7IM RESEARCH SHOWS DE-RISKING AS RETIREMENT APPROACHES NEEDS RE-EXAMINING IN A CHANGING WORLD
- 7IM calling on Government, post-election, to mandate time to make this issue a national conversation and financial education is key
- The world has changed: people are living longer, annuities are no longer the only option, and income is harder to come by
- £100bn of pension savings are invested to automatically reduce risk as retirement approaches, but 7IM research shows the model no longer works for many of us
- A small difference in investment risk can make a big difference to outcomes
With fewer people now buying guaranteed-return annuities at retirement, and in a changing world where people are living longer and money needs to work harder, Seven Investment Management (7IM) have published a discussion paper examining old assumptions for retirement.
Published today and independently reviewed by actuaries at OAC*, the paper reveals the strategy of reducing investment risk as retirement approaches may leave millions of people running out of money towards the end of their lives. 7IM ran a range of scenarios through different market cycles based on 7IM funds across the risk profiles.
7IM’s research challenges the assumptions of default ‘lifestyling’ pension funds that gradually switch from equities to bonds as the investor nears retirement. It is estimated that over £100bn is invested in such funds**. 7IM is calling on the next Government to make this a national conversation and financial education is key to this.
Chris Darbyshire, Chief Investment Officer, 7IM and co-author of the research said: “The world has changed. With a huge number of default pension funds automatically reducing risk as retirement approaches, many investors are sleepwalking into an uncertain retirement. We are not saying reducing risk isn’t right for some people, but this is a conversation that needs to be happening. Investors should not underestimate the power of compounding. By reducing investment risk at the point when you are at your wealthiest you reduce its enormous potential benefits.”
Echoing this, Justin Urquhart Stewart, Co-founder and Head of Corporate Development, 7IM said: “Taking your foot off the gas as retirement approaches is often precisely the wrong thing to do, but millions are in products doing this automatically and probably don’t even know it. It might be the right strategy for some people, but it absolutely won’t be right for everyone – and it’s time we all got talking about it. That goes for any new Government, too, who need to mandate time on this issue, and financial education should be absolutely central to this.
“It’s also worth taking advice from a financial adviser on this – yes, advice will cost you but nowhere near as much as being in the wrong retirement strategy.”
7IM research looks at a number of scenarios. 7IM’s research has modelled returns for two investors who each saved an average of around £7,500 a year from the age of 30 to 60 (starting with £500 and increasing by £500 in each year of employment), retiring with an annual pension of £22,000 a year. The amounts used in the discussion paper were larger*** but the conclusions are consistent. The principles that follow are the same whether you save £20,000 or £2,000 and draw £60,000 or £6,000.
One saver invested in a moderately cautious portfolio targeting a return of 4% a year; the other took a step up the risk ladder, investing in a balanced portfolio targeting a return of 5% a year.
At retirement the first had a portfolio worth around £375,000 and the second had £425,000. The first ran out of money at 86, having withdrawn £22,000 per year. The balanced investor still had around £275,000 left at this point, demonstrating how a very small increase in investment risk can make a remarkable difference to outcomes when pension pots are at their greatest, in retirement, and the effects of compounding are at their most potent.
What about when markets are volatile?
Markets don’t perform in consistent straight lines, so 7IM then ran the portfolios through a range of outcomes drawing on the historic volatility experienced by investment portfolios between January 2004 and January 2016.
Matthew Yeates, Quantitative Investment Manager, 7IM and co-author of the discussion paper, said: “This 12 year period included the global financial crisis, the Eurozone crisis, taper tantrums and flash crashes. Income was taken out monthly to reflect real life, ensuring any losses were locked in. The expected scenario was the midway point between the best and worst outcomes. On a scale of one to 10 (with 10 being the worst case scenario), the bad scenario was number eight – not quite financial Armageddon but pretty bad.
“In the expected scenario the moderately cautious investor ran out of money at 86. The balanced investor was still going strong at 100. But it is what happened in the bad scenario that may surprise investors. The moderately cautious investor ran out of money at 79. The balanced investor’s money lasted another four years – to 83.”
