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Investments and withdrawals: finding the balance

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AR011136 10/2018

Having set the timescale over which you plan to spend your savings, where you invest those savings and how much you can afford to sustainably withdraw should be the next considerations.

The returns you make on your investments, and the amount and timing of withdrawals you make from your retirement savings, will influence how much you can sustainably afford to withdraw.

As you are investing over your lifetime of typically 20 to 40 years, you should consider investments that are likely to produce the best returns over that period. Historically, investing in equities (shares) and commercial property, either directly or via funds, has resulted in the best returns over longer-terms (10 years plus).

However, there is no guarantee that future returns will be the same as those from the past.

If you plan to take income withdrawals over your lifetime, investing most of your savings in bonds and cash investments over your whole lifetime isn’t usually a good idea. Bonds and cash have historically produced lower returns than equities and property.

If you do have a lower attitude to risk and are only prepared to invest in government and corporate bonds, it is highly likely that you will get a higher lifetime income from an annuity than by taking income withdrawals from an invested fund. In opting for an annuity, you will lose flexibility, but if your primary goal is the highest income possible, then flexibility is a secondary consideration.  

You may want to think about investing some of your savings in fixed interest investments to diversify your overall investment portfolio. Diversification is a good idea because it means you don’t have all your eggs in one basket. You can also buy single funds that invest in a broad spread of different assets – these are referred to by a number of names such as ‘mixed funds’ ‘managed funds’, ‘balanced funds’, ‘diversified growth funds’ and ‘multi-asset funds’. 

Taking income withdrawals from investments that are falling in value can do lasting damage to your retirement savings. If you are caught in the middle of a stock market crash you should take avoiding action, such as reducing your income or living off cash savings.

Rather than wait until you are caught out by a market correction or crash, it’s best to prepare in advance. Although investing in equities and property has historically produced the best returns, you should also expect the value of such investments to be volatile – that is, their value is likely to fall as well as rise. 

Ideally, you should keep at least two years’ worth of income in cash within your pension – a rainy day fund that you can draw on in times where the capital value of your riskier investments has fallen.

Drawing income from the cash part of your pension fund means that you don’t need to touch the capital from your other investments whilst their value is depressed. By doing this, you have given your other investments some breathing space to hopefully recover their value.

The last thing you should do is sell your riskier investments at the bottom of the market. This is the time that most inexperienced investors panic and sell. But by doing so you are crystallising any losses. Rather than sell your riskier investments, allow them to recover their value.

If your riskier investments are doing well and you don’t have a cash buffer or have depleted your cash buffer during a previous market correction, you should aim to replenish your cash in readiness for any future market correction.

You should also take your income withdrawals from your riskier investments when they are performing well.

Sustainable income

There are many common misconceptions about what rate of income you can sustainably afford to withdraw. There is no such thing as a ‘safe’ withdrawal rate.

Savers who are prepared to be flexible with their pension withdrawals stand the best chance of making those withdrawals last a lifetime. For example, being prepared to reduce withdrawals to the bare minimum after a market crash, or taking income from a cash ISA rather than their pension after a market crash, until pension investments recover their value.

In simple terms, and ignoring investment returns, £100 will last 20 years if withdrawals are taken at a rate of 5% (£5) a year, 25 years if withdrawals are taken at a rate of 4% a year, and 30 years if withdrawals are taken at a rate of 3.3% a year.

Adding in investment returns should, in theory, allow you to take higher withdrawal rates than this.

However, the actual rate at which you can safely withdraw will depend on a wide range of factors, such as the investment returns you make, what charges you pay on your pension, and the amount and timing of withdrawals.       

Making sound financial plans is important and the decisions you make can be life changing. If you need support, you may wish to speak to a financial adviser. If you do not have one, you can find one near you at www.unbiased.co.uk. Whatever advice service you choose, there will be a charge. The amount and payment terms will be explained to you by your adviser.

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