Emily Perryman examines whether the ‘traditional’ models of pension investing, such as lifestyling, can still be considered appropriate
An increase in the average life expectancy and the need for people’s money to work harder in retirement has called into question whether traditional models of pension investing are still relevant.
A recent paper by 7IM claimed that the old model, whereby pension savings are invested to automatically reduce risk as retirement approaches, no longer works for many people.
It argued that lifestyle pension funds could result in millions of people running out of money towards the end of their lives.
Chris Darbyshire, chief investment officer at 7IM and co-author of the report, warned that many investors “are sleepwalking into an uncertain retirement”.
He said if people reduce investment risk at the point when they are at their wealthiest, they reduce the enormous potential benefits of compounding.
Justin Urquhart Stewart, co-founder and head of corporate development at 7IM, added: “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.”
Income certainty
For many industry experts, the 7IM research does not tell the whole story. There are no guarantees that taking more investment risk will deliver higher returns.
Stephen Lowe, group communication director at Just, said the crucial point for retirees is not risk appetite but risk capacity, i.e. how much they can afford to lose before it undermines their ability to pay the bills.
Equity markets do not deliver consistent gains but tend to lurch about unpredictably.
“While accumulating, it is possible to ride out and even benefit from this volatility.
“As the pension fund grows and retirement nears, the money at stake gets larger and the time to recover from disaster gets smaller so there remains a strong case for some to shift to a more defensive investment strategy to stop a sudden asset price shock from derailing a plan to retire around a certain date.”
Lowe argued that the state pension is well-loved because it is guaranteed income – people can spend what they receive today knowing with total certainty that more is on the way next week and for as long as they live.
“The problem is that state pension income is set only just above subsistence level. Our view is that people should seek to guarantee the income they need – from state and company or private pensions – up to the point they know they can afford to pay their basic household bills for the rest of their lives.
“Once they have this certainty of income in place, they have complete peace of mind to invest, spend or give away the rest as they see fit. That is true pension freedom.”
No crystal ball
But others agree that lifestyle or target date funds do not fit the retirement landscape anymore.
Andrew Tully, pensions technical director at Retirement Advantage, said de-risking is still appropriate for people who want the benefits of an annuity or want to cash in or withdraw substantial funds.
But for those intending to use income drawdown, there is little point in de-risking because they want to remain invested for many years to come.
Tully explained: “The difficulty is people do not necessarily know 10 years in advance which group they will fall into. And even if they did, that would require them to take action, and therefore for someone to contact them.
“The beauty of lifestyling was that it was an automated approach requiring no customer intervention. In addition, many people do not take pension benefits at a specified age (e.g. 65), which was selected many years ago, so de-risking may be appropriate but it may be automated to the wrong target date.
“Others may only take some benefits rather than taking all, so a partial de-risking may be appropriate.”
Another point to remember is that retirement is no longer viewed as a “cliff edge”. Many retirees take a phased approach to retirement, expecting to continue to work in some capacity beyond the traditional retirement age.
Others may want a blend of guaranteed income and drawdown, giving a combination of certainty and flexibility from their retirement savings.
“People who want to use drawdown need exposure to real assets – however many may also want to limit their risk,” said Tully.
“One option is to use a lower volatility fund which has an element of protection. This type of fund aims to provide a smoother journey through retirement and provide a high level of protection from major falls in stock markets.”
The meaning of de-risk
The crux of the argument is what exactly is meant by “de-risk”. Jenny Holt, head of customer and workplace proposition at Standard Life, pointed out that the 7IM research is very focused on the amount of investment risk people are taking once they start to draw an income.
“It is fair to say that the main purpose of lifestyle profiles has historically been to reduce the risk of changes in the amount of ‘purchasing power’ that a customer has as they approach retirement, by investing in assets that moved broadly in line with annuity rates.
“But now there are more options and the majority of people no longer choose to buy an annuity.
“Unless they are targeting a specific outcome, lifestyle profiles need to be designed to strike a balance between reducing a number of slightly different risks that people may face, depending on the choice they make when they come to retire.”
Standard Life’s lifestyle profiles gradually move customers into a diversified, lower volatility asset mix as they approach retirement, which is designed to reduce risk for customers whether they choose to take their benefits as lump sums, an annuity or flexible income.
“As the asset mix still includes a reasonable allocation to equities, then it helps to address the point that 7IM are making about remaining exposed to growth assets,” said Holt.
The research certainly raises some important questions for people to consider as they near retirement – a time when financial planning can offer the most value to clients.
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