Updated 30 March 2022
The COVID-19 crisis has hit stock markets hard in recent weeks. This can be a serious issue for anyone relying on a pension pot, either near-retirement or post-retirement. What can you do to cushion the impact of a market crash? Article by Nick Green.
The coronavirus has caused misery across the planet, claiming many lives and putting tens of thousands more in hospital. A less tragic, but just as real problem has been its impact on global stock markets. Falls in the FTSE and Dow Jones indices don’t just affect the traders of the stock exchange – they impact everyone, and especially anyone with pension savings. Quite simply, if you have a pension, you are an investor. So how is this turbulent time affecting your long-term finances – and is there anything you can do about it?
If you have a defined contribution pension (most pension savers do), then your monthly contributions are paid into a fund that invests in the stock market. This fund usually achieves growth over the long term, but in the short-to-mid term its value can fluctuate wildly due to ‘booms and busts’. Up until the start of 2020, the market was enjoying one such boom period, and everyone’s pension savings were growing faster than average. Then the coronavirus crisis came along, and the markets suffered their second-biggest loss of all time.
If you still have a decade or more to go before you plan to retire, you don’t have to worry too much – historically, big stock market crashes usually rebound well in the following years. However, if retirement is only a few years away – or if you are already retired and now drawing your pension – the effects on you could be more noticeable.
What these effects will be, will depend very much on your particular circumstances. We’ll go through them one at a time.
Your pension savings will have taken a significant hit, but five to 10 years is still a reasonable time in which to recover. You can help the process along by taking action in good time.
You may not have been exposed to the crash as much as you think, since your pension fund (or your financial adviser) may have moved your assets out of equities and into safer bonds in preparation.
However, if you did have some investments still in equities (stocks & shares) then your final retirement pot runs a risk of being lower than expected. Here are some steps you can take to tackle this issue.
Pensions expert William Burrows says that the key to making the right decisions now is to think ahead. ‘This is a crucial phase for pensions – invest too cautiously and you will lose out on growth, but take too much risk and you could see the value of your pension pot fall dramatically. One way of working how to invest in the years before retirement is to think about what options you might choose when the time comes. For example, if you plan to buy an annuity, investments should hedge against gilts and bonds, but if you’re aiming for drawdown it makes sense to continue investing in well diversified equity portfolios.’
Retiring right after a stock market crash is certainly not the best time, but you won’t necessarily have lost much if your pension fund was moved out of risky equities and into bonds. This should have happened automatically if you were in your pension’s default fund – talk to your financial adviser if you’re unsure.
If your pension has taken a hit, there are still things you can do to reduce the impact. If you can’t delay your retirement until the markets have recovered, consider the following.
This situation may be somewhat nerve-wracking, as you are currently reliant for income on a fund which will have shrunk visibly over just a couple of weeks. Your priority now is to limit those losses as much as you can.
William comments: ‘Drawdown is clearly at risk from falling equity prices, but a good adviser will be aware of this and discuss appropriate investment strategies. The biggest pitfall we call the “sequence of returns” risk.’
This is the risk that investment returns are lower than expected (or even negative) in the early stages of drawdown, meaning that your capital (the invested sum) is eroded faster than expected. This puts you at risk of running out of money.
To combat this, William suggests the ‘three bucket’ approach. ‘A good drawdown plan should include three key elements: cash for a few years of income, a growth fund, and a core portfolio that is diverse and errs on the side of caution. Plans with sufficient money in low risk assets should weather the storm, but those which are overweight in equities will take some time to recover.’
You can put your feet up and pour yourself a drink. You might also want to a buy a drink for whoever advised you to buy that annuity. You won’t lose any of your pension income at all, since your annuity is guaranteed for life and is now completely unconnected to the stock market.
This isn’t to say that an annuity will always be the best pension option. During times of stock market growth, they can often look like poor value compared to the more exciting drawdown schemes. But as the coronavirus crisis has reminded us, the unexpected can strike anytime – and a 25 year retirement is a long time over which various crises can happen. There are times when a guaranteed income is almost too valuable to put a price on – and this may be one of them.
One of the big risks during any kind of crisis is that of panic, and making rash decisions as a result. A financial adviser can help you see the bigger picture, weigh all your options and take a balanced assessment of your risks. In particular, if you have family or other dependents to think about, your financial adviser can ensure that your plans cover them too.
Find out more about your options for taking your pension.