounts.
Investing your post retirement fund in cash, or extremely low risk portfolios, reduces investment risk and sequencing risk but increases the risk that the income you can expect to derive from the fund will be worth less and less throughout your retirement.
This highlights the fundamental challenge to a post retirement investor: no single type of risk should take precedent or be considered in isolation. Instead, all relevant risks should be considered in a balanced manner, and your expectations regarding your eventual portfolio should involve not just a reasonable expected return over time, but also a good understanding of what your investor experience is likely to be over that period.
As always, we are here to help. If you have any questions or concerns about your retirement plan or investing post retirement, contact Harvest on 01 237 5500 or email firstname.lastname@example.org and we will be happy to assist.
This marketing information has been provided for discussion purposes only. It is not advice and does not take into account the investment needs and objectives, financial position, risk attitude, liquidity needs, capital security needs and/or capacity for loss of any particular person. It should not be relied upon to make investment decisions.