31 Mar 2015
The government’s radical pensions overhaul gives pension savers much more freedom than they had previously. While annuity purchase will remain an option for those wanting the security of a guaranteed income, it will no longer be compulsory – pension savers seeking greater control of their finances will in future be able to remain invested and draw down their pension as they see fit.
Clearly, the reforms will make a huge difference to the investment choices that individuals make regarding decumulation – the period where pension assets accumulated during an employee's working life are converted to retirement income. Specifically, the challenge is to invest the pension pot so that it can both preserve capital and provide growth, while simultaneously providing a regular and sustainable income.
How can pension savers be sure their pension pot will see them through retirement? Our own studies have revealed that a number of factors are crucial in determining the effectiveness of the investment strategy in maintaining dependable and sustainable income.
Firstly, our research suggested that taking investment risk is generally worthwhile – the returns from investing in global equities were likely to last substantially longer than placing the same amount of cash on deposit.
However, our studies also revealed that the effects of market volatility can be significant and, in certain circumstances, extremely damaging. Moreover, these effects are amplified as the pension pot diminishes. This is because if income is withdrawn when share prices are weak, then more shares must be sold to raise the same amount of money – an effect called ‘pound cost ravaging’.
Therefore, managing market volatility is paramount if we are to ensure good retirement outcomes.
In this regard, multi-asset absolute return and risk-controlled funds can play a vital role, given their demonstrable benefits in delivering consistent, low-volatility growth. For instance, an enhanced diversification approach could be used to give investors access to growth assets while also dampening short-term market swings. So, by allocating most of the fund to global equities and a portion to diversifying multi-asset positions, we can seek equity-type returns but with, say, two-thirds of equity market volatility.
Additionally, alongside these active management approaches we can incorporate simple payout controls to further enhance capital preservation and make the pension pot go further. For example, by withdrawing less when markets are weak, we can reduce pound cost ravaging and preserve capital. We can fine-tune this approach by including a withdrawal cap, limiting the maximum single withdrawal to, say, 15% of the pension pot.
Through investment approaches such as these, we aim to help pension savers achieve their retirement goals with far greater certainty.
See more about Standard Life Investments in Tools & Resources
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