Let’s make it even tougher
7IM research went a step further. They made bad really bad, turning the dial up to nine – even closer to financial Armageddon. This was the equivalent of investing at the worst possible time – just before the 2008 crash on 6 July 2007 – and then staying invested until near the bottom of the market slump at the start of 2016 (19 January). For good measure, the analysts imagined that at this point the crisis began all over again – meaning they excluded the 10-15% rally that many funds enjoyed after the 2016 correction, for instance.
They also assumed the investor hadn’t been enjoying the benefits of taking more risk in the build-up to retirement but had got the expected return of the lower risk fund in accumulation. Both portfolios started at exactly the same level when the investor retired at 60 – with a pot of £375,000.
In the really bad scenario both portfolios ran out at 81. The volatility of the higher risk fund was higher but even in this particularly scary world the benefit of the higher expected return helped to offset this over time.
Matthew Yeates, Quantitative Investment Manager, 7IM continued: “The research suggests that in the vast majority of circumstances investors would be better off leaving more of their portfolios in equities at and into retirement than they have done traditionally.
“We aren’t saying investors should take more investment risk than they are comfortable with, but they need to understand that by choosing lower-risk investment options they may be increasing the danger of running out of money in retirement – and they certainly shouldn’t do it automatically without thinking the issue through. It’s also worth bearing in mind that investment risk is not the only lever to pull when making investment decisions – longevity risk and event risk are other levers to pull. For example, how long you might choose to work, how much you plan to financially help your children – attitudes towards investment risk should not necessarily be viewed in isolation.”
Pete Matthew, Chartered Financial Planner, Jacksons Wealth Management in Penzance, said: "Arguably the time when the financial planning process can offer the most value to a client is the great transition from accumulation to decumulation. Planners and their clients need to factor in many variables to determine how long clients' money will last, and portfolios need to be managed more intelligently than ever. Automatic lifestyling just doesn't cut the mustard any more, and advisers need tools to be able to manage money and, more importantly, client expectations."
The 7Imagine app:
- 7IMagine allows anyone to capture details about their own and their families’ finances in as little as 10 minutes. A wealth of options can be incorporated into any scenario and include any number of streams of income, properties and other assets.
- Via iPad, Android tablet or PC: an easy to use cash flow planning tool, My Future, allows investors to take a look at their portfolio and see how much more they would need to save each month to reach their long-term financial goals in a very visual way. It is quick, flexible and easy to populate.
- For existing 7IM clients they can view their valuations, performance, asset allocation and where their investments are placed around the globe in an interactive way.
For further information, please contact:
PR Manager, 7IM
Quantitative Investment Manager, 7IM
Chartered Financial Planner, Jacksons Wealth Management
020 3823 8696
020 3823 8401
07776 204 610
Notes to Editors:
* The 7IM research was reviewed by an actuarial firm, OAC, who deemed our methodology as appropriate and conclusions consistent with analysis up to the 90% probability level.
** Source: Which? Money estimated around £100bn is in ‘lifestyled’ pension products, April 2016.
*** In the discussion paper, 7IM modelled returns for two investors who saved £20,000 a year from the age of 30 to 60, retiring with an annual pension of £60,000 a year. One saver invested in a moderately cautious portfolio targeting a return of 4% a year; the other took a step up the risk ladder, investing in a balanced portfolio targeting a return of 5% a year. At retirement the first had a portfolio worth £1m and the second had £1.15m. The first ran out of money at 86. The balanced investor still had over £800,000 at this point.
7IM then ran the portfolios through a range of outcomes drawing on the historic volatility experienced by investment portfolios between January 2004 and January 2016. In the expected scenario the moderately cautious investor ran out of money at 86. The balanced investor was still going strong at 100. But in the bad scenario the moderately cautious investor ran out of money at 79. The balanced investor’s money lasted another seven years – to 86.
7IM research then went a step further. They made bad really bad, turning the dial up to nine, the equivalent of investing at the worst possible time – just before the 2008 crash – and then staying invested until near the bottom of the market slump at the start of 2016. For good measure, the analysts imagined that at this point the crisis began all over again – meaning they excluded the 10-15% rally that many funds enjoyed after the 2016 correction, for instance. They also assumed the investor hadn’t been enjoying the benefits of taking more risk in the build-up to retirement, so both portfolios started at exactly the same level when the investor retired at 60 – just over £1m.
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