Pension planning in different market conditions
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Building up a pension pot is a challenging endeavour. Not only do you potentially have 40+ years of consistent, monthly savings ahead of you, but they are also likely to experience a wide range of market conditions along the way. Just consider what investors have had to discipline themselves to weather over recent decades. The ERM crisis (1991), the banking bust (2008-9), Brexit (2016-2021) and the COVID-19 pandemic since March 2020. Yet despite these difficult times in the markets and wider global economy, equity markets have continued their trend of overall growth, albeit with “bumps” along the way.
For long term investors, i.e. those looking to build up a nest egg for retirement, this should be a great encouragement. Whilst nobody can predict what will happen in the markets, there are good reasons to keep investing in them, and other assets (e.g. bonds), over a long period via a diversified investment strategy. Below, we examine this in more detail.
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The great “cash is king” myth
Imagine you are just starting out in your career and have potentially 40 years to save for your eventual retirement. Where and how should you save? One option might be to simply open a regular savings account or Cash ISA, and put £200 a month (or other amount) into it. This may seem safe, since cash is not directly affected by stock market fluctuations. However, cash will be disproportionately affected by inflation (i.e. the rising cost of goods and services over time). This is because most “decent” regular savings accounts in 2021 will struggle to offer an interest rate above 1%. The Bank of England’s (BoE’s) target base rate, however, is 2%. So, if you put your retirement savings into cash accounts and these numbers held true, you would lose 1% in real terms each year. By year 40, in other words, you would have lost nearly half your savings.
This is why financial planners recommend that those with a long investment horizon in front of them consider other assets to build a pension pot. These may involve more investment risk and volatility across your investment journey, yet hold realistic expectations of greater returns. For a younger investor, i.e. someone early in their career, this is likely to involve focusing the retirement portfolio heavily towards equity markets (perhaps with other “aggressive” asset types such as property investments). However, this is where some people start to get nervous. Putting money into the stock market means that the value of their retirement savings could fluctuate if, say, the UK encounters economic “hard times” in the future. How can this be addressed?
Taking a long-term view
It might seem unnerving to hear that the value of your capital could go up and down over 10, 20 or 30+ years of investing. However, it’s crucial to remember that this does not ultimately matter – provided you do not need the capital any time soon, and provided the overall trajectory of your portfolio is towards growth.
Take the S&P 500 as an example (one of the most prominent U.S. indices). In February 2020, this index plummeted as the realities of COVID-19 sunk into the U.S. stock market, falling from 3,337.75 on the 21st February to 2,304.92 on the 20th March. Those with a short-term view may well have panicked at this time, as they watched the value of their U.S. equity investments fall sharply. Indeed, many pulled their money out at/near the bottom of the market, crystallising their losses in the process. However, taking a look at the S&P 500 just over a year later, the situation is very different with the index standing at 4,173.85 at the time of writing – i.e. higher than it was prior to the pandemic’s initial strike in 2020! Those investors who stayed in the market, as such, have likely been rewarded for their perseverance.
This helps to illustrate how investors can plan, over the long term, for their retirement. Provided you are aware of your investment risk appetite and horizon, as well as your investment goals, it is possible to craft a pension plan which carries you through many different market conditions and economic events (good and bad). Of course, you will need to continually monitor your portfolio along the way with your financial adviser, making appropriate adjustments to ensure that your chosen asset allocation remains on course. Yet it is important to not fret too much and obsessively check your portfolio on a daily/weekly basis, making regular trades which are not necessary and which can rack up high costs which eat into your investment returns.
Conclusion & invitation
If you are interested in discussing your own financial plan or pension strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense:
01476 855 585
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