In the past, it was common to reduce the amount of investment volatility you were exposed to as you approached retirement. But retirement has changed a lot in recent years, so is it still the right approach?
The theory behind reducing risk in your investment portfolio made sense in the past. After all, you didn’t want the value of your investments falling just before you plan to withdraw the money to create a retirement income. It could mean having a lower income for the rest of your life. However, a number of factors mean that considering maintaining some level of risk as you approach retirement could be a wise decision.
Among the reasons to consider investment volatility more closely are:
Life expectancy has gradually been increasing. While the State Pension Age is rising too and will continue to do so, the fact is that most of us will spend longer in retirement than our grandparents.
Just a few decades ago those retiring may only have needed to use their retirement provisions to fund 20 years. Now it’s not unusual to spend 30 or 40 years in retirement. It means that the money you’re diligently putting away for your retirement needs to stretch even further.
If you want to maintain your current lifestyle throughout retirement, it’s likely that your savings will need to continue growing even after you’ve given up working. As a result, some level of investment risk may be necessary to ensure you can create the income you need to meet retirement goals. When planning retirement finances, factoring your life expectancy in is crucial for ensuring your savings will continue to support you for the rest of your life.
Maintaining spending power
Even if your pension doesn’t need to grow to support you for the rest of your life, considering inflation is important. If you’re not purchasing an Annuity to create a guaranteed income, you’ll need to consider how the rising cost of living may affect your spending power over the years.
At first glance, a 2-3% rise in the cost of living in a year doesn’t seem to have a large impact. But when you consider this happening every year over the length of your retirement, it can have a significant impact on your lifestyle. For example, a £18,000 salary in 1997 would have had to increase by over £13,000 to offer the equivalent purchasing power 20 years later.
You don’t need to take a high level of risk to ensure your pension provisions keep pace with inflation. However, with interest rates remaining low, saving accounts are unlikely to provide an option for some time. Taking a small amount of risk with your pension through investments can help ensure your income continues to provide the lifestyle you’ve planned.
One of the key factors affecting investment strategy as you approach retirement is the introduction of Pension Freedoms in 2015. This shake-up of the pensions industry provides far more flexibility around how and when you take an income from your pension savings.
Prior to 2015, you probably would have used the money built up in a pension to purchase an Annuity as you planned for retirement. With an Annuity providing a guaranteed income for life, you didn’t want investment volatility to reduce the value of your pension savings ahead of retiring. This could have affected the level of income you received for the rest of your life.
The flexibility Pension Freedoms offer means, if you choose to, you can take an adjustable income, allowing you to reflect the ups and downs of investment markets. Should the value of your investments fall, greater flexibility allows you to accommodate for this.
Differing income needs
In the past, retirement costs for many followed a similar pattern. The early years were marked by a greater level of activity, resulting in higher income needs. However, as retirees settled into their new lifestyle and ticked off some of their top aspirations, income needs fell.
However, this isn’t the case for many entering retirement today. Differing lifestyles may mean that your income needs may vary hugely throughout your retirement and improved health may mean you’re more active for far longer.
On top of this, you also need to consider care. As we’re living longer, more of us are likely to need some level of support as we enter our later years. Most of us will be responsible for meeting care costs, either wholly or partly. As a result, you may find that your income needs increase as you age.
Rising costs in later retirement, coupled with the uncertainty of whether you may need to fund care, can mean that continuing to leave some of your savings exposed to investment risk may be the right choice for you. It gives you an opportunity to potentially increase your funds.
Is remaining invested in retirement the right option for you?
While the reasons for remaining invested will reflect many retirements, there’s no one-size-fits-all solution.
The level of investment risk you should take when in retirement, or indeed whether you should take any at all, should reflect other areas of your life. These may include your attitude to risk, other assets that could fund retirement and your overall aspirations. A bespoke approach is essential when planning your retirement finances. If you’d like to understand how your investments should change as you approach retirement, please contact us.
Please note: The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.