Advisers are being forced to reappraise traditional approaches to retirement investing because of two significant events that have changed all the rules.
Those who fail to adapt could be letting their clients sail into dangerous waters.
The first event was pension freedoms which has driven more investors toward drawdown at retirement.
According to the Financial Conduct Authority, two-thirds of retirees now opt for drawdown over annuities.
Their investment strategy may need to last 30 years or more.
This brings into question the traditional strategy of automatically moving from equities to bonds as clients get older.
If portfolios are no longer working towards a retirement cut-off date and the purchase of an annuity, then taking too much investment risk off the table in the approach to retirement – when a client’s portfolio is at its biggest and the benefit of compounding is at its most potent – could have significant implications for wealth later on.
The second event was the financial crisis and the subsequent policy of quantitative easing, which has choked bond yields.
The yield on 10-year UK gilts, a building block of most traditional retirement investment strategies, is now less than inflation.
German 10-year bunds are offering a -0.24 per cent return – a guaranteed loss. US treasuries saw negative returns in 2018 (and a correction in the dollar could bring British investors more pain this year).
The role of bonds in a portfolio is, therefore, presently more geared towards providing a shock absorber should equity markets wane.
This sends investors towards equities.
While this is not necessarily a bad thing, here another tradition puts them at risk. Historically, many investors have sought to live off their income in retirement, leaving their capital intact.
In the accumulation phase, their equity portfolios were tilted towards growth stocks – typically less mature, higher-risk companies that pay little, if any, dividends but where profits are reinvested so that the company rises in value over time, lifting share prices in tandem.
Approaching retirement and once in it, investors moved into income stocks – usually more mature companies, kicking out solid profits, with little prospect of substantial growth.
These companies distribute their dividends regularly so the yield can provide an income stream.
Living off yield and leaving original capital for the generations to come is a lovely idea – in principle.
It may have been fine 15 years ago, but not now.
Advisers may need to educate their clients about the risks, which we will outline here. It is also possible to propose a more appropriate strategy for the current circumstances.
The siren call of dividends
In Greek mythology the Sirens were singing enchantresses who lured passing sailors to their islands. Their song was sweet, but the fate of those who fell for it was grim.