Planning for Retirement?: Engage Guide To Wealth Management
Part 2: Investment Strategies
Investing for retirement is about balancing the need for growth, to protect against inflation and provide the income you need, and the need to protect your capital so it is available to fund your expenditure.
Your investment strategy should evolve as you approach the time when you transition from accumulating wealth (adding to your savings while you are working), to spending your savings in retirement. The investment strategy should ideally be flexible so that it can evolve over time with your changing needs and provide for you in the short, medium and long term.
Accumulation Phase (Pre-Retirement)
During the accumulation phase, one of your goals is to grow your savings for retirement. This typically involves investing in assets that include:
Equities (Stocks): Historically, equities have offered higher returns than other asset classes. Investing in a mix of UK and global companies can provide growth potential.
Bonds: Bonds have historically been less volatile than equities over the longer term and provide a known level of income through interest payments. Government and corporate bonds can offer favourable investment characteristics when used alongside equities in an investment portfolio or pension.
Transition to the spending phase (Approaching Retirement)
As you near retirement, you should gradually shift your portfolio towards your shorter and medium term investment needs. The goal is to reduce sequencing risk; the risk of significant short term losses as you approach retirement, and the need to draw on your investments.
Strategies include:
Managing Equity Exposure: Holding enough exposure to equities to provide medium and longer term growth to manage inflation risk, whilst also not being overly exposed and needing to sell these investments during a cyclical low. This will help reduce the risk of market volatility eroding your retirement savings.
Managing Non-Equity Investments and Savings: Ensure these are working efficiently and aren’t creating undue risk, whilst providing the required return profile. This could include cash savings or interest paying bonds.
Diversifying Sources of Investment Return: Ensure that investments are well spread to reduce the reliance on any single investments and reduce the risk of any single investment underperforming. It’s worth remembering that the available time to recover from more risky or speculative investments is significantly shorter at that time and these risks should be reviewed.
Spending Phase (Retirement)
During this decumulation phase, your primary goal is to draw from your retirement savings in a sustainable way. Sources of retirement income include:
Annuities: An annuity provides a guaranteed income for life. You can purchase an annuity with a portion of your pension pot, ensuring a stable income. You potentially give up future income and capital value after your death for guaranteed income during your lifetime.
Phased Pension Drawdown: This allows you to withdraw money from your pension pot while keeping the rest invested. The tax implication is explained later in the guide. This provides flexibility but because there is no guaranteed income the amount that can be drawn will be dependent on the future returns of the pension investments. Poor returns and high withdrawal rates could mean that you outlive the investments.
ISAs: Individual Savings Accounts can be drawn on tax free.
Investment Bonds: Both onshore and offshore bonds can provide income streams and deferred tax on growth.
Cash Savings: Cash savings are unlikely to keep pace with inflation over the long term, but remove investment volatility in the short term. Cash savings are lower risk, and the level of risk will depend on the security of the provider you save with.
NS&I: National Savings and Investments offer various savings accounts that can be accessed as part of your overall retirement strategy.
Managing Investment Risk
Managing risk is crucial during the decumulation phase. Here are some risks to consider and potential strategies to help manage them:
Order of Returns (Sequencing) Risk: The order in which you experience investment returns can significantly impact your retirement income. Negative returns early in retirement can reduce your portfolio’s longevity. To mitigate this risk, consider maintaining a cash reserve to cover periods of expenditure when investments are falling in value.
Longevity Risk: There’s a risk you may outlive your savings. Annuities and lifetime income products can help mitigate this risk.
Inflation Risk: Inflation erodes the purchasing power of your income. Careful consideration should be given to managing this risk. Some Inflation-linked products might be expensive to buy and therefore not offer the ‘inflation-protection’ desired.