The four risks of investing in retirement and how to prepare for them

One of the most significant events in your ‘investment’ life is the move into retirement as, for many people, this leads to a switch in the direction of the flow of money.

Up until retirement investors may top up their portfolios from their earnings, taking advantage of opportunities and counter any weakness in financial markets. This period of accumulating wealth is turned on its head in retirement as the opposite happens and people look to access their capital and withdraw money from their savings and investments. This is often referred to as decumulation or drawdown. 

Taking money out of a portfolio rather than being able to add to it has a significant impact on the behaviours of investors and the risks they are exposed to. Typically, the focus shifts from growth to a greater certainty on returns. Timescales adjust, becoming shorter term as there is a more immediate need for income.  

We have identified four specific risks that you should consider when investing for and during retirement. These are longevity, inflation, market and sequencing risk. Here we define them, explore how they can impact your investments and offer possible solutions that can help mitigate the impact of these risks.

Once you enter retirement, you’ll have a fair idea of how much money you will have and this is unlikely to change significantly. What you are less likely to know is how long you will need that money to last for. While many of us probably prefer not knowing when we will die it does present a challenge when it comes to investing. 

According to the Office for National Statistics, the average life expectancy in the UK is 79 years for men and rises to 83 years for women.  Of course, these are averages so some people might live much longer than that and indeed longer than they expect. The risk is they run out of savings and investments in their later years.

At Evelyn Partners our financial planners use specialist software to predict your cash flow. Working with our investment managers, through our combined wealth management service, they can help to ensure you have sufficient cashflow throughout retirement . It’s important to also have an ongoing review of your financial plan to consider any change in your personal circumstances.

Inflation is insidious, it constantly erodes the value of your hard-earned wealth and over the long-term, even low inflation, has a significant impact on the real value of any investments or savings. Inflation does not need to be at headline grabbing highs to really impact your wealth.   For example, since 2015 inflation, as measured by the consumer price index (CPI), has cut the value of your savings by a third.¹    

Inflation will erode your current and future purchasing power and could affect the lifestyle you have in retirement. Our financial planners and investment managers can work together to guard against inflation by regularly reviewing your portfolio, particularly in the lead up to your retirement.

Volatility is unavoidable, but the relationship people have with it changes in retirement. At this time, your focus will potentially switch from targeting growth to achieving capital preservation. 

People are often less tolerant and more sensitive to market volatility in retirement because they are less able to add more money to their portfolio in the event of any falls and could suffer a permanent loss which impacts their retirement plans.  

Closely linked to market volatility, sequencing risk looks at the timing of when markets rise and fall. Even small drops in a portfolio at the start of retirement can have a significant long-term impact on your investments. This is because you are taking money out of your investments and the size of the withdrawal as a proportion of the whole is larger when the value drops.

The chart below illustrates how sequencing risk impacts two example portfolios which have £500,000 invested in them. Performance of the two portfolios over 30 years is identical. Both have £20,000 taken out each year but Portfolio A experiences a rising market in the first three years (4%, 3%, 5%) whereas Portfolio B falls (5%, 3%, 4%). Portfolio B runs out of money, whilst portfolio A has over £200,000 left.

With our combined wealth management service our financial planners and investment managers work collaboratively to reduce the decumulation risks and build a strategy that supports the rest of your retirement plans.

There is no one size fits all solution as everyone’s experience will be unique so investing for retirement will need to be tailored to your individual circumstances. A common approach to investing in retirement is to switch all investments into lower risk, income generating assets, such as bonds. 

This approach could be the right solution for some people, particularly those who can comfortably live off the income. However, it doesn’t protect you from the four risks mentioned and may lack the flexibility others need. 

To mitigate the risks, it’s necessary to remove the immediate need to access the portfolio, changing how the annual income is taken from the portfolio. To achieve this, you could split your savings and investments into three buckets.

First bucket – The cash buffer 
Typically, advisers recommend having one to two years’ worth of income in cash. This should be enough to cover your daily expenditure, the occasional unexpected event such as replacing an old boiler, and offers some protection against the market risks but doesn’t remove it entirely. 

Second bucket - Drawdown portfolio 
This would take a portion of your wealth and use it to build a specific portfolio designed to meet any income requirements for the next four or five years. The investments here are typically going to be lower risk and may include short-dated government bonds, structured products, which tend to offer a higher total return, or both. 

A drawdown portfolio can be tailored to your personal income needs. This approach means there is a clear cash flow for the short and medium term, up to seven years so there is no need to draw on the remainder of the investments.

Third bucket - Growth portfolio 
The remaining bulk of the portfolio is invested in growth assets. There isn’t an income requirement for the portfolio so the focus can be on delivering long term growth. This would help to address the longevity and inflation risks as growing the portfolio, ideally above the rate of inflation, should increase the size of the overall pot. However, there would still be an investment risk and the assets could fall in value.
At Evelyn Partners, our investment managers can work in tandem with our financial planners to create these separate pots to fund your retirement. 

Evelyn Partners design a bespoke plan to manage your pension and the decumulation of it as tax efficiently as possible. The financial planner will help to design your cashflow to meet your needs and the investment manager will build your portfolio to take into account your income and growth needs.

Decumulation can be complex, but with our combined wealth management service, you will benefit from the knowledge of our experts who know you, your family and goals and can help you achieve them as you approach retirement. 

If you have any questions about decumulation and retirement planning, please contact your usual Evelyn Partners adviser, book a complimentary consultation online or call 0207 189 2400.

1. LSEG Datastream/Evelyn Partners