Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.
How a stock market downturn could hit your retirement plans
With the record-breaking global stock market bull run now into its ninth year, investors could be forgiven for looking nervously over their shoulder for the next big downturn.
There’s no shortage of uncertainty to feed such worries as political tensions between the West and Russia ferment, major economies begin to be weaned off quantitative easing (QE) and central banks prepare to ratchet up borrowing costs. And then, of course, there’s Brexit…
Any one of these things could potentially damage market confidence and send stock prices spiralling downwards.
If you’re taking an income from your pension through drawdown – or are finalising your retirement plans – a dip in asset prices could be particularly damaging.
HOW IT WORKS
To understand why, here’s a simple example. Imagine two 65 year old investors – Jonathan and Kara – each with £100,000 in their drawdown pots.
They both have generous defined benefit (DB) pensions on top of £8,000 a year in state pensions. They only need to take out £6,000 a year from their portfolio to cover their retirement costs. Each enjoys average investment growth of 4% a year after charges.
While Jonathan’s pot increases in value by exactly 4% every 12 months, Kara’s ride is rockier, with the value of her investments dropping by 10% in the first year and 5% in the second year before returns pick up. You can see the result in the accompanying chart.
Despite enjoying the same average investment returns as Jonathan, the order of Kara’s returns – with bad years at the start when her pot was biggest – mean her portfolio runs out before her 87th birthday. Jonathan, in contrast, is able to continue drawing an income until he reaches the ripe old age of 91.
Or put another way, Jonathan earned an extra £24,000 from his pot – even though his returns were, on average, the same as Kara’s.
SO WHAT CAN I DO ABOUT IT?
Stock market risk is part and parcel of retirement investing; the key is to be aware of these risks and stay on top of your portfolio with regular reviews.
This is even more critical when you’re taking an income from your portfolio. Large withdrawals coupled with poor investment performance could do serious damage to your retirement prospects.
This doesn’t mean you shouldn’t take any investment risk or hold off taking money from your portfolio. You just need to think about what you’d do if your fund suffered bad investment performance. Could you reduce your income to balance it out? If the answer is no, you might want to consider reducing the risk in your portfolio.
One strategy which could help is to leave your capital untouched and live off the income generated by your underlying investments (sometimes referred to as a ‘natural yield’ approach).
While this will help ensure your pot lasts longer, it requires you to accept variations in the income you take from your portfolio.
senior analyst, AJ Bell