Pensions: How to balance risk and reward

Know your strength

Consider not just risk per se but your capacity for loss. Your ability to absorb falls in the value of investments and any loss of capital or income would have a materially detrimental effect on your standard of living in retirement. Your attitude to risk may not change, but the drop in regular monthly income as a result of retirement may result in lower capacity for loss.

The risk factor

Identify the level of income you need, relative to the level of risk chosen. With interest rates at record low levels many savers have turned from “risk-free cash” to riskier investments like gilts and corporate bonds to maintain their level of income. These are now rightly concerned at the outlook for bonds given the prospect that interest rates will begin to climb again in due course and that inflation, although currently said to be “under control”, may also begin to increase as a result of policies undertaken to stimulate the global economy. However, the income received from bonds is typically more secure than from shares.

Beware unintended consequences

The practice of “lifestyling” a pension fund – reducing exposure to risky assets as retirement approaches – is well known. However, where additional funds are involved the de-risking of the pension assets can increase interest rate and inflation risk. Where it is necessary to supplement pension income by drawing on capital,  the suitability of maintaining exposure to historically volatile investments (such as emerging market equities) needs to be considered e.g. will there be sufficient time for prices to recover from any downturn? An advantage of personal savings, despite the recent changes made to pensions in the Budget, is their flexibility and ability to meet unforeseen expenditure. Consequently, whenever possible it is advisable for a cash reserve to be held outside a pension pot.

Stay focused

Striking the right balance between holding cash and less liquid assets as retirement approaches can be addressed by monitoring and reviewing one’s own position and anticipating any change in personal circumstances with possible financial implications. In an industry that is typically “benchmark driven” over relatively short periods of time,

• Charles Robertson is senior investment manager at Murray Asset Management