Counter intuitive investing at retirementPosted by Peter McGahan
Pension freedoms and pension drawdown, we've all heard about them but how do we best make use of them for the long term.
Following a column I wrote for Olderiswiser's sister site, 50connect, looking at the level of income you can take from your pension in retirement without eroding your capital, I’ll add some tips on how we might maintain your financial security by shoring up your pension values.
The ‘safe’ rate at which you can draw down income is considered, by some experts, to be between 2.5% - 3.5%. The theory is based on back testing against historical returns on a pension portfolio split equally between bonds and equities, that the capital will last for at least 30 years.
An investor who invested more wisely than this broad strategy, would of course have a higher ‘safe’ withdrawal rate, but investors who take a withdrawal of 5% have a 55% chance of their plan failing and their funds running out.
Maximising return, minimising loss, lowering charges and taking what you ‘need’ rather than want from your pension pot, will all go a long way to securing a long healthy retirement.
Investments don’t return in a straight average line, so taking higher income from a falling market plays havoc with the pressure on your fund. As an example, if I use the long running Jupiter Merlin Growth Portfolio as an example, it has produced a 63.7% return over the last five years. However, that portfolio only produced a + 5.5% return last year, + 28.2% the year before, and minus 0.1%, + 12.0% and + 9.2% in the three previous years.(3) An investor starting drawdown in the year it produces a minus is off to a bad start, and if it’s a big minus, coupled with a reasonable withdrawal, the impact could be permanent.
How to make decisions about drawdown
The UK drawdown advice arena is said to be lagging its US counterparts somewhat.
‘Drip feeding’ is becoming the ‘next thing’ but it has two meanings.
The first involves segmenting your tax-free cash and withdrawing it over a longer period of time to supplement your actual drawdown income (the taxable bit). By keeping the main drawdown income low and below the tax threshold there is less strain put on the capital through tax.
Furthermore it encourages the tax free cash to remain invested for longer, naturally stabilising the remaining fund. It is beneficial for Inheritance tax (IHT) planning too as it would be paid out free of IHT (Inheritance Tax), but if you had paid it out at the beginning it would be subject to tax.
The other ‘drip feed’ is a clever thought process which is counter intuitive to normal financial planning.
I’m always uncomfortable with the arbitrary ‘rules of thumbs’, and one such view is that you should hold as much bonds in a retirement portfolio as your age. Painting by numbers!
If I’m 70 years old and the bond market is top heavy and overpriced, I wouldn’t buy any of it!
What constitutes a balanced portfolio?
The general ‘thumb view’ is that you should slowly divest away from equities and into bonds the older you get.
Research from a Professor of retirement income shows very much the opposite. A drawdown portfolio which starts conservatively in bonds and is drip fed to equities has a significant impact on the risk of your plan failing and the magnitude of failure.
The research clearly demonstrates that a portfolio beginning with 30% in equities and finishing at 60% outperforms one that starts and finishes at 60%. It also produces better returns than a portfolio that follows the thumb rule and starts at 60% equities and ends at 30%. (4)
Your asset allocation should pay attention to your budgeting requirements not a thumb, so you can maintain what equity exposure you need. What are your liabilities in retirement now and what are your remaining assets? Balance your portfolio based on this and next year, rebalance again.
Studies show the optimum allocation for equities begins at 20-40% and ends at 40-80%.
Interestingly, for an investor looking for a 4% withdrawal rate, the studies confirm that a 30% start in equities, rising to a staggering counter intuitive 80% provide the best success rates. (4)
Static allocation just didn’t cut the mustard demonstrating again the importance of reviewing your portfolio regularly.
If you have a question about retirement planning please call 01872 222422 or visit us at WWFP.
About the author
Peter McGahan is Chief Executive of Independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority.
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