James Baxter talks about the retirement jouney and how people should approach their pension at each stage of their life.
How to manage a large pension pot
One school of thought suggests large pots should be lower risk, to avoid huge falls in capital
If you have 20 or more years until you retire, you might be inclined to target high-growth investments with all of your pension money, and this remains a tried and tested approach for the vast majority of savers. But there are circumstances in which you could consider investing part of your pot via a more balanced allocation. James Baxter, managing partner of wealth manager Tideway, suggests that if your pension reaches a value worth around 15 times your annual contributions, you could consider combining it with a slightly lower-risk approach. This would reduce the risk of large falls in value of this portion in any given year, and the size of the pot would mean your annual return, on average, could still exceed what you are putting in. “A good compounding return will have a bigger impact than future contributions,” he says. “Consider a risk/return trade-off for the accumulated fund to avoid a big capital loss that may set planning back many years.”
Even in this case, you should continue to put new contributions into higher-risk, growth-focused investments. If these contributions are a regular, fixed amount of money they will benefit from ‘pound cost averaging’: where you contribute the same amount each month, and so over time average out the valuations at which you invest. Splitting your pension pot into two parts may lend itself well to your circumstances – for example, if you are making contributions to your current employer’s pension scheme but also have pensions from former employers to which you are not contributing, perhaps consolidated into a self-invested personal pension (Sipp). You could manage the pensions to which you are not contributing via a slightly lower-risk approach.
While changes depend on individuals’ circumstances, you could, for example, switch the pension funds you have already built up via a growth-focused investment strategy to the following allocation: 20 per cent investment-grade bond funds, 20 per cent high-yield bond funds, and 60 per cent in a mix of growth, value and income equities. “The impact is roughly a reduction in forward return expectation from 5 per cent a year after costs and inflation to 4 per cent, but also a reduction in peak-to-trough loss of around 45 per cent for pure equity to around 28 per cent,” says Baxter. “Thinking about the impact of the loss, a 45 per cent loss when earning 5 per cent after inflation and fees might take nine years to recover, whereas a 28 per cent loss earning 4 per cent after fees and inflation might take around seven years.”
However, Baxter admits that a strategy of running pensions you have already accumulated in a lower-risk way “is not an exact science. We only have past experience to go by and the next market downturn will in some ways be different to any that have gone before.”
There are still compelling reasons why you should take a higher-growth approach with most or all of your pensions, other planners argue – not least because the lifetime allowance is due to be abolished from next April. Strong growth within a large pension will no longer mean that its value breaches a pre-set limit (of just over £1mn), and nor will it incur a tax charge as a result.
Pensions are also a good vehicle in which to hold growth assets because they can grow free of capital gains tax, and pass to beneficiaries after you die free of inheritance tax. So if you have enough assets outside your pension to fund your retirement it could make sense to use those up and leave your pension invested via a high-growth strategy for your beneficiaries. “There is an argument that you need a balance between growth assets such as shares and property, and non-growth assets such as cash and fixed interest,” adds Michael Lapham, director at Mercer & Hole. “But if you have 20 or 30 years until retirement, why play safe? You [should] get some growth over time.” Clearly, you need to consider your timeframe and risk appetite, and what you want to achieve in terms of size of pot and income. “For example, if you are x years from retirement and have a pot worth y – is its value enough to achieve what you want?” says Lapham. “What growth level over inflation do you need to achieve your objectives?”
The portion of the pension which is focused on growth assets can include the likes of index tracker funds, and smaller companies and technology stocks. Ways to get exposure to smaller companies include Abrdn Global Smaller Companies (GB00BBX46522). If you do decide to rebalance some of your pot more cautiously, it could be invested in a more diverse way to make real returns of at least 2 to 4 per cent a year after costs. “You no longer need high risk to beat inflation if it comes down below 5 per cent [as now expected],” says Baxter. “At the moment, some bonds are locked into these returns for 20 years plus.” Investment grade corporate bond yields are now just over 6 per cent so if inflation gets below 5 per cent, corporate bond funds will offer positive real returns above inflation after fees.
For exposure to investment grade corporate bonds rated BBB- or higher – types of bonds considered less likely to default – he suggests Artemis Corporate Bond (GB00BFZ91W59). At the end of May, 40 per cent of its assets were in bonds with a maturity of over 10 years. “It’s been very expensive to own longer duration bonds with interest rates and inflation rising because you get capital losses, as in 2022,” says Baxter. “This [pattern] looks to be largely over, so owning longer duration is looking more attractive.”
Alongside this you could hold Royal London Sterling Extra Yield Bond (IE00BJBQC361) for exposure to high-yield corporate bonds. The equities portion, which could account for the balance, could be de-risked by avoiding smaller companies and, argues Baxter, reducing “index tracker funds because those [that track world and US indices] include expensive tech stocks”. He instead suggests moving towards an active approach to investing. You could also increase exposure to value equities – stocks that appear to be trading at less than their intrinsic value – and higher-yielding equities on the basis that they have “better capital preservation properties”, says Baxter. “You may miss out on some upswing, but will protect against downside.”
One option for exposure to value and income equities, via an allocation which is fairly distinct from MSCI World Index, is Schroder Global Equity Income (GB00BDD2CM95). The more growth focused portion of the equity allocation could be invested in a world index tracker or active fund such as Fundsmith Equity (GB00B41YBW71). The proportion you put into growth/value and higher-yielding equities could start at around 70/30 per cent, respectively, with allocations to the latter increasing the closer you get to retirement. The amount of exposure to sterling and fixed interest could also increase as you de-risk with an increasing focus on wealth preservation, say, within 10 years of your retirement or when you will need to start withdrawing capital and or income from the fund.
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