Anthony Gillham, head of investments at Quilter Investors, explains the importance of defending capital when making your retirement pot last as long as you need it to.
Pensions are one of those investments no-one really ever worries about until something goes wrong. Like a lot of things, we tend to take them for granted until they break, potentially often at great expense.
While the introduction of pension freedoms in 2015 alerted people to a world of new possibilities, it did nothing to educate them about the risks. Amid rising equity prices, retirees have seen their assets grow at the same time as enjoying new flexibility.
But after a decade of increasing asset prices, in the 'new normal' environment, as quantitative easing is being tightened or removed, we are entering a lower growth environment where significantly higher volatility should be expected.
Unfortunately, pension pots do not act in the same way in decumulation as they do in the accumulation phase. After building up a pension pot over decades of hard work, the wrong decision at the wrong time can undo all that patience and investment growth.
Tax free cash
The temptation, as many newspapers suggested at the time but which never really manifested, is to cash in savings to pay for a car, or a holiday, or pay off the mortgage. A recent FCA review found most consumers go into drawdown to access their tax-free cash and tend to overlook the fact that a pot of cash in a savings account is not providing the same growth as in a diversified investment strategy held in equities, bonds and alternatives. In fact, it is likely losing money in real terms as a result of inflation.
Of course, some clients may have other forms of income, yet while they may feel re-assured their cash is safely in the bank, over time the value is slowly eroded. Over the decade to 2017 the Bank of England estimates an annual average inflation rate of 2.8%, which over a 20 year period could reduce the purchasing power of £250,000 to around £142,000. Clients that access their tax free cash and don’t take a decision to invest the rest may find themselves unstuck when they come to access regular income.
This is not a theoretical problem. Between October 2017 and March 2018 the FCA’s latest data bulletin revealed 272,752 pension pots had been accessed for the first time, of which more than 50% (137,777) were wholly withdrawn in cash, with 75% of these customers unadvised.
The FCA specifically highlights that by investing their pension pots into a mix of assets rather than just cash over a 20 year period – i.e. their retirement – the expected annual income of these unadvised consumers could increase by 37%.
This provides a significant opportunity for advisers to add value, as why would an investor choose to ignore that huge uplift, especially at a time when costs for care might suddenly increase? The FCA’s findings show the main reason is they’re concerned about losing money. But having worked so hard to build up a pension, clients need to understand the importance of not only keeping up with inflation to maintain purchasing power, but also to protect their capital against unexpected events, whether that is an acceleration of the trade wars that halt the equities bull run and sees markets plunge, a hard Brexit that pushes up inflation, raises the price of goods and cuts interest rates, or the need to withdraw more income than expected to fix a boiler or pay for a funeral.