Approaching retirement is one of the biggest financial milestones you'll ever face. While many investors focus on growing their wealth during their working years, retirement brings a new set of priorities. Deciding whether to change your portfolio requires careful thought about income, risk and how long your money needs to last.
The focus during your 20s, 30s, 40s and 50s is often on growth-oriented investments, particularly shares, with less emphasis on generating an income. Once retirement comes in view, you start to think about how the bills will be paid and whether your current investment portfolio needs a makeover.
Before you rush to load up on income-generating assets, consider that retirement is not necessarily the end of investing for growth.
The first question: what is your money for?
Having a pot of money when you start retirement provides different options, and it’s important to define what role that money should play. Each purpose can help define the level of risk that might be appropriate, as well as the amount of risk you're willing to take. That feeds into investment choices.
For most people, it’s about replacing the monthly salary that’s landed in your bank account to pay the bills and enjoy life. However, it’s not always that simple.
It can be about maintaining purchasing power by ensuring your investments grow faster than inflation over the long term. Retirement savings can also bridge the gap before the state pension starts and, for some people, before defined benefit pensions begin paying an income.
Certain people will have more money than they need to cover outgoings and a comfortable lifestyle. For them, retirement savings – be it through a pension and/or additional accounts like an ISA – can also be their legacy as they pass wealth to family and friends at death.
The biggest mistakes people make
The next step is to review your current portfolio and work out if it needs reshaping for retired life. This is when people often make mistakes.
Investors often assume they need to adopt a low-risk investment approach as soon as they reach retirement. Many people drastically reduce their exposure to shares and assume their pension should be dominated by bonds.
Becoming too cautious too soon can backfire and leave you short of money later in retirement. People are living longer than previous generations, meaning retirement savings often need to last for decades. That means pension pots still need to have an element of growth alongside stability.
It’s worth mentioning lifestyle funds at this point. Historically, they’ve been popular choices for investors who wanted to access a strategy that automatically dials down risk in the lead up to retirement. These funds gradually shift your money from higher-risk assets such as shares into lower-risk assets such as cash and bonds. The downside is that they can leave portfolios more cautious than necessary.
Lifestyle funds were designed for people who would buy an annuity at retirement and get a fixed income for life. They’re less relevant now that so many people leave their pension invested in retirement.
Another common mistake is reaching retirement with too many funds and investments, leaving a pension that is cluttered and difficult to reorganise.
Investors who are around five years from retirement may benefit from gradually simplifying their portfolio, starting with duplicate holdings. Lots of investors find they have different funds that provide exposure to the same areas – look for the lowest cost option and consider making that the priority.
Finally, avoid making knee-jerk changes if markets experience a sell-off close to retirement. It can be tempting to move everything into cash as a safety precaution, but doing so risks missing any subsequent market recovery and the gains that could strengthen your retirement finances.
One of the biggest risks facing retirees is sequence risk. Poor investment returns in the early years of retirement can have a disproportionate impact on the longevity of a pension pot, particularly when withdrawals are being taken at the same time.
Maintaining an appropriate mix of growth assets, defensive investments and cash can help reduce the risk of selling investments at depressed prices to fund spending needs.
Given that you’re doing a thorough review of your retirement savings at this point, it’s a good idea to check for any lost pensions. AJ Bell can help to find misplaced or lost pension pots. You might also want to consolidate pensions to make it easier to manage. It’s also worth reviewing your pension beneficiaries at this point.
How portfolios might look approaching retirement
Investors may wish to review the building blocks of their pension to ensure they are fit for retirement.
A key focus might be income-producing assets including equity income funds and bonds, alongside global equities for growth. Supporting assets might include infrastructure, property and cash.
The mix will vary depending on an individual’s circumstances and what they hold in non-pension assets.
Dan Coatsworth: Head of Markets
Dan Coatsworth is AJ Bell's Head of Markets. Dan has been with the company since December 2012 and has more than 18 years' experience in the industry, following the markets and all things investing. He...
