View from the City by Justin Urquhart Stewart 7IM Rethink the risks for retirement investments For decades, a traditional strategy that many investors have adopted for their pension pots has been one that reduces the level of investment risk that they take as they get nearer and nearer the day they retire. Known as the ‘lifestyle’ approach, the investment mix changes as individuals reach pre-set ages, steadily shifting investments into ones that are deemed to be less risky. This is achieved by switching from stocks and shares (aka equities or ‘riskier’ assets) to bonds (seen as ‘safe havens’) as you get older. So, you might start off with as much as 70% of your portfolio in stocks and shares and 30% in bonds and, by the ti me you retire, the majority of your assets would be invested in government bonds or Gilts. While annuities gave us certainty as to how much we would get each year, it was important not to suffer a big investment hit just before you bought one. So lowering that level of investment risk as your approached that date made lots of sense. But the world we live in has fundamentally changed. Investors were no longer forced to buy an annuity when they retire. Meanwhile we’re also at 200-year record lows for interest rates. Not only has this negatively affected our expectations of the future investment returns from bonds, and indeed other investments, those prospects are not likely to get any better given bonds generally don’t do well in a rising inflationary environment. Inflation’s now at 2.7%. Last June it was at 0.5% quite the difference! We’re also now going to be living longer than previous generations, and that longevity is set to continue extending. In England, a baby boy born in 2012 can expect to live almost six years longer than one born two decades before. So our savings have to last longer too.
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It was this combination of events that led 7IM to research the options for our clients. There were some interesting results. We learned, for example, that taking more risk early on in an investor’s career didn’t actually make much of a difference. There simply isn’t enough in the pot to build on until much later in life when – after you’d been investing a regular sum over a long period – you’ve got more money ‘at stake’. Lifestyle strategies would look to lower your investment risk profile precisely at this very point in time i.e. exactly when the power of compounding is at its most powerful and your investment returns effectively generate their own profits. In addition, every scenario we ran highlighted another risk for investors: the risk that you could outlive your savings. If you have a pot of money and take out 5% each year to cover life’s expenses, but you’re only making 3% on your money, your overall pot would probably shrink over time. If you’re 65 today, you have a 7% chance of living long enough to get a telegram from the Queen according to the office for National Statistics. If you’re 35, that chance more than doubles to 15%. But each year you live may mean you are more likely to run out of money – not really a great thought! Solving this problem therefore requires you to balance the various sources of risk. So you need to do a combination of saving more while you’re working (savings risk), look to retire later (job risk), take a lower income in retirement (lifestyle risk) or seek a higher investment return (investment risk). Here we have to be careful – we are absolutely not saying everyone needs to take more investment risk as it could result in you getting back less than you originally invested. We know that risk is a very personal choice. However, taking some additional investment risk can also provide the potential for greater returns, and there are a number of other levers you can ‘pull’ to give you the retirement you’d like to enjoy rather than one you have to endure. At least having a proper conversation about this subject now, rather than in 20 years’ time, and which gives you the chance to make an informed choice.
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