When you approach or arrive at retirement, there are some important considerations to make when it comes to managing your pension or ISA pots
By Edmund Greaves
Like most people, the chances are you will want to convert the savings you have built up through your working life into an income to replace a salary.
That means investing for an income becomes the most important aspect of any portfolio at retirement.
But there are also other considerations. It’s also important you maintain the capital value of some or all of your portfolios to ensure it continues to support you throughout your golden years.
Depending on what age you retire, you could be retired for 30 years or more. A 55-year old male today is expected to live to the age of 84 or 87 if you’re a woman, according to the Office for National Statistics. In fact, if you’re female and 55 now, then you have a one in four chance of living to be 94-years-old while males have the same odds of living to be 92.
This means at 55, the age at which you are given access to your pensions, you could be looking at more than 30 years of retirement, depending on how fit and healthy you are.
The value of investments can fall as well as rise and any income from them is not guaranteed and you may get back less than you invested. Past performance is not a guide to future performance.
EQi does not provide investment advice. If you are in any doubt as to the risk or suitability of an investment or product you should seek advice from an independent financial adviser.
The extent and value of any ISA tax advantages or benefits will vary according to the individual's circumstances. The levels and bases of taxation may also change.
With that in mind, income and the preservation of the value of your portfolio should be your top priorities. Once you reach a point in your life where you have access to pensions or have enough saved to feasibly think about creating an income to retire on, your mixture of investments should largely reflect that.
First and foremost, if your aim is to create an income, when you buy units in investment funds you should make sure the name of the fund has “Inc” on it instead of “Acc”. Many types of investment funds will have either/or. For example you can buy Evenlode Income as either accumulation or income classes with the following monikers:
Both types invest in the exact same way. But the “Inc” version will pay any earnings, such as company dividends, as cash into your portfolio rather than reinvesting it into more units of the fund.
However, it may be the case, especially if you retire young, that you want to achieve portfolio growth, rather than just maintenance. That isn’t necessarily a bad thing, but you should be more conservative with what kinds of investments you buy as a series of bad investments could leave your pension pot in tatters.
Higher-risk companies and funds offer the greatest opportunity for growth but also the greatest risk of setbacks Looking for lower-risk opportunities is preferable.
Most income-focused investment funds will offer to provide both income and capital growth, or preservation at least. This is worth bearing in mind alongside income because inflation will devalue your portfolio if it isn’t at least keeping pace with that level.
For instance, inflation in the last 30 years has averaged at about 3.1% per year according to the Bank of England. That means in order for your portfolio to not lose any value over time, it needs to be aiming to achieve this level of growth each year.
Once you’ve decided how much of your portfolio to allocate to income or accumulation, you need to consider how you’ll achieve that.
To generate an income, you’ll want to target companies – either by buying shares or into a fund – that pay dividends, which are semi-regular payments made to investors. Luckily for UK investors, there are a lot of firms based here that pay dividends.
However, remember that the share prices of companies can fluctuate, which can cause problems if you are in retirement and are reliant on your pot to pay you an income. That’s because the income you are paid will drop when your pot falls in value.
For that reason, it may be a good idea to consider investing a proportion of your portfolio in bonds. Bonds are debt guarantees issued by either governments or businesses. As a rule of thumb, government bonds are safer than company bonds, but this depends slightly on which government. For instance, the UK government’s bonds are judged much safer than a country such as South Africa.
Bonds are considered a safer bet than shares but they also offer much lower returns. So think carefully before dedicating too much of your portfolio to them. Ideally, you will want a combination that allows your portfolio to generate an income while growing or at least maintaining your overall pot.
Bonds however do also change in value and the yield that they deliver. Over time a good quality bond fund will provide some capital growth alongside income, albeit more modestly than shares. Conversely though, in times when markets are bad, bonds will typically hold their value much better than equities.
Finally, when managing your portfolio for retirement, it pays to be diverse in terms of the assets and geographies that you invest in.
For example, it might be a good idea to invest a small part of your portfolio in gold, which is considered a ‘safe haven’ and often offers some protection when markets are choppy.
Another very important aspect to think about is having some liquidity in your portfolio. Or, in other words, it’s a good idea to hold some cash. There are two reasons for this.
Firstly, holding some cash – around 5% of your total portfolio is usually about right - will offer some protection if markets fall. This cash can also be used to help maintain your income when your investments may not be paying as much. A cash buffer can prevent you from being forced into selling investments in order to maintain an income, something that will just crystallise any losses you have made.
This can be held in an easy-access cash ISA, although the interest rates on these tend to be very low these days. Make sure if you’re transferring money from a pension or ISA to put the money into a cash ISA not a savings account as this way it will retain its tax-protected status.
Secondly, having cash in your portfolio can provide you with an opportunity to buy when markets have lost value, and there are suddenly a lot of bargain shares and funds available to be snapped up. Of course, if this is something you’d be keen to take advantage of, make sure to do your research beforehand, as not everything will bounce back and pay dividends in short order.
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This article was written by Edmund Greaves, personal finance journalist.
The views and opinions expressed by the author may not necessarily represent views expressed or reflected by EQi.