What are the risks to personal contribution pension pots of share prices falling and should anyone within five years of retirement do anything to reduce risk of the portfolio being insufficient?

John

Tom Selby, AJ Bell Senior Analyst says:

Because personal pensions – often referred to as ‘defined contribution’ retirement pots – are invested in bonds, stocks and shares, their performance can be volatile, particularly over a short time.

We witnessed a classic example of this activity during March and April, when Covid-19 and the subsequent lockdown sparked a stock market sell-off, with the FTSE 100 down over 20%.

In investments a period of negative performance such as this is sometimes called a bear market (while you might hear strong performance labelled a bull market).

The extent of the impact of a bear market on your defined contribution pension will depend in part on the amount of risk that you take and the mix of assets you hold.

Someone who invested their entire pension in a fund which tracks the performance of the FTSE 100, for example, would have total exposure to the performance of that index and so would have experienced double-digit falls at the start of lockdown.

This is one of the reasons diversification is important for retirement investors – by investing in different assets around the globe which are not correlated – this just means they don’t rise and fall in tandem with each other – you should be able to reduce volatility without lowering your ability to generate investment returns.

If you don’t feel confident in picking your own investments, you can pay a fund manager to do it for you. Some managers even offer multi-asset funds where the portfolio is diversified by asset class.

Because investments can be volatile, particularly in the short-term, it is important you understand and are comfortable with the risks you are taking.

You should also bear in mind that if you have a long investment time horizon, you can be less worried about short-term ups and downs in the value of your pot. Historically short-term volatility has been the price for long-term investment growth.

Your approach to investing as you close in on retirement will depend in part on what you plan to do with your money. If you are going to withdraw all of it at once or buy an annuity, you should consider reducing the level of risk in your fund to protect against market falls just before you retire.

If you are planning to keep your fund invested and take a steady stream of income through drawdown, you might want to review your investments as you approach retirement but, provided you are happy with the risks you are taking, you might not need to make any big changes.

When making this decision, remember that a healthy 65-year-old might still have an investment time horizon of 30 years or more, so should still have capacity to take some investment risk.

DO YOU HAVE A QUESTION ON RETIREMENT ISSUES?

Send an email to editorial@sharesmagazine.co.uk with the words ‘Retirement question’ in the subject line. We’ll do our best to respond in a future edition of Shares.

Please note, we only provide information and we do not provide financial advice. If you’re unsure please consult a suitably qualified financial adviser. We cannot comment on individual investment portfolios.

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