The classic ‘lifestyle’ approach to investment risk, where bonds and equities are rebalanced in a fund as an investor gets older, can no longer be seen as the rule of thumb for advisers, according to 7IM.
Speaking at a roundtable event on 22 May Seven Investment Management (7IM) quantitative investment manager Matthew Yeates said the default method of ‘de-risking’ a portfolio by opting for a lower risk investment in later life threatened to leave people short of money in retirement.
7IM chief investment officer Chris Darbyshire added the industry had been stuck in a traditional investment risk mindset and had failed to effectively communicate that risk now included not having enough money to last the entirety of retirement, as well as the fear of taking too much risk.
The pair said a single percentage point in extra risk taken could make a £275,000 difference in later life, based on an average pension.
They called on the next government, following the General Election on 8 June, to make the discussion about risk a “national conversation” through financial education.
Darbyshire said: “I think the industry has continued with this way of thinking because it got into a groove and found a business model that works.
“And once you have a business model that works that thing is a proverbial ‘super tanker’ that cannot be moved off course.”
Jacksons Wealth Management Chartered financial planner Pete Matthew agreed. He said: “It’s been an easy sell for the provider and the adviser.” He argued advisers could no longer rely on this ‘file and forget’ default investment strategy.
‘Remarkable’ difference in outcomes
7IM had examined the effects of various approaches to investing in later life by modelling returns for two investors who saved an average of £7,500 a year from ages 30 to 60, retiring on an annual pension of £22,000 a year.
One saver invested in a moderately cautious portfolio that targeted a return of 4% a year, while the second invested in a balanced portfolio with a targeted return of 5% a year.
At retirement the first investor had a portfolio worth about £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 The first ran out of money at 86, having withdrawn £22,000 per year.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 about £275,000 left at this point.
Despite these findings 7IM found an estimated £100bn was still invested in ‘lifestyle’ pension products.
7IM said it did not want to encourage investors to make large jumps in risk but to consider how a very small increase in investment risk could make a “remarkable” difference to outcomes when pension pots were at their greatest in retirement, and the effects of compounding were at their strongest.
Continuous de-risking
Yeates explained investors needed to think about risk like a series of tools, or ‘levers’, that could be utilised at different points of saving.
He said: “When you’re younger, the saving lever is more powerful as there is more impact to be made to your savings but as you reach retirement, this pot will have grown relatively large compared to your salary. At this point the investment lever therefore becomes more powerful.”
Darbyshire said: “You have an opportunity, not a risk with retirement wealth but a lifestyle strategy purely sees this as a risk and wants to continually de-risk you.”
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