When you think of financial risk, it’s probably potential investment losses that come to mind. But not taking enough risk with your wealth can be just as damaging financially.
News that UBS, the world’s largest wealth manager, will introduce a penalty for clients that hold a large portion of their assets in cash accounts gives the perfect opportunity to look at whether you’re taking enough investment risk.
From November, wealthy clients of UBS will face an additional annual fee of 0.6% on cash savings of more than €500,000 (£458,000). The penalty rises to 0.75% for those with savings that exceed two million Swiss francs (£1.7 million). The minimum fee is €3,000 (£2,746) a year. A UBS client holding two million Swiss francs in cash would face an additional annual charge of 15,000 francs (£12,624).
The negative interest rates set by the Swiss National Bank and the European Central Bank are behind the decision for the new penalty. Negative interest rates mean cash deposits incur a charge for using an account, rather than receiving interest.
Whilst the UK does not have negative interest rates, they have remained low since the 2008 financial crisis. The Bank of England base rate is just 0.75% and has been below the 1% mark for the last decade. As a result, it’s likely your cash savings are generating lower returns than they may have in the past.
Why cash isn’t always king
You’ve probably heard the phrase ‘cash is king’ but this isn’t always the case.
Cash is often viewed as a safe haven for your money. After all, it won’t be exposed to investment risk and under the Financial Services Compensation Scheme (FSCS) up to £85,000 is protected per person per authorised bank or building society. If you’re worried about the value of your assets falling, cash can seem like the best option.
However, that’s a view that fails to consider one important factor: inflation.
The rising cost of living means that your cash effectively falls in value in real terms over time. In the past, you may have been able to use cash accounts to keep pace with inflation. But low-interest rates mean that’s now unlikely. Over time, this means the value of your savings is slowly eroded.
At first glance, the annual inflation rate can seem like it will have little impact on your savings. But, over the long term, the effect can be significant. Let’s say you had a lump sum of £10,000 in 1988. To achieve the same spending power 30 years later you’d need £26,122. If you’d simply left that initial lump sum in a cash account generating little interest, it’ll be worth less today.
Of course, that’s not to say there isn’t a place for cash accounts in your financial plan. For an easily accessible emergency fund, a cash account may be the best home for your savings, for example. Yet, in some cases, taking the right level of investment risk is essential for not only growing but maintaining wealth.
How much investment risk should you be taking?
Whilst holding your wealth in cash is potentially harming the outlook of your financial plan, you may be wondering how much investment risk you should be taking.
Unfortunately, it’s not a question we can answer here. It’s a decision that’s personal and should be made taking your circumstances and aspirations into account. For some people, investing in relatively low-risk investments that aim to match inflation will be the right path. For others, taking greater risk will be considered worth it when the potential for higher returns is considered.
When deciding how much risk your investment portfolio should take, areas to think about include:
- The reason you’re investing
- How long you’ll remain invested for
- Other assets you have and the risk profile of these
- Your capacity for loss
- Where investing fits into your wider financial plan
- Your overall attitude to risk
Understanding the level of investment risk that’s right for you and the portion of your wealth that should be invested can be challenging. This is where we, as financial planners, can help you. We aim to work with you to create a financial plan that puts your short, medium and long-term goals at the centre of decisions. If you’re unsure if you’re taking enough, or indeed too much, risk financially, please get in touch.
Please note: The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Since 2015, retirees have had far more control over their pensions. Rather than purchasing an Annuity, more are choosing to leave their pension invested. This has benefits and can help you build a flexible income, but there are things to keep in mind too.
Figures from HM Revenue and Customs (HMRC) revealed that in the second quarter of 2019, retirees withdrew £2.75 billion from their pension flexibly. It represents the greatest amount withdrawn in a single quarter since Pension Freedoms were introduced. In total, £28 billion has been withdrawn flexibly over the last four years.
From the age of 55, you’re now able to start accessing your pension whether you’re ready to retire or not. One of the options open to you is Flexi-Access Drawdown. This is a pension product that allows you to make withdrawals that suit you, altering the amount and choosing the time. The capital that remains in the pension is typically invested. As a result, more retirees are now having to consider how to manage investments.
