Are you taking enough risk in your pension?

Here are three reasons why you might be able to take more investment risk than you think when accruing assets for retirement.

1. Time

Many people we work with in relation to their retirement planning approach us when they are in their late 30s or early 40s.

By this point, they are approaching the peak of their earning power and it has occurred to them (often suddenly) that retirement seems a lot closer that it did when they were 25!

Even so, if the average person aims to retire sometime between age 60 and 67 (the current state pension age), this still leaves more than 20 years as an investment time horizon.

History tells us that, over almost any 20+ year period, the best performing asset class is equities. It would seem sensible then that most of a retirement portfolio should be allocated towards equities, and certainly until someone is within 5-10 years of retirement.

Furthermore, under the current rules, even if you wanted to, you cannot access your pension until age 55 (rising to 57) which provides an enforced time horizon.

2. Always buying the dip

When investing for retirement, you are almost always doing so by adding monies on a regular basis. In most cases this will be monthly, however, it is not uncommon to make annual contributions where larger sums or more complex planning is involved.

As such, rather than investing your entire retirement savings pot on day one, you are effectively enjoying multiple entry points into the market. Though the general direction for stock markets is up, during any given year they can experience significant drawdowns.

For example, since 1928 the average drawdown for the US equity market in any given year is a decline of around 16%.

Investing regularly increases the likelihood that you will invest during a drawdown when prices have fallen in value. If you have a long enough time horizon, you are effectively buying these assets for a discount.

This is often easier said than done, which is why a well thought out and disciplined approach to investing is needed. Many investors have missed out on generational buying opportunities such as January 2009 and more recently March 2020, because they lost their nerve when markets fell.

A disciplined plan you can stick to is better than the perfect plan you cannot as it takes the emotion out of the decision making process and ensures long-term thinking at times when rationality is hard to find.

3. Your true asset allocation

Even if your first pension contribution at age 40 is invested entirely in equities, this is not representative of its true effective asset allocation. To explain, consider the following example:

Lucy is starting to consider her retirement planning. She is a balanced investor and can afford to contribute £40,000 each year for the next 20 years.

In total then, she will eventually make contributions of £800,000 into her pension but on day one, she is only contributing £40,000. Therefore, even if Lucy invests 100% of her first year’s contribution into equities, it will still represent an equity allocation of just 5% of her future retirement pot. The remaining 95% (£760,000) is still effectively sat in unearned cash.

With this in mind, Lucy can afford to invest the money she does have more adventurously as all things considered, her true asset allocation will remain relatively cautious for some years to come.

Year on year, Lucy’s true asset allocation will gradually tilt towards equities. However, even after 10 years, it will only just be passing 50%. At this point, and as Lucy approaches retirement, it would be appropriate to review her circumstances and potentially reduce the risk within her pension.

To conclude, anyone who throws enough darts at a dartboard will likely hit the bullseye eventually. However, those who have been coached to adopt a consistent and disciplined approach to their throw will undoubtedly hit the bullseye with greater frequency.

In the same way, working with your Wealth Manager to shape, outline and understand the right retirement plan for you will result in a far higher chance of success.

Understanding the level of risk you can take and why is just one piece of this puzzle.

Written by Philip Feast