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Ask the Expert: Pension Derisking Strategies for Investors in Their 40s
Fidelity personal finance specialist Marianna Hunt returns to address a critical question from a reader planning early retirement. The focus is on when and how to transition from high-equity investments to a more balanced portfolio as retirement approaches.
Reader's Query: Timing Portfolio Derisking for Early Retirement
Q: I'm in my late 40s and have calculated that I've saved enough into pensions to retire at age 57. Currently, I am heavily invested in stocks and shares, with approximately 85 per cent of my portfolio in equity funds. When does staying invested become reckless? At what age should I start de-risking my portfolio, and what is the best approach to do so?
Expert Analysis: The Importance of Strategic Derisking
A: Congratulations on saving sufficiently to retire a decade or so before your state pension age, which is likely 67 or 68. Your question about de-risking is crucial. If addressed too late, a stock market downturn could significantly impact your savings just as you begin to access them.
The first consideration is how you plan to access your pension savings. Will you use flexible drawdown, purchase an annuity, or opt for a blend of both? This decision will heavily influence your investment strategy over the next decade leading up to retirement.
Drawdown Strategy: Balancing Growth and Protection
Starting with drawdown, this involves keeping your pension savings invested while drawing income from those investments. In this scenario, it's essential to ensure your savings continue to grow to outpace inflation, which can erode purchasing power over time. Maintaining some allocation to stocks and shares is important, especially for early retirees who need their money to last several decades.
However, most retirees balance this with lower-risk assets like bonds to protect their pot during market downturns. A common approach is a 60/40 split, with 60 per cent in equities and 40 per cent in bonds, though some may prefer a 50/50 allocation. There is no single right answer; it depends on your risk tolerance. Some investors diversify further with asset classes like gold or property.
Investing in retirement to ensure longevity of funds is complex, and consulting a financial adviser may be beneficial.
Gradual Allocation Adjustments
Once you decide on your portfolio split, gradually shift your allocations from your current position to your target. For example, if your portfolio is 85 per cent stocks and 15 per cent bonds, and you aim for 60 per cent stocks and 40 per cent bonds in 10 years, you need to reduce equity exposure by about 2.5 percentage points annually.
If you're still contributing to your pension, direct new contributions towards bonds to avoid unnecessary selling of equities. This allows equities to naturally shrink as a percentage of your portfolio. If contributions aren't sufficient, rebalance your portfolio annually or semi-annually to meet your target mix, similar to lifestyle funds used by pension schemes.
You must also decide how to handle market volatility. Option one is to stay the course regardless of conditions. Option two involves a semi-flexible approach, de-risking faster after strong equity returns and pausing reductions after sharp market falls.
Consider the type of bonds you add. For capital protection, a globally diversified fund investing in high-quality bonds with short- to medium-term duration is advisable, reducing sensitivity to interest-rate movements while offering diversification.
Note that stock market crashes can be most damaging in early retirement, so some investors de-risk beyond long-term targets (e.g., to 50/50 or 40/60) before re-risking a few years into retirement.
Annuity Purchase Considerations
If you plan to buy an annuity, focus on preserving your pot's value and reducing volatility before purchase. Within two years of buying, many financial planners recommend 0–20 per cent equities and 80–100 per cent bonds and cash-like assets. Create a 'glide path' from current to target allocations and have a plan for market moves.
For a blend of annuities and drawdown, designate amounts for each and plan investment strategies accordingly. Additionally, consider your tax-free cash; some investors ringfence it for specific purposes like mortgage payments or gifting, separating it from broader retirement planning.
Final Recommendations and Disclaimer
This analysis assumes you are investing equities in a sensible, diversified manner. If not, the question of recklessness might already apply. Remember, this is not financial advice. Each person's situation is unique, and speaking to a qualified financial adviser is often valuable.
Do you have a personal finance question for our experts? Email asktheexpert@cityam.com. Questions will be published anonymously.
