Investing a pension by gradually de-risking near retirement can cost retirees hundreds of thousands of pounds, according to research by Murphy Wealth.
Known as ‘lifestyle investing’, the most common pension strategy used by many is to move out of higher-risk equities and into safer bonds and cash-like investments as retirement approaches.
However, this reduces the potential returns on offer from the pot, which can stack up to make a huge difference, particularly as making mistakes late can cost more as the total pot is at its largest.
Adrian Murphy, chief executive of Murphy Wealth, said: “On the face of it, the approach lifestyle pensions take sounds sensible enough, but the reality is that they are actually far riskier than you initially think – particularly when the way people use their wealth and plan for retirement has changed significantly.”
Someone earning the current median UK salary and making the minimum pension contributions through auto-enrolment would be paying in £132.80 per month. Applying 3% wage inflation, this could build up a pot of nearly £395,500 over the course of 40 years, assuming investment growth of 6%.
By dropping this growth rate by 2% for the final decade, which is a typical occurrence when moving more money towards cash and bonds, this reduces the pot to £232,500 – a difference of £163,000.
The figures become starker the larger the pot. For example, someone contributing £500 per month over the same length of time would have a pot of nearly £1m at retirement. Lifestyling would almost halve this to just £558,000.
Murphy said the lifestyle investment approach was made popular in conjunction with annuities, which are financial instruments that can be purchased to provide a guaranteed income throughout a person’s life.
“But times have changed – retirement is now a 20-to-30-year period when a pension needs to keep growing to maintain its longevity, perhaps taking a degree of risk off the table to reduce volatility. Annuities are only the go-to option in very specific circumstances,” he said.
He noted that US investing guru Warren Buffett has made some 95% of his fortune after the age of 65, adding that the power of compounding means that the most money is often made later in life. Even a few percentage points a year can result in a difference of tens of thousands of pounds.
“Even on an average salary, you are looking at a six-figure difference. That is a serious amount of money and can make a real difference to your retirement. So, if you suspect you are in a lifestyle pension fund – bearing in mind the majority of people likely are – check the date it begins to de-risk and carefully consider whether that type of product matches your plans for later life,” said Murphy.
“The key is to make sure your investment strategy is aligned with how you actually intend to use your wealth, taking independent financial advice to build out that plan, rather than relying on a default pathway that may not be appropriate for your circumstances."