The pros and cons of Flexi-Access Drawdown
Before we look at managing investments in retirement, it’s important to recognise that Flexi-Access Drawdown isn’t the right option for everyone. As with all financial decisions, there are pros and cons to weigh up, as well as alternatives to explore.
- You’re in control of the income you take and when you make a withdrawal
- As the money remains invested, there is potential for the value of your pension to increase
- You can choose the level of investment risk you take with your retirement savings
- It can provide you with a tax-efficient way to pass on wealth if your estate may be liable for Inheritance Tax
- You will need to take responsibility for ensuring withdrawals are sustainable
- Investment can decrease in value and short-term volatility may have an impact
- You will need to consider life expectancy when calculating how much can be withdrawn, as well as considering what will happen should you live longer than average
- You will need to understand how withdrawal levels and when you make them will affect your tax position
If you have any questions about the pros and cons of Flexi-Access Drawdown, please contact us.
Flexi-Access Drawdown is still relatively new but analysis looking at the last four years suggests many retirees will have profited.
According to Aegon, an individual with a £400,000 pension taking a £20,000 annual income from day one of the Pension Freedoms would have seen their pot grow by £62,000 after four years in the ABI Global Equities sector. This is despite the impact of £80,000 of income payments. The same retiree invested in the UK Equity Income, Mixed Investment 20%-60% Shares sector average and Global Fixed Interest, would have seen some erosion to the capital. However, crucially, such erosion was less than the total income taken in all three cases.
The analysis illustrates how leaving a pension invested can deliver returns for retirees, but it should be noted that this will depend on individual circumstances and the assets the pension is invested in.
So, if you do decide to go ahead with Flexi-Access Drawdown, what should you keep in mind?
1. Risk profile
As your pension remains invested, it’s important to consider the amount of risk you’re taking. Traditionally, it was common to decrease the level of risk as your approached retirement age, when it was then withdrawn. However, longer retirement and changing lifestyles mean this isn’t always suitable for those considering how to access their pension today.
As with all investment decisions, the level of risk you take with your pension should consider a range of factors. This may include your overall attitude to risk, other assets you hold, how long you expect to be accessing the pension for and when you’ll make withdrawals. There’s no single solution to the level of investment risk you should take when retired, it’s one that should consider your personal circumstances.
2. Impact of volatility
Investments will experience volatility. But how should you respond to this when you’re withdrawing an income from it?
If you choose to, you can continue taking an income as you planned, despite volatility. However, this can mean your savings are depleted far more quickly than you planned and place future financial security at risk. Should investment values fall, for example, you’ll need to sell more units to achieve the same level of income. In turn, this can mean investment returns don’t meet expectations.
Adjusting the income taken in line with investment performance can help you stay on track and ensure your pension will continue to support you throughout retirement.
3. Financial safety net
Having a financial safety net is often cited as important during your working life and it’s no different when you retire. How will you cover unexpected bills or expenses? If investment performance falls, will you be able to reduce the income taken from a pension and still maintain your lifestyle?
If your retirement income is invested, it’s important to understand the financial safety net you have in place. It can give you peace of mind and the confidence to fully enjoy your retirement. A financial safety net is likely made up of different assets, but may include an emergency savings fund, the State Pension or a guaranteed income from a Defined Benefit pension.
4. Life expectancy
Using Flexi-Access Drawdown means you’re responsible for making sure your pension lasts for the rest of your life. That can be a daunting prospect and your life expectancy should be directly linked to the level of income you take. There are two important things to keep in mind.
First, most people at retirement age underestimate how long they’ll live for. According to a report from the Institute of Fiscal Studies, those in their 50s and 60s underestimate their chances of reaching age 75 by around 20% and their chance of reaching 85 by 5-10%. It’s a mistake that could mean you run out of money during your later years.
Second, whilst looking at average life expectancy can be useful, you should keep in mind many people exceed this. Thousands of people celebrate their 100th birthday every year in the UK and it’s a trend that’s on the rise. Your financial plan should consider what will happen if you lived longer than average, as well as how to pass on wealth that remains.
If you want to discuss how Flexi-Access Drawdown may suit your retirement plans, please get in touch.
Please note: 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.
The value of your investment can go up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.