Make your pension last a lifetime
Recent figures from the Office for National Statistics show that the typical 65-year-old woman can expect to live for between 19 to 24 years more, while a man of the same age should live for a further 16 to 21 years.
Following the pension reforms, savers now have more choices as to what to with their money but the responsibility is on you to make sure you don’t outlive your savings.
Leaving your money invested
Instead of being expected to buy an annuity, it is now easier to leave your money invested in the stockmarket and take a regular income. In this way, retirees can continue to benefit from investment growth well into retirement rather than limiting themselves to the relatively low income – but low risk – offered by an annuity.
New investment challenges
This means that a sizeable number of savers will continue to hold some investments after they retire. The challenge is what you do with that money.
You don’t want to take so much risk that you live your financial security vulnerable to a stockmarket collapse, but at the same time you don’t want to be so cautious that your capital doesn’t deliver the growth you need.
Jason Hollands, managing director of Tilney Best Invest says that if you’re maintaining investments into retirement it doesn’t make sense to totally ‘de-risk’ your portfolio. “The logic behind this well-trodden approach has been to reduce the potential of being hit by any nasty surprises such as a stockmarket crash the closer a saver gets to the critical point of turning their amassed pension pots into the one-off purchase of an annuity.”
Now, says Laith Khalaf, senior analyst at investment company Hargreaves Lansdown, “investors need to think about taking the level of risk that an investment horizon of 20 or maybe 30 years affords them.”
So how do you strike the right balance? Patrick Connolly, a chartered financial planner at Chase De Vere says there is no easy answer: “All investment decisions should be bespoke to the circumstances, objectives and attitude to risk. What could be right for one person could very easily be wrong for another.”
Broadly speaking Connolly says there are two investment strategies you can use.
“The first is buying an all-in-one fund, such as a multi-asset fund [a fund which invests across many types of investments e.g. equities, property, bonds…], which is essentially a whole portfolio in one fund,” he explains. “The second is to buy a range of individual funds, which are structured to build a suitable portfolio to meet the needs of the individual.”
He adds: “Multi-asset funds can certainly have a role to play. While they are far from the perfect solution, they should at least stop investors going too far wrong. This shouldn’t be underestimated.”
Whichever approach you adopt, once you’re retired, equity income funds are likely to feature in your strategy. These are portfolios that invest in shares that are expected to pay regular dividends – these can be taken as income or reinvested for growth.
While income may be your priority the importance of growth cannot be underestimated. This is because it will help you beat inflation and deliver a rising income over time. “Inflation is the silent assassin of wealth, eroding its real value over time,” says Hollands
Although inflation is currently low, the long term target rate of the Bank of England is 2%, this means to stay flat in real terms your investments need to grow by this amount after costs.
“So even when you start to draw an income off your investment to live off in retirement, it is important that the value of the investments continues to grow,” he adds.
To put that into perspective Connolly says: “If you have £10,000, assuming inflation at 2% a year, after 10 years the real spending value of that money will have reduced to £82,034. Over 20 years it will only be worth the equivalent of £67,297 and over 30 years, just £55,207.”
How much should you invest?
Finally, there is the decision on what proportion of retirement savings should be exposed to equities.
Connolly says: “After people retire, capital protection is likely to be at least as important as capital growth and so individuals should also diversify risks by holding money in other asset classes such as fixed interest, cash and property. But the right mix of investments will depend on somebody’s specific circumstances and requirements.”
So while a higher risk investor, say somebody that has income from other sources to cover regular bills and wants to grow their capital over the long term, may keep as much as 65% of their fund in equities – a more cautious investor who is totally reliant on their pot to generate an income might want to cap their equity exposure at 30% of their savings.
The key is to strike the right balance between your need for an income that will rise and a need to protect your capital. It’s not easy to do and can be one good reason to hire an IFA.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.