While it’s probably not the most reassuring thing to begin an article on financial planning by mentioning gambling, I’m going to start this one by comparing retirement to a long holiday in Las Vegas. Now, I have to admit that I’ve never been to Vegas, and I’m not yet retired. However I understand that the goal for both is to enjoy it to the fullest… but not so fully that you run out of money.
Bright lights and slot machines aside, funding your retirement is one of the most complex financial challenges you’ll face. You need enough money to cover daily expenses, hobbies, holidays and potentially healthcare – and you need to do it over 20 to 30 years, or maybe longer.
Investing in retirement
Keeping your money invested in retirement is potentially a way to help it grow in value and to protect your money from the erosive effects of inflation.
No-one knows how long they’ll live for, so you need your money to last the length of time you may need it – and perhaps be able to leave a lump sum to loved ones too. This is often of even greater interest following ‘Pension Freedoms’ introduced in April 2015, which mean you have a lot more flexibility when it comes to passing pension funds on to your dependants.
However, your primary concern will generally be around making sure there’s enough money for you to live the life you want, and part of that involves needing your money to carry on growing to keep up with rises in the cost of living. Even a 3% average rate of inflation can almost halve the spending power of your pension savings over 20 years. And we could be creeping quite close to that figure as the latest figures put UK inflation at 2.3% with many commentators suggesting it could rise to 3% by summer.
Keeping your money in cash is unlikely to provide enough growth for it to support your chosen lifestyle for as long as you’re likely to need it. Whereas holding growth assets, such as equities, can substantially increase your chance of success but, equally, because they’re riskier, you also increase the chance of large losses if markets fall.
It’s important to be wise about withdrawals
When you’re investing, we often say that it’s important to focus on the long-term goal and not worry about general market movement along the way – as long as you get where you need to, the journey isn’t so important. However, when you start withdrawing your money it’s time to start looking out the window and paying attention to the journey.
Taking an income in retirement often involves withdrawing a fixed amount at regular intervals. If you’re in a volatile portfolio, it can increase the chance that you’ll end up taking money out when the value has dropped – thereby locking in your losses. This makes it much harder for your portfolio to bounce back.
Take a look at the example below:
Imagine you have £100,000 in your retirement portfolio and the market drops by 10%, so your portfolio is now worth £90,000. This means it would have to increase by 11% to get back up to starting value.
Now imagine that you want to make a withdrawal of £5,000. If you do that when your portfolio is only worth £90,000 it means that it would need to increase by 17% to be worth £100,000 again.
However if the market rose by 10% instead of falling, your portfolio would’ve been worth £110,000 when you made your withdrawal, meaning you’d still have £105,000 left.
Obviously this is a very simplified example, but it helps me illustrate the point that taking a withdrawal during a market fall could magnify your losses and lead to your pension savings running out sooner.
Performance in the early years can matter most
Of course, perfectly timing the market is practically impossible and you won’t always be able to make withdrawals when investments are up. However, the returns in the first few years after you begin taking an income have the greatest impact on how long your pension savings will last, so it’s really worth thinking about when you start to drawdown your money.
In fact, depending on when they start retirement, two people retiring with identical pension assets can have entirely different financial outcomes, despite having received identical long term average returns.
Bill and Ben, shown below, both started with £100,000 and both take £5,000 income from their portfolio each year. They retired at different times, so the graph shows how their portfolio did over different time periods, but overall, they both received an annual average return of 7.86%:
However, as you can see, Ben’s portfolio did much better at the start of his retirement, compared to Bill’s which delivered the bulk of its returns towards the end. Although long-term average returns were the same, the timing of the returns dramatically impacted their outcomes:
This is because of the magnifying effect that I mentioned earlier, which is hugely more painful if it’s felt at the start of your retirement.
So what can you do?
This is where the expertise of your 1825 Financial Planner comes in. They can help you navigate through the challenges and choose an appropriate investment strategy to try and help your money last as long as you need it to.
They’ll seek to achieve balance by carefully selecting assets that provide both growth and protection from volatility, and they’ll help you to identify if and how you need to make changes to your income levels. And perhaps most importantly, they’ll help you put a plan in place to give you control over when you access your money, to make sure that you aren’t forced to withdraw when investments are down.
So if you’re starting to think about financing your retirement, now’s the time to speak to your 1825 Financial Planner. They’ll help you balance the retirement you want with the retirement you can afford and set out a plan to help you achieve it. After all, as Tony Curtis said, if you know how to live in Vegas, you can have the best time – and the same goes for retirement.
Investments can go down as well as up meaning you may get back less than you put in. The information in this blog or any response to comments should not be regarded as financial advice.