Retirees: are you taking the right risk?
In 2015, pension freedoms were introduced meaning those approaching retirement no longer had to buy an annuity and had greater flexibility on how they took their retirement income.
With greater flexibility comes greater responsibility and retirees have to make the right decisions to ensure they don’t run out of money in retirement.
A report compiled by Royal London said there are two hidden dangers in deciding the best investment strategy to sustain an income in retirement:
- taking ‘too little’ risk – the ‘risk averse’ retiree;
- taking ‘the wrong sort’ of risk – the ‘reckless’ retiree.
Both these approaches increase the danger of a saver either running out of money during their retirement or having to face a reduced standard of living in their golden years.
The average 65-year-old can expect to live for more than 20 years. People are tempted to shift their pension money into cash but Royal London said playing it too safe can mean your investments stop growing and don’t keep pace with inflation, increasing the chance of your pension pot running dry.
Its figures suggest that a typical £100,000 pension pot left in a cash account over the past decade, where the retiree is drawing an annual income of £7,500 from the age of 65, would be worth just £27,000 now.
As such, to ensure your pension pot lasts longer, your investments need to grow and this almost certainly means keeping part of your money in the stock market. If retirees had invested the same £100,000 pension pot in UK company shares 10 years ago, taking the same £7,500 annual income, retirees would be left with £48,000 today.
Turning to the ‘right kind of risk’, Royal London said large losses early in retirement can have a very negative impact on savers’ ability to sustain an income for the long term.
Retirees shouldn’t take excessive risk in the hunt for income; some of the exotic high yield investments on offer today such as aircraft leasing or peer to peer lending could expose people to unexpected losses when interest rates rise, it argued.
The report added: “For most people, the right approach will be to aim for steady growth but to reduce risk by spreading investments across a range of different investments including company shares, bonds and property, both at home and abroad.”
As such, rather than investing in an ultra-low risk way or high risk investments, those approaching retirement should spread the risk across a range of assets. A multi-asset approach should provide a better return than cash, but may also helps to smooth the ups and downs of individual investments.
Trevor Greetham, head of multi asset at Royal London Asset Management, said: “Pension freedoms open up new possibilities for people in retirement, but create new dangers as well. There is the danger of being too cautious and not making your money work hard enough – investing in retirement is still long-term investing. There is also the danger of taking the wrong sort of risk, chasing high returns but putting your capital at risk.
“We believe the best approach is to spread your money across a range of asset classes and in different markets at home and abroad. This is likely to deliver better returns over your retirement – and a more sustainable income – than being stuck in cash, without exposing you to the capital risks that can come from chasing after more exotic or risky types of investment”.