Large withdrawals from a pension pot when fund values are depressed can significantly reduce the sustainability of income. In the UK, flexible drawdown was introduced with pensions freedoms in 2015, and the extended 2022 bear market in both global stocks and bonds was its first real test. Meanwhile, today's higher bond yields mean annuities are a more competitive investment solution than they used to be, albeit with significantly less flexibility.
In this article, we demonstrate the importance of managing downside risk during the several recessions and associated bear markets the average person is likely to encounter over the course of their retirement. To do this, we use historical returns to simulate the 20-year experience for cohorts retiring from the mid-1990s onwards. We compare outcomes, assuming fixed annual withdrawals, for a range of investment strategies encompassing cash, global equities, and two multi asset approaches – one a passive balanced strategy rebalancing between stocks and bonds; the other an active strategy focused on total return and downside risk management.
Unsurprisingly, we find that keeping your pension pot entirely in cash is unlikely to generate enough return to sustain an income reliably. For the vast majority of the cohorts in our study, diversification means both multi asset approaches control sequencing risk better than equities. However, the actively managed multi asset option is the clear winner with better risk-adjusted returns and lower peak to trough losses driving superior outcomes when compared to a passive balanced fund offering broadly the same average return. The return of structural inflationary pressure is pointing to shorter business cycles. For this reason, the management of downside risk will be as important as the management of return in a successful retirement solution.
What makes a good retirement income solution?
The asset management industry has had decades of experience designing and managing portfolios during the accumulation phase of saving. However, in our view, many providers aren't yet addressing the distinct investment challenges faced by people withdrawing money from a pension pot to meet their retirement income needs.
For professional investors only. This material is not suitable for a retail audience. Capital at risk. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice. Forward looking statements are subject to certain risks and uncertainties. Actual outcomes may be materially different from those expressed or implied.
