Friday July 10, 2020
The coronavirus (COVID-19) is having a widespread impact across all aspects of financial life, including retirement plans. The current global stock market turbulence, as a consequence of COVID-19, will no doubt be concerning for individuals whose pension savings are invested partly or fully during these volatile market conditions
However, making decisions based on what’s happening in the short term can be a risky thing to do. It might be tempting, for example, to move all your investments into cash or other lower-risk investments for a while – but in doing that, you might miss out on the point when the value goes back up, so you could lose out in the long term.
TIME FOR MARKETS TO RECOVER
It’s really important to remember that pension savings are for the long term and it is time in the market rather than timing the market.
If you’re young and currently paying into a workplace pension, then there is time for your pension pot to achieve growth over the long term and recover from the fluctuations currently being experienced in the stock markets. You shouldn’t be too concerned, as you have many years ahead of you, and this will provide time for markets to recover before you take your pension income.
If you’re older and closer to retirement, you may have seen your funds ‘life-styled’. This means your pension will have been moved into predominantly less risky funds and invested in ‘safer’ places such as in cash, gilts or bonds, which are lower risk and usually offer a fixed rate of return. The older you get, the more schemes tend to choose to invest in such assets to limit investment risk. Not all pension schemes offer automatic life-styling.
In retirement we essentially have two choices.
An annuity: The savings from your pension fund are used to buy an annuity and in return you receive a guaranteed income either for the rest of your life or for a fixed time period.
Drawdown: The savings from your pension fund continue to be invested in the stock market. You have an option of taking up to 25% tax free as a lump sum on retirement and then drawing down a regular or variable income monthly, quarterly or annually to supplement your income.
ANNUITIES vs DRAWDOWN
Annuities are certain once taken can’t be reversed. With interest rates currently so low, it’s difficult to get a good guaranteed income for life. Your pension will not be subject to any volatility either positive or negative. The fees can be expensive to set up and on death you need to have guarantees or a spouse’s pension added to the pension or the annuity will die with you.
As a rule of thumb, take your pension savings and divide by about 20 or 25. That's a rough guide to how much you would receive as income per year if you buy an annuity.
Drawdown allows you to remain invested in the market and decide how much and when you take your pension income. This will be subject to market volatility.
In an ideal world you would have a hybrid of both options which is where speaking to an adviser at Sands Financial Management will really help.
THE LONG-TERM VIEW
Markets in March took us all by surprise and the volatility swings we have seen will continue for the rest of the year. As we cannot predict the future, one option we are offering our clients is to drip-feed into the market each month rather than making one lump sum at the end of the tax year. This could mean that you have some months where you buy assets cheaper. And some months where you buy near the top
Cash rates are really poor and going nowhere fast in the short-term. (We might get inflation at some point which will change this, but that is likely to be some way off). So, we are facing the most unpalatable choice. Rubbish cash. Or volatility in the stock market.
There is no easy answer and it comes down to how much risk you are willing to accept – in a cash account you have the risk of inflation eroding your savings and in the stock market you have volatility risk. A pragmatic view is that with a 10 year + window you can ride out any storms in the stock market as I said in the beginning it is all about time in the market not timing the market and holding your nerve when things take a sharp drop, as they did in March, as the recovery is normally not too far behind.
If you take the view that markets will not grow over the next 10 years, that is similar to saying that you think there will be next to no growth, innovation or opportunity with companies - no room for any big global brands to become bigger and more profitable than they are today. 10 years is a very long time to hold such a pessimistic view for. There will inevitably be some sectors which will grow whatever the broader doom and gloom.
With many people living longer than ever, nervousness could force people to sit on savings and not think about the long term effects of holding cash for long periods of time - and as odd as things are today - that doesn't feel like the right approach.
Here are a few practical things to help you harness some pragmatism and (cautious) positivity:
- Read up on annuities and drawdown so you know your options.
- Volatility is not a bad word, understand the level of risk you feel comfortable accepting.
- Make sure you balance your caution with making your money work hard enough.
- Make sure you have at least three months of expenditure as easy access cash to weather any short-term needs so you're not forced to sell at the wrong time.
- With the markets lower this would be a good time to consider increasing your pension contributions if you can.
- Set up a plan and stick to it. Split your money into short-term (cash), medium-term and long-term pots.
The team at Sands Financial Management can help you see the bigger picture, weigh all your options and take a balanced assessment of your risks to develop a plan that will stand you in good stead for the future.
The Financial Conduct Authority does not regulate taxation advice.
The value of your investment can go down as well as up and you may get back less than the amount invested