It’s a relatively well-known pension investment maxim that the optimal way to go about maximising the value of your final pot is to take on more risk in the pursuit of higher returns when younger and de-risk the portfolio the closer you get to retirement. The logic behind the approach is that the most powerful investment portfolio value builder is compounded returns. It’s important to target average returns of 5% while building an investment portfolio earmarked for retirement and re-invest those returns as you go.
If there is a market downturn, you have plenty of time to ride it out and any years of losses will be reversed when things turn around again. However, when you have retired and need to start drawing an income from your retirement investment pot, you need to avoid it slumping in value if markets take significant losses. If that happens you’ll be cashing in assets that are worth less. Possibly even less than you paid for them. That’s why it’s recommended to rebalance the portfolio towards fixed income assets like bonds and keep a larger cash allocation. That rebalancing should be done gradually over the years leading up to retirement as any loss of value then may mean a market recovery isn’t complete before withdrawals need to start being made.
Makes sense, right? The problem is, according research carried out by Seven Investment Management (71M) and the London Institute of Banking and Finance, the over-50s demographic are going too conservative too early with their investments. While they are very good at budgeting to set money aside and regularly pay into their pension pots, they are afraid of then taking any risk and keep a large portion, or everything, in cash and bonds. This means that many have missed out on the second longest equities bull run in history and one that could have more than doubled their savings over the past decade when taking compounded returns into account.
Separate research data published by pensions company Retirement Advantage saw 40% of over-50s respond that they are unwilling to take any risk with their pension pot. That leads not only to missing the opportunity to add to savings but value being eroded by inflation levels currently running ahead of interest rates.
At the same time conservative over-50s are making an effort to up the percentage of their income they save into their pensions. 71M research, however, suggests that those lucky enough to have a reasonable pension pot value, of at least 3.5 times their annual income, would gain 3.5 times the benefit of saving an extra 1% of their income by simply slightly increasing their risk exposure.
The lesson appears to be that if you are 65 years old and entering retirement, it makes sense to be risk averse with the portion of your pension you plan to cash in over the next 5 years. The portion earmarked for the following 5 years can probably tolerate a little risk and the rest should probably be invested in the same way as would be the case for a younger investor – targeting an average return of 5%. For those in their 50s and still 10 years or more away from retirement, being too cautious will significantly impact the value of your future pension pot. That doesn’t mean it is wise to take on high risk investments but a focus on moderate to average risk funds targeting returns of around 5% is more financially prudent than squirreling away cash.Risk Warning:
Please remember that financial investments may rise or fall and past performance does not guarantee future performance in respect of income or capital growth; you may not get back the amount you invested.
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