4 reasons why being risk-averse could be hazardous to your retirement

02/12/2021

Research suggests millions of people are being too risk-averse with their pensions. If you’re one, you could be putting your retirement at risk. Discover why.

Date posted: 02/12/2021

According to IFA Magazine, research suggests millions of workers are being too cautious with their pensions. The study, carried out on behalf of interactive investor, reveals that 4 million workers aged between 18 and 39 have their pensions in low-risk funds.

While this may not sound like too much of an issue, being invested in a low- or medium-risk pension could jeopardise your retirement plans. This is because it may result in your pension pot being significantly lower than it might otherwise be when you retire, which could affect the lifestyle you can then afford.

Whether you have a personal pension plan or a workplace scheme, it’s essential to ensure your money is exposed to an appropriate level of risk. Read on to discover why this is and how we, as your financial planner, actively work to make sure that your pension’s level of risk is suitable for you.

1, Pensions are investments

If you have a defined contribution (DC) pension, your contributions and the tax relief you receive – as well as any employer contribution if it’s a workplace scheme – are typically invested to provide greater growth potential.

This means that even “low-risk” pensions have an element of risk, as without any risk at all there would be very low growth potential.

This is because pensions include higher-risk investments such as stocks and shares, which are also known as equities. While equities often provide the greatest growth potential, they also have a greater potential to lose value when the markets take a downturn.

To help shield your pension from a drop in value if this happens, lower-risk investments are also included in the majority of pension funds. These include:

  • Bonds: loans to governments or businesses that pay an income during the life of the loan.
  • Commercial property: used to generate a regular income through rent, as well as capital growth through an increase in the value of the property.
  • Cash: despite historically low interest rates, risk-averse portfolios still include cash.

The level of risk that your pension carries depends on the amount of higher-risk investments in relation to lower-risk investments.

2. Too little risk could be as harmful as too much

If you have more than five years before you intend to retire, you might want to consider having your pension in funds that do have some risk. To demonstrate why, consider the graph below.

It’s taken from the 2019 Barclays Equity Gilt Study, which tracked the nominal performance of £100 invested in equities and different types of bonds between 1899 and 2018. These bonds are gilts and Treasury bills.

Please note that past performance is not a reliable indicator of future results. There are no guarantees of returns on any investment.

Source: Barclays Equity Gilt Study

As you can see from the value on the left-hand axis, equities performed significantly better than bonds, despite downturns along the way. Please remember, past performance is no guarantee of future growth.

The study also revealed that if £100 was invested in cash in 1899 it would be worth just over £20,000 in 2019. If it had been put into equities, however, it would have been worth around £2.7 million.

3. Inflation could devalue your pension in real terms

Inflation is the increase in the price of goods and services, which means that £1 today is likely to buy more than it will in 10 years’ time. This is demonstrated by using an inflation calculator, which shows that in November 2021 you would need £132 to have the same spending power as £100 in 2011.

In other words, your pension would have needed to grow by 31.6% to counter inflation, which stood at an average rate of 2.8% during the period.

This means that if you are in a lower-risk fund that might not be growing by this amount, the value of your pension could drop in real terms. When you consider the Office for National Statistics reported that inflation stood at 4.2% in October 2021, you may want to consider increasing the growth potential of your retirement fund.

4. A higher-risk pension may be more appropriate

While you may want to consider exposing your pension to higher levels of risk and potential growth, care must be taken. Speaking to us could help you understand what level of risk we think is suitable for you, and whether exposing your retirement fund to greater risk is right for you.

We could help you identify a level of risk that might be appropriate for you, and confirm any changes in fees that might arise from switching pensions. They could also ensure you don’t lose any benefits you have with your current pension that you’d probably rather keep, such as a guaranteed annuity rate.

Get in touch

If you’d like to discuss your pension’s exposure to risk, or your retirement fund and strategy more generally, please contact us. Either email info@douglaswhiteltd.com or call us on 0151 345 6828.

If you know anyone else who could benefit from speaking to us about the amount of risk in their pension, we’d be delighted to help them. Either pass on our details or we can call them if they’re happy for us to do so.

Please note

This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HfMRC legislation, which is subject to change.

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.