Can you please explain ‘pound-cost ravaging’? It’s a term I’ve heard several times but have yet to fully grasp how it works or whether it’s something I should be concerned about. I’m 64 and planning to start taking an income from my SIPP in 2025 (when I’ll become entitled to a state pension worth around £10,000 a year). My SIPP is worth just over £200,000 and I’ve already taken my 25% tax-free cash.

Paul

Tom Selby, AJ Bell Head of Retirement Policy, says:

When you are building up a savings pot, experts often recommend drip-feeding money into investments to smooth out the impact of market volatility. This works because it avoids having to time the market. Instead, you buy into investments on a regular basis, usually monthly.

When markets dip, you can buy more units of an investment; when markets rise, the same amount of money buys you fewer units. The outcome of this approach is often referred to as ‘pound-cost averaging’.

Taking a flexible income from your pension is called drawdown and the remainder of the pot stays invested. The benefits of drawdown include having the flexibility to manage withdrawals to suit your needs and giving your pot the opportunity to benefit from long-term growth.

However, drawdown also comes with risks. Let’s say you’re taking large withdrawals in the early years of retirement and your investments suffer big falls – something plenty of people will have experienced over the last 12 months or so. It’s harder to regain the lost ground. This is often called ‘pound-cost ravaging’ and is best demonstrated with an example.

Take two 65-year-olds, Jack and Jane, with pensions each valued at £200,000. Both are taking £15,000 a year out of their pots, rising each year by 2%.

Jack experiences investment returns in the first five years of: -10%, +4%, +4%, +4%, +4%. As a result, his pot is worth just over £125,000 at the end of that period.

Jane, meanwhile, experiences the same returns, but in a different order: +4%, +4%, +4%, +4%, -10%. At the end of the period, her pot is worth almost £135,000.

In other words, simply by experiencing bad investment performance in year one rather than year five, Jack has been left with a pension worth around £10,000 less than Jane.

This is one of the reasons it’s important to keep your drawdown strategy under review and be prepared, if necessary, to adjust your withdrawals. This should help ensure your retirement income plan remains on track.

DO YOU HAVE A QUESTION ON RETIREMENT ISSUES?

Send an email to asktom@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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