A research report published today (13th Jan) by mutual insurer Royal London warns pensioners about two very different risks when deciding what to do with their savings in retirement in a world of ‘pension freedoms’. It then identifies an investment strategy to overcome both of these dangers.
The two dangers for savers in retirement are:
- taking ‘too little’ risk – the ‘risk averse’ retiree;
- taking ‘the wrong sort’ of risk – the ‘reckless’ retiree.
Each of these approaches increases the danger of a saver either running out of money during their retirement or having to face a reduced standard of living.
- The risk-averse retiree:
How can you take too little risk?
An example of taking ‘too little’ risk is the saver who takes their tax-free cash at retirement and invests the rest in an ultra-low risk investment such as a cash ISA, believing this to be the safe approach. The paper points out that ‘investing in retirement is still long-term investing’ and shows that decades of low-return saving can seriously damage the living standards of retirees. It highlights the case of someone who retired ten years ago with an illustrative pension pot of £100,000 which they invested in cash. Assuming they withdrew money at £7,500 per year (in line with annuity rates at the time), they would now be down to £27,000 and likely to run out in around four years’ time, less than fifteen years into retirement. By contrast, if the same money had been invested in UK shares, there would still be around £48,000 left in the pot, despite the 2008 stock market crash.
- The reckless retiree:
What is ‘the wrong sort of’ risk?
In an era of low interest rates, retired people may be tempted to seek out more unusual forms of investment with apparently high rates of return but accompanied by much greater risk to their capital. Examples could include peer-to-peer lending, investment in aircraft leasing or even cryptocurrencies such as Bitcoin. Concentrated exposure to a single, potentially volatile, investment can produce very poor outcomes, particularly if bad returns come early in retirement. The pension pot in our previous example would still have £88,000 in it if the bad year for UK shares had happened at the end of the ten-year period we looked at and not at the start.
- The rational retiree:
What is the best way to handle risk in retirement?
Rather than invest in an ultra-low risk way or chase individual high-risk investments, the paper identifies a ‘third way’ of spreading risk across a range of assets, including company shares, bonds and property, both at home and abroad. This multi-asset approach can be expected to provide better returns over retirement than cautious investing in cash but also helps to smooth the ups and downs of individual investments.
Commenting on the research, 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."
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About Royal London:
Royal London is the largest mutual life, pensions and investment company in the UK, with funds under management of £117 billion, 8.8 million policies in force and 3,745 employees. Figures quoted are as at 30 June 2018.