W
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HOW SHOULD YOU INVEST YOUR
PENSION FOR INCOME DRAWDOWN?
by Sam Hulson of First Equitable
The decisions you make about how best to structure and invest your
pension for drawdown over your retirement years are likely to be amongst
the most important financial decisions you will ever need to make. For
simplicity here we are going to assume that you have already opted against
purchasing an annuity and decided that the flexible drawdown route is the
path that you would like to take.
What are the main strategies used for drawdown?
Drawdown is now very flexible and provides a number of options for
individuals to consider:
Leave the fund invested to grow
If you don’t have an immediate need for the income and can afford to leave
the fund invested, investing for capital growth may still be a sensible option.
However, ensuring they at least keep pace with inflation will be important so
that your money retains its purchasing power. Taking a large cash position
for too could have damaging effects on the real value of your funds over time.
Limit withdrawals to only the income from the investments
For those that have large enough pots relative to their income requirements,
then one option is to draw only the income that the investments produce –
known as the natural yield. The fund can be structured to focus on generating
a stable (and ideally growing; so as to protect against inflation) income stream.
This type of strategy can help allow an investor to shift their attention from
the worry about the day-to-day prices of their investments (otherwise known
as “market noise”) and keep the focus primarily on the sustainability of the
income that is being received
Draw from the capital
Whilst having a portfolio that produces a natural yield of income sounds
ideal; the reality is that it won’t always be possible unless the size of your fund
is sufficient relative to the amount of income you require. Taking excessive
risk trying to chase yield is a game most investors would be wise to avoid.
Another option then is to draw part growth (hopefully!) and part capital. This
is achieved simply by selling investments periodically to generate income.
Some important considerations
There are various considerations here and in particular this will involve your
appetite for risk and your capacity for loss. Appetite or tolerance for risk can be
defined as the degree of variability in investment returns that you are willing to
withstand. Capacity for loss is slightly different, as this considers your ability
to absorb falls in the value of your investments, and whether any loss of capital
would have a materially detrimental effect on your standard of living.
Consider a lifetime cash flow analysis
By plotting the various inflows and outflows over your lifetime, a lifetime cash
flow analysis can provide visibility and clarity on how decisions taken today
can affect your future. This can help you to align your finances to meet your
goals.
Ensure you have diversification
It is a basic fact that all investments carry risk. While investment risk cannot
be removed completely, by spreading your money in a range of investments
you can reduce its effect through diversification. However for diversification
to be effective, an understanding is required between the correlations that exist
between different asset classes and the market forces that drive their returns.
True diversification comes when the portfolio has exposure to a range of assets
that are driven by different market forces; each asset class will go through
periods of positive and negative performance, but rarely all at the same time. If
constructed properly then this can provide a smoother ride – especially when
things take a turn for the worse.
Keep some cash
It would be considered prudent for any drawdown investor to consider holding
at least one years’ or possibly two years’ income as cash if your investments are
not relying on natural income but growth to fund withdrawals. This will let
you draw the income you need without having to sell any of the investments.
Should I take financial advice?
If your investment holdings are largely based on “top tips” from financial
columns or from looking over lists of “best performing funds” you might want
to take a step back before committing to any plan. If successful investing really
was that simple, there would only ever be one fund that everyone needed to
invest in – it’s called “the top historical return fund!” Taken in isolation, this
kind of investment strategy is a little bit like driving down the motorway at 80
mph whilst looking in the rear-view mirror!
Let us help
At First Equitable we are passionate about building long lasting relationships
with our clients and helping them achieve their financial goals and objectives.
We believe that income drawdown is a key area where the expertise of a
professional and experienced financial adviser can really add value for a lot
of clients.
To arrange your free initial consultation, or if you would just like to ask
a few questions: please give us a call or complete an enquiry form via our
website. You can also email me at: sam.hulson@first-equitable.com
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