Navigating investment risks in retirement What you need to know

While longevity is certainly something to be celebrated, it adds complexity to retirement planning. For example, a 65-year-old today has a roughly 50% chance of living into their mid-to-late-80s.[1] Couples have an even higher chance that at least one partner will live well beyond that.

Why it matters:

If your retirement plan is based on a 20 year horizon but you live for 30 years, you may find yourself relying more heavily on state pension benefits or reducing your standard of living in your later years.

Mitigation strategies:

• Consider how annuities might fit into your broader plan. Lifetime annuities can provide a guaranteed income for life, which some retirees find reassuring. However, they often come with limited flexibility and may not suit everyone’s needs or goals. It is important to weigh them carefully as part of a well-rounded retirement strategy.[2]
• Build in conservative estimates for life expectancy. This helps ensure your financial plan remains resilient, even if you live well beyond average projections.
• Revisit and adjust withdrawal plans regularly with your financial adviser to ensure long term financial stability.

Inflation risk: The silent erosion

Inflation is often called the “silent thief” of purchasing power. Even modest inflation rates can have a significant impact over time. For example, an inflation rate of just 2.5% means your money will lose roughly one-third of its value over 15 years.

For retirees, this matters because you are no longer receiving a salary that typically rises with inflation, and some income sources, such as fixed annuities or non-index-linked defined benefit pensions, may not adjust over time. This can make it harder to maintain your lifestyle, especially when it comes to costs that tend to rise faster than general inflation such as healthcare or long term care.

Why it matters:

Without inflation protection, your ability to afford goods and services in the future could be compromised, especially for healthcare and long term care expenses, which often rise faster than the general inflation rate.

Mitigation strategies:

• Incorporate inflation-sensitive assets into your portfolio. Assets like index-linked gilts or other inflation-linked investments may help offset the impact of rising prices over time.[3]
• Maintain a well-diversified portfolio that includes equities. While equities can introduce volatility, they have historically offered long term growth that outpaces inflation, helping your portfolio keep pace.[4]
• Delay withdrawals or take smaller amounts in early retirement if inflation is high.

Market volatility: Timing and sequence of returns

Market volatility is a reality for any investor, but in retirement they can have added significance. This is largely due to what is known as sequence of returns risk.[5] This is the risk of experiencing poor investment returns early in retirement when you’re beginning to drawdown your portfolio.

Imagine two retirees with identical portfolios and identical average annual returns. If one suffers a market downturn in the first few years of retirement and the other doesn’t, their financial outcomes can diverge dramatically. Early losses, when combined with regular withdrawals, can be more difficult to recover from.

Why it matters:

The combination of market declines and portfolio drawdowns can accelerate the erosion of your retirement savings. However, this risk can be managed with thoughtful planning that aligns investment time horizons with your income needs.

Mitigation strategies:

• Keep a short term cash or bond buffer. Holding a reserve of low-risk assets can help allow you to draw income without selling investments during market dips.
• Segment your portfolio by time horizon. Earmarking strategies assign different parts of your portfolio to short, medium, and long term needs, allowing for more stability and growth potential.
• Consider variable or flexible withdrawal strategies, adjusting income based on market conditions.

Decumulation risk: The challenge of withdrawing wisely

Decumulation (or drawdown) is the process of turning your pension pot into retirement income. It can be more complex than accumulation. This is because there are fewer universal rules and more individual variables, such as health, spending habits, tax efficiency, and legacy goals.

Poor decumulation planning can result in over or under-spending, increased tax liabilities, or failing to meet long term needs. Unlike the accumulation phase, mistakes in decumulation are often harder to correct.

Why It Matters:

Mismanaging withdrawals can either shorten the life of your portfolio or result in a lower standard of living than necessary.

Mitigation strategies:

• Develop a sustainable withdrawal strategy (e.g., the 4% rule, adjusted for your situation).[6]
• Factor in tax implications. Withdrawals from pensions are often taxable and should be planned around tax brackets. Of course, this can change each year dependent upon the Budget!
• Revisit your expenditure/budget and income sources regularly to adapt to changing circumstances.

Behavioural risk: Emotional reactions to market events

For some retirees, they may feel more vulnerable during market downturns, leading to emotional decision-making, like selling investments in a panic. This behaviour can realise losses and derail plans.

In retirement, your tolerance for risk may naturally decrease, but letting emotions dictate investment decisions is a risk in itself.

Why it matters:

Emotional decisions can lead to poor market timing and long term underperformance.

Mitigation strategies:

• Stay committed to your long term investment strategy. A well-designed plan, aligned with your personal risk tolerance and time horizon, can help you stay on course, even during periods of market turbulence.
• Maintain perspective through context and guidance. Understanding the bigger picture and having a clear sense of what market movements mean (or do not mean) can help remove emotion from decision-making and support more rational, confident choices. A financial adviser or investment manager can be particularly helpful in this regard.
• Use goal-based investing to help maintain focus on long term outcomes rather than short term fluctuations.

Managing a pension pot in retirement: What changes?

In the accumulation phase, the focus is primarily on growth and contributions. You can afford to ride out market cycles because you’re not withdrawing funds and may even benefit from buying more at lower prices (pound-cost averaging).

In retirement, your priorities often shift. You need to balance capital preservation, income generation, and growth. You’ll need to consider tax planning, estate planning, and healthcare needs in more detail. The margin for error narrows, and proactive, rather than reactive, management becomes more important.

Conclusion: Plan, monitor, adjust

Investing in retirement is not a set-it-and-forget-it exercise. It requires ongoing attention, adaptability, and a clear understanding of the risks that can impact your long term financial wellbeing.

Working with a financial adviser can be beneficial in helping you:

• Assess and maintain your risk tolerance
• Invest in a diversified investment strategy that adapts to market cycles
• Adjust your plan as your circumstances or market conditions change

By acknowledging and planning for the risks of longevity, inflation, volatility, and decumulation, you can approach retirement with greater confidence and a financial strategy designed to sustain you through the years ahead.