The importance of an early start

Some of these you have total control over, such as your rate of saving and spending or how much risk you take with your investments. On other factors, you have some degree of control, such as the duration and earnings level of your employment and your own longevity. Finally, there are a range of factors over which you have absolutely no control, such as market returns and policies governing taxation, savings and entitlements. Knowing that a wide range of variables can determine financial security in retirement, understanding retirement spending and planning accordingly is critical.

This leads us to two potential models for structuring a sustainable DIY retirement income stream. The first involves a so-called bucket method shown below. Put your assets into three categories according to time horizon. In the near-term portfolio that you are going to be regularly dipping into for spending, put that money in cash and cash alternatives such as short-term bonds. The medium-term portfolio, where you will want to keep assets that you do not immediately need but likely will draw down, can be invested in slightly higher yielding assets such as dividend-paying equities. The third bucket in the portfolio should be assets that you can afford to leave invested. Reserve this for riskier, higher-return strategies or for longer-dated savings instruments. Such a model can certainly help investors to grow wealth over time while maintaining spending to support their lifestyle. However, it is at best an inexact rule of thumb.

A second model for structuring a retirement income, which we would tend to favour, involves a pyramid. Starting from the base of the pyramid, you move up the spectrum of risk and return to the top, as shown in figure 1. The bottom and largest portion of the pyramid comprises your needs – the basic assets that are going to cover your regular expenses. Your sources of income for the bottom of the pyramid come from your state or defined contribution pensions, Isas, short-term bonds or cash savings. Moving on to the middle of the pyramid, this is the part of your wants, comprised of your desires to pursue a lifestyle in retirement, such as travel. Sources of income in the middle of the pyramid tend to come from investments in equities or fixed income. As you reach the top of the pyramid, representing the smallest part, you reach the legacy considerations, where you might be considering assets to leave to your children. This income, unlikely to ever be drawdown for paying expenses, can be sourced from more high-risk investments or structured in trusts.

Structuring a suitable retirement income stream is different for everyone, taking into account a huge amount of personal considerations. So it is important to keep in mind that these models are only rough guidelines – they would not work for all individuals. In fact, the vast majority of people can definitely benefit from seeking some form of advice when planning their retirement income.

That said, what is the same for everyone is the desperate need to start retirement savings earlier and to do it more consistently. The numbers speak for themselves on the power of compounding over time, and they are too important to ignore. Let’s compare the following three investors:

• An investor who saves £5,000 a year from the age of 25 and then stops at the age of 35, saving £50,000 in total

• An investor who saves £5,000 a year from the age of 35 to 65 years old, saving £150,000 in total

• An investor who saves £5,000 a year from the age of 25 to 65 years old, saving £200,000 in total

Who has the most in their retirement pot at the end? Assuming an average 7 per cent annual return for all three of our investors, our investor who started at 25 years old and saved consistently throughout her working life had the most, with a comfortable £1.2m by the time she is 65 years old. That is perhaps not surprising, but interestingly our investor who saved early and then stopped at only 35 years old actually has more in her retirement pot than our investor who started at 35 years old and saved significantly more of her income over her working life. The investor who started early and then stopped has £602,000, whereas the one who waited until 35 years old to start saving has just £540,000.

Saving is important and so is diversification, as a balanced portfolio is better poised to generate returns in all types of market environments. We know that the best and the worst-performing asset classes can vary widely in any given year, but over the long term, a portfolio that is diversified across equities and bonds can help to dampen volatility, providing a smoother ride.

No matter how you choose to tackle the retirement income question, many investors are going to find they are well served by multi-asset income funds that are accessible and easy to understand. These funds can offer the potential to build and preserve wealth, beat inflation and reduce the risk of outliving your assets.

Jasper Berens is head of UK funds and Talib Sheikh is a fund manager of JP Morgan Asset Management

Key points

There are two potential models for structuring a sustainable DIY retirement income stream.

Structuring a suitable retirement income stream is different for everyone, taking into account a huge amount of personal consideration.

The investor who started at 25 years old and saved consistently had a comfortable £1.2m by the time she is 65 years old.