Equities have had a rocky time in recent months but they can still play an important part in retirement planning says Adrian Shandley
Whatever the lasting legacy of 2008 becomes, one thing is for certain, this year will never be forgotten in the financial services world. Attitudes have changed, risks have been redefined and traditional investment models have had to be abandoned.
One of the worst hit categories of investors has been those approaching retirement or those in drawdown with wild swings in fund values having a dramatic effect on retirement income.
These events have led to a short term crisis of confidence in equities, and it is understandable that questions are being asked about their role in retirement portfolios. This applies equally to investments held in pension products and those held directly in portfolios.
All bull markets tend to have the effect of encouraging exuberant investors to increase their equity holdings. This increased exposure also leads to increased risk. When markets collapse or turn to a bear phase, these increased risk positions are exposed.
However, we should not let this fact deter us from equity investing in retirement focused portfolios. Indeed the case for equities remains compelling.
Arguably anything does well over a long period, simply because time irons out the peaks and troughs of any asset class. Long term we can look for potential, without the need to generate short term returns, a good example would be emerging markets which are inevitably a rollercoaster ride, but in the long term have to be a good bet. Therefore, the investor trying to build the portfolio over perhaps twenty years to a proposed retirement date can certainly afford to allocate a good percentage of their fund to equities for at least the first ten years. While I am a firm believer in income investing, growth focused equities and funds can certainly play a valuable part in wealth creation during the first part of a long term investment period.
The approach to retirement
Retirement investment becomes critical during the seven to ten years prior to the proposed retirement date as well as in the post retirement phase. Risks can be taken, but they have to be calculated and balanced. Recent events have certainly unnerved equity investors and the broadcast media is quick to tell us that the FTSE Index is at a four year low, but what is not mentioned is the dividend story, particularly the dividend reinvestment story.
In my opinion, whatever percentage of a retirement fund or pension is held in equities has to be income focused. Unlike growth, dividend income can never be lost. Regardless of whether the dividends were taken in cash or script, income is a form of volatility insurance.
As there will inevitably be a phasing of portfolios and pensions into more stable investments, equity income funds come into their own. Income funds and shares by definition involve investing into larger companies, who are making profits, who are not in a growth/risk phase and are therefore distributing income. In normal times it would also be safe to assume that these companies are reasonably stable in their share price.
"You should always hold your age as a percentage in fixed interest/gilt investments". I am sure we have all heard the phrase!
While the comment might have been true at one time, and perhaps partially still is today, the big difference is the increase in life expectancy and, with regard to pensions, the advent of drawdown. Increasingly, investors have been phasing to bonds and fixed interest stocks later and later in retirement. I don't believe that there are any set percentages dictated by age, the equity content of a pension or portfolio will be more dictated by the clients' dependence on income from the pension or portfolio, the method and frequency in which this income is required, the client's age and their dependent's. However, perhaps the most important factor is the risk profile of the investor and their willingness to accept fluctuations in underlying values. Accurate assessment of risk profile is fundamental before adopting any asset allocation models.
Where from here?
For years I have mentioned the fact that all asset classes were correlating together, a fact that nobody seemed to take a lot of notice of at the time. But just as all asset classes rose together, recently they have all fallen together, and this has become an issue that everybody is interested in!
The funny thing about equities is that they are always highlighted as higher risk in periods such as this, and I simply do not believe that that is the case, especially high income equities. It amuses me that people will take no notice of the fact that their house has gone down in value 30%, but they will get upset if their balanced portfolio of investments has gone down by 20%!
At times like these, equities can become an unfashionable holding, or indeed a taboo subject, but it is exactly at times like these that we should be taking on greater exposure to equities and increasing the dividend income of portfolios. In October, the yield on the FTSE 100 index was the same as the gilt yield, clearly indicating that equities have to be valued at the present time.
While there may be further falls in world indices, the scope for upside over the next three to five years is much, much greater. While we are facing a recession in the UK and globally, we will surely look back on this period as a good buying opportunity in the future, and if we do not, then we are all in trouble.
So for me the case for equities in a retirement portfolio or pension has never been greater and for those investors who are lucky enough to be underweight at the present time, or possibly in cash, perhaps the phrase should be 'increase your equity income exposure while there is blood on the streets!
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