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"In the back of the cab"

07 October 2015

David Lane, Partner, Business Development Technical Director

In my job I do a fair amount of travelling up and down the country and as a result spend a lot of time trundling around in taxis. This can be an experience as you get to hear so many different, interesting and sometimes very strange opinions from the person upfront! I would not pretend that all the conversations I have are about the state of the markets, but occasionally they do flirt with some of the more thorny issues that people are becoming increasingly aware of. Recently on the A28 in Kent I started to talk about pensions. Surprising as it was 8 o’clock in the morning but the chap driving the cab was keen! Maybe he had caught some of the recent press coverage on the newly arrived pension freedoms and what this can mean for pension funds that remain invested and are used to provide an income. I suspect there are some huge issues here for people who, if caught on the wrong side of a market downturn, could find their standard of living seriously compromised. Australia may offer us Brits a salutary lesson in this regard. The Aussies have had their pension “freedom” legislation in place for a few years. At a conference I attended recently, the speaker, with his tongue only slightly in his cheek, talked about how on a trip ‘down under’ visiting Sydney he had never seen so many people in their seventies, and older, driving cabs. Maybe my cab driver on the A28 wanted to avoid this outcome at all costs. But the lesson is salutary as we are seeing the reality of retirement funds being depleted to such an extent that people are forced to supplement their retirement income by going back to the salt mines to earn some additional income!

I think there are a number of reasons for this outcome: overpayment of income at a level that was not clearly sustainable by their respective pension assets, particularly in the early years; not really understanding the level of ‘investment risk’ they were taking. At Vestra, we talk a lot about an individual’s risk profile and capacity for loss, but understanding what these terms mean is important as they form the foundation for any successful investment strategy. They matter because if you get this wrong then your lifestyle in retirement will be affected and not in a good way. Similarly, if you are looking to leave as much of your pension assets as possible to family members as a result of the recent tax changes then the value left to your waiting and expectant beneficiaries may be considered (by them) to be a disappointment!

Academic research suggests that one of the key drivers to a successful investment outcome for retirees is the way returns are delivered. Sometimes referred to as the “sequencing” investment returns, this research shows that the more positive returns are in the early years of a portfolio the better it will be for its longer term viability. Particularly important on the basis that we are all living longer. Switch this around and if returns are poor in the first years of retirement then the effect on the long term value of a portfolio can be significant, especially when combined with a high and potentially unsustainable level of income being taken. A sense of what is realistic is therefore crucial. Understanding market volatility, liquidity, and being sensible about the levels of “income” a portfolio can reasonably sustain, are all key factors to a successful retirement strategy. The new pension freedoms offer huge opportunities for retirees, but they do come with a health risk and as the experience ‘down under’ shows us.... caution is advised!