Why you should reconsider your pension withdrawal strategy during periods of market volatility.
Stock market volatility can be unsettling for investors of all ages, however much they’ve invested and whatever their objectives may be.
The market fluctuations triggered by the coronavirus outbreak and its impact on the global economy can have particular implications for investors taking income from their retirement pots, however.
There are two related concepts – or risks – at work in retirement investing that can help us understand why this is.
The risk of pound cost ravaging
The first is a twist on the pound cost averaging – or splitting up of the total amount of an investment into several smaller investments, in order to reduce the impact of volatility in the market – that investors benefit from when building up their pot.
“Pound cost averaging works for the investor when they are saving in a volatile market,” explain Tony Clark, Head of Retirement Marketing at St. James’s Place Wealth Management.
“But that turns on its head when you’re withdrawing retirement income in a declining market, because the unit price of your investments also falls, and you have to cash in more of your pot to maintain the same level of income as before.”
This less desirable outcome is known as pound cost ravaging.
…and sequencing risk
An associated peril, called ‘sequencing risk’, highlights the danger that the timing of withdrawals from your retirement pot can pose to your overall returns.
Simply put, taking money out of your pension in a declining market will cost you more than a withdrawal in a strong one, because – as a retiree – you’re no longer contributing new capital to your pot, and the withdrawals you’re making are not being offset by new gains.
Regularly taking an unsustainably high amount of cash out of a pot that’s steadily dwindling will, in turn, make recovery over the longer-term much harder – especially when a period of prolonged volatility coincides with the beginning of your retirement.
It’s at this point, when you still potentially have a significant number of years of retirement ahead of you, that your portfolio value is at its greatest – and also most vulnerable.
“It’s the taking of income at the outset that’s the significant factor,” affirms Clark. ‘It’s cruel maths. And it will often not be evident until a year or two down the line. Everything can work against retirement income pots when markets are volatile.”
Mitigating their effects
The good news, however, is that there are several ways to minimise the impacts of these risks.
They include having a cash fund to draw down from in times of volatility, so that equity investments are allowed to fluctuate and weather the storm. While this provides stability, however, any money held in cash will lose its value.
Another is to take only natural income – such as dividends – rather than drawing from the capital. The downside here is that income tends to fluctuate in volatile markets too.
If you’re able to, you could consider putting your withdrawals on hold for a while. The more you can leave invested, the more time your pot has to hopefully recover.
Being able to navigate difficult times may well be about the way in which your retirement income is structured. Different approaches work for different people.
“You need to be flexible,” says Clark. “You can have several income strategies. The art of managing market downturns in retirement is knowing exactly what to do and when – and that’s where our financial advisors really earn their stripes.”
If you’re worried about the effects of market volatility on your retirement income, or you want to understand more about making withdrawals during this period of uncertainty, McGrady Financial Services Ltd can help. Just ask.
The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select, and the value can therefore go down as well as up. You may get back less than you invested.