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Pension Drawdown Investment Strategy – An Overview

24/05/16 Pension Drawdown

The pension freedoms delivered a new option for those approaching retirement – flexi pension drawdown. Pension Drawdown offers a number of potential advantages over an annuity but it also has risks.

One of the main risks of Drawdown is running out of money in retirement. To avoid this unwelcome scenario a funds withdrawal plan and an investment strategy is essential. In this article we cover how to build a pension drawdown investment plan.

You may employ a financial adviser. If you do they will discuss investment strategy as part of your retirement planning review. They will take on the investment management task on your behalf. If you do not have an adviser we strongly suggest you  build your own plan if pension drawdown is the retirement option that is right for you .

If you do take the DIY route it is important to make a brutally honest assessment of your attitude to risk. You need to decide if you are confident monitoring and controlling  a potentially significant pension fund over the long term. Are you able to make key investment decisions?

When building a pension drawdown investment strategy there are three main issues to consider, they are:

  • Diversification
  • Regularity of income
  • Capital maintenance

Diversification Minimises Risk

Investment decisions should be based on balancing risk against return. While it is impossible to eliminate investment risk entirely and still maintain the income you require in retirement its impact can be reduced.

At this point we need to dive into some industry jargon. There are various asset classes. Examples include shares (Equities) Corporate Bonds and Gilts (securities issued by businesses and Governments) and Property. There are various commodities. The most well known is oil.

You could invest in various industry sectors, such as pharmaceuticals, retail, healthcare. You may decide to invest in various parts of the World for example Japan, America or some of the so called emerging markets like Argentina or Brazil.

With a diversified spread of investments, the impact of picking the wrong asset type, the wrong sector or the wrong region at the wrong time can be minimised. With a well chosen mix you should be protected to an extent. If one or more areas perform badly but others remain strong the overall loss should be minimised. The issue all investors face is how to set a balance that reduces risk but still provides an income.

You may want to minimise risk by placing your money is standard bank savings accounts. At the next level up you may wish to invest in relatively safe assets such as Gilts (U.K. Government bonds) where your only real risk is if the Government financially collapses. Both are relatively safe but both pay low levels of interest or income which means your pension fund will not grow as you hope.

At the other extreme, more risky investments may deliver the income (and more) you aspire to but may crash leaving you with a severely depleted retirement fund to provide an income over the remainder of your lifetime. A balance is required.

Regularity Of Income

Financial markets rise and fall in value over time and sometimes they crash. Taking an income from an invested pension fund when investment markets are down can have a major impact on the value of the fund. This value can be difficult to recover in the short to medium term.

Any investment (or range of investments) delivering high returns, followed by significant lows may deliver a satisfactory average level of return over the long term but, if a regular income is required, this option should be avoided.

It is wise to have some cash reserves (many recommend sufficient funds to cover 2 years worth of income) to avoid the need to take income from investments when the markets are at a low point. If cash is available investments can be allowed the time to recover before further income is taken.

Capital Maintenance

A prudent strategy could be to maintain, as far as practical, the initial sum in your pension fund while relying on capital growth to deliver an ongoing income. The original capital sum is then available to draw upon should you live significantly longer than expected.

In the worse case the original capital sum may be used to pay any care costs that may apply in later life. Or, on a more positive note, it could be passed on to your beneficiaries on your death.This can be one of the major advantages of pension drawdown as, unlike most annuity products the fund does not die with the pension holder.

Life expectancies are increasing and there is a chance a pension drawdown fund may run out during retirement if it is not managed properly. Making every effort to maintain the capital sum for as long as practical minimises this risk.

Building a pension drawdown investment strategy is far from straightforward. The balance between risk and reward  is the key, combined with the flexibility to deal with whatever life (and the markets) may throw at you.

To try to keep this article as short and to the point as possible we have made several statements we have not expanded upon or tried to explain in greater detail. If there is anything you don’t understand or you would like more details please give us a call or email us at LetsTalk@fathomfinancial.co.uk and we will try to help

 

This blog is intended to provide a general review of certain topics and its purpose is to inform but NOT to recommend or support any specific investment or course of action. The past is not a guide to future performance. The value of investments can go down as well as up and you may not get back the full amount you invested. Tax and financial regulations can change. Any figures quoted above are correct at the date of publication.