Ed: When you’re still working and contributing to a pension, the ebb and flow of markets can work in your favour. If share and bond prices fall for a period, the overall size of your fund might shrink but it means that the new money you’re paying in buys more - you’re buying low instead of buying high.
Once you cross the bridge from work to retirement though, you won't get this benefit. Now you’re taking money out and if you need to do that after the market has fallen, the withdrawals come on top and the damage to your retirement fund can be even worse.
The way investments work means it can be difficult to get those losses back even if markets do recover. Let me explain more...
When you’re paying into a pension, your contributions will make your pot bigger and with luck there is a bit of investment growth on top. But as we know prices can fall and when that happens your pot will get smaller. But even now it’s possible for this to work in your favour because the next time you make a contribution, your money buys you even more, and so when prices do rise your pot gets an even bigger boost.
When you’re taking money out of a pension it works in reverse so that you might lose some from investments, and if you make withdrawals on top of that, you compound that loss and your pot is depleted even more quickly.
Managing your pension pot through the ups and downs of the market is always important, but it’s particularly so once you start drawing an income from your savings. I asked Charlie Nicol from Fidelity’s team of Retirement Specialists about ways to reduce the risks.
Charlie, those in retirement living from their pension money will face market falls from time to time, but is there anything they can do to protect themselves?
Charlie: When living from your pension in retirement, the safest thing you can look to do is to not dip into your investments. Now one way in which to do that is to restrict your expenditure and live off the natural income from your investments. The natural income would be the dividends from your shares or the interest from your cash or bonds.
Ed: Okay and if you do have to take money out at that point, what’s the implication of that?
Charlie: The problem with selling your investments when markets have fallen is you have to end up selling more of your investments just to take the same level of income.
Ed: So what practical steps can you take?
Charlie: One way to avoid having to sell your investments when markets have fallen is by looking to hold a cash buffer - typically speaking six to twelve months’ worth of income. So if you do go through a period where markets have fallen, you can withdraw your money from the cash without having to sell your investments. And then hopefully as time goes on you’ll see your investments start to rise again, and in that situation you can then start to build up your cash reserve.
Investing after retirementis very different from investing before retirement and it's crucial to understand exactly the risks of withdrawing money at the wrong time. As we've heard however, there are steps you can take that remove some of that risk.