As illustrated by this recent Financial Times report, which indicates more than 12% of workers aged 50 and over are adapting their retirement provision due to the economic disruption caused by Covid-19, there has never been a more important time for individuals and their advisers to revisit and review their future financial plans.
The current market volatility is forcing some people to pause or even opt out of their ongoing pension contributions. At the same time, interest rates and bond yields are both at record lows, leaving little opportunity for ‘safer’ income-generating investments. That being so, here are five key points people should investors and their advisers should bear in mind when rethinking retirement plans.
Sustainability of cashflow
Ensuring sustainable cashflow is all about making sure an individual’s financial resources are not completely depleted during retirement. This may sound like a relatively straightforward issue to resolve by asking the question, when will my money actually run out? Nevertheless, there are many factors to consider when assessing someone’s personal circumstances.
If an individual is relying on a fixed stream of income, for example, it is important to analyse the security of its source, be it rental, bonds, or an annuity. With NS&I recently cutting its rates, weighing up the risk of further reductions in the future could provide an opportunity to mitigate that risk now.
Although an increasing number of people now rely less on fixed income to fund their retirement, it is nonetheless vital to create a retirement framework that affirms the sustainability of cashflow of the overall retirement pot. This is particularly important for investors who are relying more heavily on capital.
Tax efficiency
Investments are popular with retirees because of the returns they can offer. However, tax frictions can impinge on returns if not managed carefully. Financial resources should be structured to avoid any unnecessary taxes and simultaneously benefit from the various allowances available – thus ensuring gross and net returns are as closely aligned as possible.
When it comes to the task efficiency of a portfolio, success comes from building a solid foundation. It is vital that investors make good use of any allowances available, such as pensions and ISAs, to the fullest possible extent each year, maximising the tax-exempt proportion of their savings and withdrawals.
In addition, losses must be recorded properly, and investors should consider the likelihood of any losses offsetting future gains. Evaluating loss-making investments is just as important as analysing those that have performed well, since portfolio rotation is necessary for keeping up with the changing economic landscape.
It is also important for investors and their advisers to consider what may not be in a portfolio. Is this a good time to think about additional investments? How can the tax-efficiency of these additions be maximised? It is vital that these questions are asked when investors are calculating the share of their portfolio that could be taxable.
Investment performance
It is not always practical to assume a linear growth in investment returns. The pandemic has dealt a major blow to many portfolios that were not equipped to withstand a ‘black swan’ event such as this. As a result, that FT piece also reports, more than 30% of older workers have seen their financial situation worsen this year, with 8% now retiring later than originally planned.
Whether or not an individual’s portfolio was adversely affected by the market disruption caused by COVID-19, it is imperative investors prepare for future events such as a second wave. More broadly, they should assess the risk profile of their investments and consider whether the current situation would be more amenable to a more cautious profile. They may find it suitable to consult with their portfolio manager on developing a new investment policy statement.
For some investors, there will be the additional dilemma of whether to invest their surplus cash, and if so, when. Reinvesting may be counterintuitive for those lowering the risk profile of their existing investments, but others may consider it preferable to watching their cash lose ‘real’ value while being held in a bank account. Either way, informed and impartial judgement is key when projecting the future performance of existing and potential investments.
The importance of diversification
The pandemic has underlined the importance of having a diverse investment portfolio, since it has negatively affected such a vast range of assets. Portfolios that were overly focused on chasing yield and highly concentrated were among the hardest-hit in the first quarter.
Diversifying between sectors is obviously important, and so too is geographical diversification. While this crisis is a global one, certain UK equity markets are particularly concentrated in poorly-performing sectors and have suffered as a result. The short-term future should see an increase in investors looking further afield, as well as a preference for relatively stable havens such as bonds and gold.
It is also helpful to recognise that periods of contraction can lead to investment performance becoming highly correlated, even between relatively disparate assets. Investors and their advisers should keep this in mind when they consider bolstering their portfolio with greater diversification. Diversification cannot mitigate all risk of lossmaking, but it should help in most cases.
Expenditure
There is little point calculating the likely returns on investments if individuals neglect to measure them against their projected spending. When planning for the retirement, it is important to have an idea of the difference between income and expenditure – and the degree to which both will likely change once retirement begins.
Retirement is not the only eventuality to prepare for, however. Investors should also consider other factors that might impact on their expenditure – from unforeseen changes to personal circumstances, such as illness, to much wider-reaching events, such as the current global crisis. Since March, for example, many people have undergone dramatic lifestyle changes, such as cutting out commuting, which has influenced their spending habits. It is well worth considering other changes that could be on the horizon.
Planning is paramount
When planning for a secure retirement, it is vital to ensure cashflow will remain sustainable and investments are as tax-efficient as possible. It is also important to be flexible when anticipating future returns and spending habits, and when assessing portfolio diversification. Investors – along with their portfolio managers and financial advisers – should consider all these areas when evaluating their retirement plans.
Christopher Yardley is client director at Strabens Hall
