As you might expect there is no single allocation that suits everyone; it is important to consider your unique situation and requirements. Questions to consider are:
- what is the value of your pension fund?
- how much income will you need each year?
- what other income will you have in retirement?
- what do you have in savings to support periods when markets fall in value?
- will you need to withdraw lump sums to pay off a mortgage or for other ad-hoc costs?
The fact that this person intends to enter drawdown when they retire means they can consider a higher equity allocation than somebody who may be using the fund to purchase an annuity. However, it is easy to discount annuities without fully considering whether they have a role to play in your retirement income in full or in part.
For example, using some of the fund to purchase an annuity to cover essential costs is an option some choose to take.
Think About Risk
Assuming full drawdown is appropriate the mix of stocks to bonds then becomes a balance of the risk you are willing to take, need to take and can take.
The first part, the risk you are willing to take, comes down to your psychological risk profile. This is your view on investment risk.
The second part is the risk required to generate sufficient growth to support the income withdrawn from the pension for the remainder of your life. Or until you decide to purchase an annuity if that will be the case.
The final part is what the Financial Conduct Authority refer to as ‘capacity for loss’. Simply put, do you have sufficient capital and/or other income to sustain falls in value in your pension fund without detriment to your financial security in the short and long-term?
This is why having savings to fall back on in times of stock market corrections is important; it provides an alternative source of capital to allow the pension to recover without having to support income withdrawals at the same time.
Balancing Act
It then comes down to taking sufficient risk to enable the fund to grow above inflation and support income. However, too much can lead to significant falls in value that have a detrimental effect on your wealth (or such that you get panicky and sell at the wrong time).
Some advisers will argue that because stock markets go up more than they go down, and the long-term trend is positive, it is appropriate to have a high equity allocation. Especially if you are looking at a multi-decade retirement. I understand this point of view, but without the capacity to suffer short-term losses and because human behaviour can have a significant negative impact (i.e. panicking and selling out at the bottom), I wouldn’t warrant taking more risk than you would be comfortable with.
To distil it down to a ratio, I would say anything less than 40% in equities is probably too low to support long-term income withdrawals and growth and more than 70% may impact your capacity for loss and/or cause too much panic in times of turmoil. It’s not an exact formula but may provide helpful parameters.
As always, your own unique circumstances need to be taken into account.
The content of this post does not constitute advice. Neligan Financial is regulated and authorised by the Financial Conduct Authority.
Photo by Piret Ilver on Unsplash
