Many of our clients at Tideway either have a current or a historical defined contribution pension(s) that they have contributed to during employment. Many of these pensions are invested in what is known as a Lifestyle strategy, rather than investing into individual funds that are aligned to their risk profile and objectives. But what exactly are Lifestyle strategies and how are they managed?
Lifestyle strategies were first introduced in the 1980s and remain the default investment style of choice for most employers with defined contribution pension schemes (these include many workplace arrangements). Lifestyle profiles may initially invest in growth assets, such as global equities, commodities etc, which can have a higher level of risk attached to them but offer greater long term return potential. The initial split of investments depends on which date the employee nominates as their ‘retirement date’ on the form they initially complete when setting up their pension.
As the member approaches their nominated retirement age, funds are progressively switched into less volatile investments, such as cash and gilts. Ultimately, they are designed with the aim of using the pension to purchase an annuity at retirement; the ‘de-risked’ funds aim to shelter the portfolio against market falls immediately prior to retirement.
Like most financial products, pension planning has evolved considerably since the 1980s and now, for many savers, this strategy can present several drawbacks:
· The timing of the switching from higher to lower risk investments is based on a pre-determined retirement age that will likely have changed, particularly if the plan was started at the beginning of a person’s career.
· Less than 10% of pension funds are now used to purchase an annuity; currently annuity rates offer really poor value for money when comparing the purchase price to the level of income they can provide (see graph below).
· Cash and gilt rates are currently very poor and therefore members are losing out on growth potential in the years leading up to retirement.
· Investors in this strategy may be faced with low, zero or negative growth prior to retirement and low annuity rates at retirement if they decided to purchase an annuity.
· Retiring at age 60, for example, still means having a pension, invested, for perhaps 30 years or more, thus requiring some long-term investment planning.
· Many people are retiring later, phasing retirement and the simplistic automatic switching process may have commenced prematurely, resulting in limited growth.
Here is a chart showing the yield of the 10-year UK gilt, a reasonable proxy for the broader gilt market. The yield is currently 0.8%, down from some 14% in the early 1980s. As noted earlier, and as highlighted in previous pieces, with inflation and interest rises a likely possibility in the medium term, investing into government bonds currently offers really poor value and could well erode capital significantly. In our view, this is not a low risk investment option at present.
Today, more individuals are choosing a flexible drawdown retirement and will therefore remain directly invested beyond their retirement date. This throws in to question the need for fully de-risking funds. Once in retirement, liquidity is needed to meet immediate and short-term income needs; on the other hand, investment growth is required to support future needs, together with protection against long-term inflation.
Tideway’s Horizon approach is specifically designed for individuals looking to use income drawdown in retirement with a view to deliver stable returns ahead of inflation. The portfolios reflect the realities of a more complex investment arena and changing personal circumstances, allocating capital into three broad time horizons. In the current financial landscape, Horizon planning should be given as much attention as asset allocation when building any retirement portfolio.
So, if you are still employed and have a workplace pension, check the underlying investment strategy. If you are invested in a Lifestyle strategy, check the options you have for switching investments. Likewise, if you have recently left employment or have a legacy pension, it is worthwhile checking the strategy of these too.
Your wealth manager will be able to help with reviewing your existing pensions and ensure you are invested appropriately.
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