A reader wants to know whether having their retirement pot invested in the stock market is too risky
In our weekly series, readers can email in with any question about retirement and pension savings to be answered by our expert, Laith Khalaf, head of investment analysis at investment platform AJ Bell. There is nothing he does not know about pensions. If you have a question for him, email us at [email protected].
Question: I’m five years from retirement, should I move my pension into cash to avoid stock market crashes?
Answer: In the run-up to retirement, it’s natural to think about reducing risk. But how you go about it very much depends on what you’re planning to do with your pension when you hit your chosen retirement date. If you’re planning to simply take all your pension as a cash lump sum, then yes, it does make sense to move out of a fund allocated to shares and bonds, and into cash.
You would probably want to do this gradually though, over the five years until your retirement. That way you might continue to experience some stock market growth while also increasingly protecting the capital value of your pension by steadily building up cash.
Most people with reasonably sized pension pots probably won’t take their pension entirely as cash, but will instead opt for an annuity – a guaranteed regular income for life – or keep their pension invested (via a ‘drawdown’ plan).
Either of these options requires a different approach to investing as you approach retirement. If you’re looking to buy an annuity with your pension pot, then the traditional investment strategy in the run-up to retirement is to buy an annuity-hedging fund, which invests in long-dated bonds.
Annuity-hedging funds – also known as lifestyling funds – invest in long-dated government and corporate bonds, with the objective of hedging annuity rate movements.
They work in this way because annuity rates are determined by bond yields – essentially interest rates – which move in the opposite direction to bond prices.
Switching into one of these funds as you approach retirement can be a good idea if you’re going to buy an annuity with your pension, because any falls in annuity rates are made up for by rises in the value of your lifestyle fund.
Conversely, if bond yields are on the up, your lifestyling fund might be falling in value, but annuity rates should be rising, again broadly maintaining your level of retirement income.
By gradually switching your money across into an annuity hedging fund bit by bit, you can also leave some of it exposed to the stock market for growth. That exposure is an increasingly small part of your overall pension as you approach the point of retirement, to reduce your risk.
If you’re planning to keep your pension invested after retirement and take an income from it, via a drawdown plan, then you’ll need a different strategy again. It’s likely you’ll continue to take some stock market risk after retirement, so you don’t want to totally do away with it.
If you know what you’re going to be invested in after retirement, then it makes sense to gradually transition your pension towards your chosen post-retirement portfolio.
For many people this will be a combination of stock market funds and bond funds. A lot of investors choose a multi-asset fund which is a one-stop shop that bundles up stocks, bonds, cash, and sometimes other assets like property and gold too.
Many people won’t have a good idea what the shape of their post-retirement pension portfolio will look like. Indeed many people won’t know for sure if they’re going to buy an annuity or invest their pension via drawdown, or indeed a combination of the two, until they’re closer to retirement.
In this instance, gradually moving your pension into a multi-asset fund might work until you make some concrete decisions. These funds come in a variety of risk profiles so you can pick one which suits your own appetite for risk.
They are less risky than the stock market at large because they diversify across shares, bonds and cash. But they are not risk-free and can fall in value. However in the absence of any firm decision about how you’re going to draw you’re retirement income, they can serve as a holding position until you move in one direction or another.
Whichever route you take, you may also want to build up some cash to be ready to take your 25 per cent tax-free cash lump sum at retirement. It’s also a point at which you might benefit from financial advice, because there are lots of options to consider, and your pension is probably at its peak value.
