Pension drawdown jitters in post-Brexit world: how to shield your money
Retirement savers have the option to take pension drawdown, which is when you keep your savings invested and spread the balance over time.
As we now know the predictions of doom and gloom surrounding the impact of a Brexit leave vote have not, as yet, materialised. In fact, based on the Investment Association (IA) performance tables, the only investment sector that has fallen over the last three months is UK Gilts.
The UK All Companies sector gained 3.6% and if you had money in the Global Emerging Markets sector you would have seen a 12% rise.
This begs the question – in an uncertain world, where should you be investing if you are in pension drawdown, or planning to go into drawdown when you retire?
Unlike the pre-retirement ‘accumulation’ phase, where you benefit from the effects of what is called ‘pound cost averaging’, in the post-retirement or ‘decumulation’ phase the opposite applies, often called ‘pound cost ravaging’.
When you are making a series of regular investments (typically monthly contributions for pension scheme members), fluctuating unit prices caused by market movements are generally compensated by the fact that when the unit price drops you get more units for your monthly premium. Over a period of years this has the effect of evening out the impact of market volatility, and consequently investing in more risky asset classes generally works well.
On the other hand, if you are in pension drawdown then most likely you will be taking monthly withdrawals from your plan. If the unit price falls, you will therefore be selling more units to achieve the same payment. This can be extremely damaging and depending on the pattern of returns, could devastate your retirement pot especially if a downturn takes place in the early years of drawdown – what is known as ‘sequencing risk’. So how should you be invested?
There are generally two approaches. Firstly, investing for yield and only drawing the income. The dividend yield on the FTSE100 is currently around 3.5%, which is not bad compared to cash. However, the main detraction from this approach is that most people have varying income needs and don’t want to be constricted by natural yield.
A more flexible approach is to have a professionally managed multi-fund strategy. Unlike a multi-asset fund (which also spreads investment across a wide range of asset classes) the multi-fund approach helps mitigate sequencing risk, by holding contra-cyclical asset classes in separate funds.
A classic example of this was the 2008/9 stock market crash created by the credit crisis. When equity markets were down as much as 30%, other markets were significantly up due to the flow of money into so called ‘safe haven’ assets, such as sovereign bonds.
By splitting your pension fund out into a range of funds that invest in different asset classes you can ‘cherry pick’ the gains, taking advantage of market fluctuations while avoiding crystallising losses.
However, this needs regular monitoring, typically with a quarterly top up to the cash account from which your monthly pension is paid. A professionally managed multi-fund strategy may cost a bit more but can really make a big difference over time.
Steve Patterson is managing director at Intelligent Pensions