With two decades to go to retirement: increase risk or play it safe?

In the second chapter of our six-part retirement series, in which financial journalists offer a personal perspective on their own pension portfolios, Ceri Jones reveals how she’s investing in the run-up to retirement.

The two decades before retirement are a time when good performance can make a huge difference to your pension pot because your fund should be sizable already, and therefore any profits will be based on a larger fund.  

From around age 50, an employer’s pension scheme would probably start gradually switching its members out of equities and into a higher component of low risk bonds and cash, on the basis that no-one wants to lose money on equities just as they come up to retirement. Employer schemes must work to the rule of averages, mindful for example that over 98% of people do not choose their retirement date anyway.

Switch to bonds will stunt growth  

For an individual self-invested personal pension (SIPP) holder, however, the switching mechanism does not have to be a blunt instrument because you should have a better idea of how long you personally will be able to work. Keeping a large portion in equities will offer you growth through these middle years, while switching to cash or bonds prematurely will deny you this growth. 

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This is particularly true today, as government bond yields (the income generated) are trading at historically low levels and in some cases are negative, meaning a loss is guaranteed if the bond is held until maturity. Bond yields and bond prices have an inverse relationship – so if over the coming years bond yields rise from their historically low levels bond prices will fall – resulting in a capital loss. 

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“Many people believe switching to bonds is the right thing to do, because it is ‘less risky’, but in the current Alice in Wonderland environment, it is not clear what ‘low risk’ means,” says Ros Altmann, a former pension minister. 

Of course, the automatic de-risking in employer schemes takes no account of where we are in the investment cycle. Overall, since the global financial crisis, global markets have performed well, despite a few bumps along the road (including the Covid-19 pandemic). This cycle has lasted considerably longer than the historical average of seven years, and you don’t need to be a clairvoyant to diagnose what comes next: lower returns.

Being overly cautious can be damaging 

Firstly, then, have an honest think about when you are likely to retire because once you are sure of your timescale, it is easier to work out the optimal portfolio split. Bear in mind that the age at which you are allowed to withdraw benefit will rise to 57 in 2028 from 55 currently, and also that many experts believe that in a few decades, the state pension will become means-tested. 

Think too about your other sources of income and your partner’s pension. If, like me, for example, your partner has a decent public sector guaranteed pension, then that allows you to pursue more adventurous investment opportunities. Being overly cautious can be damaging. More women than men suffer ‘reckless conservatism’, and women with the same salary history as men have lower self-invested pensions as a result.

“A lot depends on whether your SIPP is your only or main source of retirement wealth or whether you have other guaranteed sources of income,” says Steve Webb, another former pension minister and partner at Lane Clark & Peacock. “If you are part of a couple and have two state pensions - and you’ve got forecasts and you’re both going to get around £9,000 per year -  and one of you has a substantial defined-benefit pension, then you may have a floor income of say £25,000 to £30,000 aside from your SIPP. 

“That probably gives you the security and confidence to invest for growth for longer, not just up to traditional retirement but into retirement. It is crucial to remember that you may well be drawing down on your pension for a quarter of a century, so de-risking too soon could be a mistake.”

How I invest my SIPP

This freedom to take a more aggressive stance, has allowed me to hold bonds at the racy end, notably exchange-traded funds (ETFs) focused on emerging market debt. In equities, I diversify to an extent by geography and style. Different nation’s stock markets lead the world at different times. No single region always outperforms, because if that was the case, it would attract so much interest it would become prohibitively expensive.

Last year for example the UK was out of favour owing to Brexit and the UK’s preponderance of old legacy stocks such as oil majors, but today, even though these problems remain and the Covid-19 pandemic, the consensus is that the UK has been oversold and offers some potential bargains. 

For the most part, however, I try to minimise home country bias, and have always been overweight Asia, and Taiwan and South Korea in particular, as leading suppliers of semiconductors and integrated circuits.
Another debate that has shaped the last decade is value versus growth. Value stocks - unloved and cheap companies in unfashionable industries - have performed poorly for a decade but historically it was a sensible strategy, working well for example after the tech bubble at the turn of the millennium. 

Today, however, cheap stocks are staying that way because the pandemic has escalated change in a wide range of technologies. Over the past decade, US growth stocks have soared by more than 300% — three times the returns of value stocks. I’ve bought a hefty chunk in Temple Bar investment trust (LSE:TMPL), primarily as a diversifier (the top three holdings are IWG (LSE:IWG), Bayer (XETRA:BAYN), American Express (NYSE:AXP)), but I’m not holding my breath for a reversal in its fortunes any time soon. 

Why I mainly invest in investment trusts 

I primarily use investment trusts, which are often available at a discount (meaning you can buy the underlying investments at a cheaper price than they are worth, referred to as their net assets), and where expert managers can offer access to broader range of illiquid assets - things that can't be bought and sold so quickly - such as infrastructure. 

Pre-Covid-19, I avoided active managed funds and took advantage of ETFs as a cheap way to buy into a rising tide that lifted all boats. Today, some companies face real challenges, and an index tracking fund cannot swerve individual disasters. 

I avoid big name managers, as they almost always come back to earth with a bump. Sometimes, the manager just struck lucky with his or her sector or strategy which happened to work well at that juncture in time. Then the money starts to pour in and the fund becomes too big to manage effectively; or maybe the cycle turns and the strategy no longer pays off. Before you know it the manager starts to press every button at his disposal to try to keep his performance on track, departing from the brief. 

I also avoid funds where I am not sure what the strategy is. This is a golden rule when it comes to investing – if you don’t understand, don’t invest. 

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Markets are currently very volatile, but at such times it is important to think long term and keep a cool head. One enduring pattern of stock markets is that following any crash there are some big up-days. 

JPMorgan Asset Management has crunched the data showing the devastating impact of pulling out of the market. Over 20 years (1999 to 2018), if you sold and therefore missed the top 10 best days in the market, your overall return would have been slashed by half. Of course, if you’re not invested, you miss the worst days too, but many of the best days come soon after the worst days, so when the market as a whole sinks, keep calm and carry on!