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The clocks have now gone forward an hour, but imagine if you were putting them forward multiple years or even decades. It would allow you to see if your retirement has the same promise of sunny days that the summertime should yield. The issue with this scenario is that to achieve any enjoyment, you have to make some decisions about risk. But are you aware of all of the risks involved?
Here, Joe Cooper, Senior Performance Specialist at Seven Investment Management (7IM), explains crucial – but often unheeded risks – to consider.
Any article or promotion featuring the wealth management industry pretty much always includes something along the following lines: that the value of your investments can go down, as well as up, to the extent that you could lose more than you originally invested. Other risk warnings are shorter – they can just state that your capital is at risk.
Meanwhile, conversations with relationship managers may reference some industry jargon in appropriateness, capacity for loss or suitability. They won’t hopefully use these terms, but if you weren’t aware they speak to your ability to absorb any potential financial losses to your portfolio without you having a heart attack. To assess this, you typically undergo a risk assessment at the start of the investment process to work out what level of risk you’re comfortable with. Any investments subsequently recommended to you should fall within that risk bracket.
These caveats can be quite sobering – especially when you’re a novice investor. After all banks don’t flag that if they’re paying you less in interest rates than the rate of inflation (i.e. anything less than 2.7% at the moment), you could effectively be losing money in real terms given your savings are not necessarily keeping up with the rate at which prices are increasing.
It’s even more worrying when you realise that investment risk is actually an umbrella term for a variety of risks. These include market risk (where investment values are affected because of a development that impacts on the whole market), liquidity risk (the risk that you might not be able to buy or sell an investment when you want) and credit risk (the risk that a borrower could fail to make a debt repayment).
However, while we realise that doesn’t encourage people to invest, it’s important to flag them. These are risks that we as a firm need to talk about proactively. It makes sense given that we’re a regulated industry. And we want to make sure that people are aware of the risks when committing their savings to the markets.
The problem is that these aren’t the only risks that relate to your savings. Without wanting to frighten the horses, there are others that we believe are just as important. They include savings risk (you can’t save enough income while you’re working), job risk (you end up retiring earlier than you intended), and longevity risk (you run out of money in retirement). These can be collectively categorised as goals risk i.e. that you don’t achieve your retirement goals (and aspirations).
However, while you are likely to have had investment risk explained, it’s our experience that few have been informed and had the right conversations about goals risk. But, given some recent changes and particular with regard to pensions, we believe that these risks should be better understood and heeded.
The first reason for the conversation is increased longevity. When the 1908 Old-Age Pensions Act was introduced, it provided for a pension for people over the age of 70 who had been earning below a set level. But people only lived around an average of 50 years. Now for the youngest of generations, life expectancy is heading towards 100. And people are still keen to retire at an age where they can be fit and active and enjoy their retirement – hence the furore about raising the state pension age back towards that original level. However, that means that the timeline for retirement is years longer than for your parent’s generation and higher levels savings will be needed to cover the increase in years that you will spend as a pensioner.
The second factor to bear in mind is that pension freedoms now mean that people have even more choice now that annuities are no longer the default option. And even once you’ve decided between an annuity and remaining invested, more decisions will need to be made.
Another key reason you need to have the conversation is that investment yields in general have fallen, and bonds in particular have been negatively impacted by the current market backdrop. The yield, for example, on a UK 10-year gilt and a typical asset of choice in retirement or for cautious investors is 1.44% as at the time of writing. At the end of March 2008, they had stood at 4.5%. This means that you have to think through alternatives to a “traditional” portfolio and especially if it was constructed some ten years ago.
The mantras of many firms engaged in investment and wealth management activities revolve around helping clients to meet their financial goals and aspirations. But for clients to really get good value, perhaps a conversation about your goals and aspirations, as well as any around risk assessments, could lead to better outcomes. We are not advocating that everyone maximises investment risk, but we do want people to appreciate goals risk too and review both levels regularly. It’s too important a target to miss and it’s one that you’ll only realise you’ve neglected when you’re actually retired.