Weathering the storm
Over the last few weeks we have been busy reviewing many of the pension drawdown plans we have arranged for our clients looking to see how they have weathered the recent the recent fall in global equity prices.
The recent market correction was not a full-blown crash, probably not even a mini crash, just a short-term reaction to the possibility of an overheated US economy. We think there is no need to panic but it might be helpful to understand what has happened to the market and some investment funds as there might be some valuable lessons for the future.
Setting up drawdown plans
Generally speaking, we set up drawdown plans with some money in cash and very low risk funds to fund pay the income then the core of the money is invested in a range of medium risk multi-asset funds and some money is invested in growth funds. One of the advantages of using multi-asset funds is they invest in a wide and diversified range of assets which reduces volatility but at the same time aiming for investment growth. All portfolios are set up on an individual basis and take full account of the client’s attitude to risk and drawdown objectives.
The fall and a soft landing
I caveat what I am about to say with the following. Care must be taken when looking at very short-term time frames and past performance is not an indicator of future outcomes.
I looked at the value of one of the core multi-asset funds I use for my drawdown portfolios on 12th January 2018 which was the highest point for the FTSE and I looked at the valuation on the 9th February which was the lowest point at the time of writing.
During this short period the FTSE 100 fell by 8.82% but the value of the multi-asset funds we use fell by 3%.
In this instance it seems that the multi asset fund did its job by providing a safe landing at a time of falling equity prices.
I also looked at a typical passive fund with 60% equities and 40% bonds and during this period it fell by 4.67% and the 100% equity fund fell by 7.23%.
|12/01/2018 to 09/02/2018
So far so good, as this shows the core fund I am using doesn’t fall as far as 100% equity market in bad times but there is a price to pay for this, namely the reverse is also true. A medium risk fund will not grow as much as a 100% equity market in good times.
For example, over a 5-year period the 100% equity fund returned 70% cumulative growth but the multi-asset fund returned 37.9%
I think we can make the following observations from these results:
- One of the reasons why clients shouldn’t panic when market falls is there funds should be properly diversified and these funds are less volatile than higher equity funds
- It is important that funds in drawdown are invested in a way that cushions any stock market volatility as this helps reduce the sequence of return risk*
- The price investors pay for the reduced volatility is less grow in good times compared to funds with a higher equity content. This is consistent with the aim of “not shooting the lights out but aiming for reasonable returns without taking undue risk”
- You need a good adviser to arrange a drawdown portfolio with the most suitable investments as it is difficult to get make the right investment decisions without advice
Why advice is so important
I was recently reminded why it so important that people get financial advice. A senior director of an insurance company with over 25 years’ experience of the industry said to me; “I didn’t realise what a responsibility and worry it is to look after your own pension pot, but a good adviser takes away the worry”.
Our clients, can breathe a sigh of relief this time that not only did the core funds do what they are intended to do, but it seems the correction was short lived.
However, we don’t know when the next correction will come but a suitably invested drawdown portfolio will enable you to meet your retirement income objectives without undue worry or concern.
*Sequence of returns risk is the risk that investment returns are lower than expected in the early stages of drawdown resulting in capital being eroded quicker than anticipated. If this happens your drawdown fund may not be able to sustain future income payments and there is increased risk your income may be reduced or in the extreme, running out of money unless investment returns are higher than expected in the future.