Ask the expert: I’m in my 40s. Should I start derisking my pension?
Fidelity personal finance specialist Marianna Hunt is back to help a reader who wants to retire early but is unsure on how to protect the value of their investments as they prepare to stop working.
Q: I’m in my late 40s and calculate that I’ve got enough saved into pensions to retire at age 57. I am still heavily invested in stocks and shares, with around 85 per cent of my portfolio in equity funds.
When does staying invested become reckless? At what age do I need to start de-risking my portfolio and how should I do that?
A: Well done, it is no mean feat to have saved enough to retire a decade or so before your state pension age (which is presumably 67 or 68).
Your question about de-risking is a crucial one. If people come to this question too late, they risk a stock market downturn hammering the value of their savings just as they want to access them.
The first thing to consider here is how you plan to access your pension savings. Do you want them flexibly via drawdown? Do you want to buy an annuity? Or do you want a blend of the two?
Your choice will be key in dictating your investment strategy in the next 10 years or so before retirement.
Drawdown from pension
Let’s start with drawdown. This is where you keep your pension savings invested and draw your income from those investments. In this scenario, you will want to ensure your pension savings continue growing in value so that they keep (and ideally beat) rising prices, otherwise inflation will erode your purchasing power over time.
It is therefore important to maintain some allocation to stocks and shares, particularly if, like yourself, you are retiring early and need this money to last for several decades. However, most retirees will balance this with lower-risk assets like bonds that could help to protect the value of their pot in a market downturn.
Many retirees will opt for something like a 60/40 split. For those more focused on growth, this might mean 60 per cent in equities and 40 per cent in bonds. Some might go for a straight 50/50.
There is no single right answer, it all depends on your risk tolerance. Some investors might include other asset classes in there for further diversification, such as gold or property.
Investing in retirement to ensure your money lasts is tricky, and some people may prefer to speak to a financial adviser for help with this.
Moving allocations
Once you’ve decided what your portfolio split will be, you need to gradually start moving your allocations from where they are now to your final intended destination.
For argument’s sake, let’s say your portfolio is currently 85 per cent stocks and 15 per cent bonds and you want to get 60 per cent stocks, 40 per cent bonds in 10 years’ time. To get there you need to reduce your equity exposure by around 2.5 percentage points per year.
If you’re still contributing to your pension, you could do this by directing new contributions towards your bond allocation. This avoids selling equities unnecessarily and means they naturally shrink as a percentage of your portfolio.
Where contributions aren’t enough, you could look to rebalance your portfolio once a year (or once every six months) to bring the portfolio to your target mix for that year. This is like how pension funds derisk people’s portfolios as they near retirement when they are in a so-called ‘lifestyle’ fund.
You will need to decide up front how you’ll handle big market moves.
Option one is to stay the course regardless of market conditions. Option two is to adopt a semi-flexible approach, de-risking a little faster after a year of strong equity returns and pausing equity reductions temporarily after sharp market falls.
You also need to consider what kind of bonds you are adding. Given the bonds are there to protect your capital, a good option would likely be a globally diversified fund investing in high-quality bonds with a short- to medium-term duration. This should reduce sensitivity to interest-rate movements while still offering diversification.
A stock market crash can do most damage in the early years of retirement, so some investors choose to derisk beyond their long-term target allocations (e.g. go down to 50/50 or 40/60) before re-risking a few years into retirement.
Buying an annuity
But what if you plan to buy an annuity? In this scenario, you really want to preserve the value of your pot and reduce volatility just before the purchase.
By the time you’re within two years of buying the annuity, many financial planners would expect something like: 0–20 per cent equities and 80–100 per cent bonds and cash-like assets. Here too, you’ll need to create a ‘glide path’ from your current allocations to your target allocations and have a plan for what you’d do in the wake of big market moves.
If you plan to use a blend of annuities and drawdown, then designate how much money you want to put towards each and plan your investment strategies for each pot accordingly.
We haven’t yet mentioned your tax-free cash. Some investors ringfence this portion of their pension for a purpose (e.g. paying off a mortgage, gifting to children, etc.), and segregate it from their wider retirement planning.
Finally, with all the above, we are assuming you are currently investing your equities in a sensible, diversified way. If you aren’t, the question of “at what point does this become reckless?” could be: “It already is!”
Please remember that this is not financial advice. Every person’s situation is unique, and, in many cases, it would be valuable to speak to a qualified financial adviser.
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