It can be equally exciting and unnerving to think about your retirement day, but it is more of a process than a finish line.
After spending decades thinking about how to grow your pension pot, you reach a point where you might want to switch gears, instead putting more weight on preserving your wealth and generating income to support retirement. For many people, the thought process begins five years before they finish working.
Central to this shift is looking at the shape of your portfolio so you can decide whether you want to dial down some of the risks. Part of this will be weighing up how you might fund retirement in the early years when lifestyle spending is often greater than later in life. De-risking can be done gradually, rather than in one fell swoop.
Some people might first lean on cash savings or ISAs to fund retirement, but others might have no choice but to start drawing on their pension immediately.
Individual circumstances will be different, but what unites people transitioning from work into retirement is the need to think differently with the shape and style of your investment pot(s).
Often overlooked is the importance of maintaining an element of growth with your investments, rather than simply opting for income. People are living for longer and it is vital that you don’t outlive your savings, which would mean a major change in lifestyle. You also need to consider the impact of inflation so that your purchasing power is not eroded.
Review your asset allocation
Investors often prioritise growth over income when building up their retirement savings. That typically involves a large weighting to shares and less to bonds. A typical adjustment made in the last few years before retirement is dialing up bond exposure and pulling back on shares, albeit only slightly. The aim is to bring more stability to a portfolio in case there is market weakness just at the point you transition to retirement.
Multi-asset funds are a straightforward way to shift the weighting of assets in your portfolio. They come in different forms, allowing you to select the percentage of equities and bonds that suits you. For example, you might have a fund that is 100% equities and, with five years to go until retirement, feel now is an appropriate time to have one fifth of your portfolio in bonds. You might consider an 80% equity multi-asset fund in this situation, potentially switching again to 60% equity multi-asset once you hit retirement. These funds’ 20% and 40% remaining asset allocation, respectively, would typically be held in bonds.
What to consider with ‘Lifestyling’ funds
Lifestyling funds have historically been a popular choice among people approaching retirement, but it is important to note their downsides.
The funds are an automated investment strategy designed to reduce the risk of a sudden fall in the value of a pension pot close to retirement. This is achieved by shifting the proportion of investments in higher risk assets, like equities, into lower-risk assets, like bonds, often from around seven to 10 years before retirement. The switch happens bit by bit once a month over this timespan.
What they do not consider is your risk tolerance, any other assets you might have, and your retirement plans such as finishing work early or phasing out work over several years. The risk is that you end up being too cautious or too risky for your needs.
The switch happens automatically, regardless of market conditions, which means you could sell shares after a market fall and lock in losses or move into bonds with unattractive yields.
These products typically assume the investor buys an annuity at retirement, meaning they shift heavily into bonds and cash in the final chunk of the investor’s career, and the money is used to secure a fixed income for life. More investors are now staying invested in retirement and look for their investments to keep growing.
Time to declutter?
Five years before retirement is often a good point to do a stock check of your portfolio. Just like a shopkeeper would remind themselves what is in the store cupboard and on the shelf, an investor might want to remind themselves what they have amassed over the years. It is easy to fall into the trap of being a collector with investments and now might be a suitable time to think about slimming down the collection and locking in some of your hard-earned returns or at least forming an exit plan when you are ready to reshape for retirement.
Think about what you have already got, the role each investment plays, the associated risks, and whether you have duplication with other holdings. You might find there are cheaper alternatives. As a bonus, fewer holdings often make your portfolio easier to manage.
Consider topping up your pension
For many people approaching retirement, earnings are at their peak. Children may have left the nest, and the mortgage may be close to being paid off.
This means that where circumstances permit, it may be possible to top up pension contributions for an extra boost in the lead up to retirement.
If you have not used your full pension allowance, it is possible to carry forward unused portions from the last three tax years.
Martin Gamble: Shares and Markets Writer
Martin Gamble is Shares and Markets writer at AJ Bell. He was previously the Education Editor of Shares Magazine. He has been with the business since 2019.
Martin graduated from the University of Kent in...
