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Maximising your retirement income: The impact of market fluctuations

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Is your retirement income at risk? Exploring pound cost ravaging

Sean Gilbert

Chartered Financial Planner

2nd October 2023

Pension investors face a crucial decision upon reaching retirement: either opt for ongoing investment and flexible withdrawals (known as Income Drawdown), or secure a lifetime of consistent income by purchasing an Annuity. Read more about the different ways to take money from a pension.

While long-term investors saving for retirement can usually weather the stock market’s fluctuations, if opting for Income Drawdown, the sequence of market events can significantly impact individuals relying on income from their investments.

Withdrawing more or the same amount of money from your retirement savings during market downturns can cause your savings to shrink faster than expected, a situation often referred to as ‘pound cost ravaging.’

To understand this better, think about having a fixed amount of money for retirement and regularly taking some out. It’s not just about how much you make overall; it’s also about the order in which your investments perform. If your investments lose value early on, it can have a big negative impact on your savings, even if they later bounce back. Let’s explore this concept with some practical examples.

An Example

In the table below, the first column illustrates a consistent 5% return over 10 years. The second and third columns depict the same overall growth (on average) over the same period but with varying returns each year. In the second column, there are better returns in the early years, while in the third column, better returns come after some challenging initial years.

If no withdrawals were made, the final values after 10 years would be nearly identical, just under £163,000 in each case.

However, for individuals making regular withdrawals, different sequences of annual returns can lead to vastly different outcomes. In the below example, the investor starts with £100,000, and their funds achieve an average 5% annual return while they withdraw a steady £5,000 income per year. While it might be assumed that the fund value would stay constant, the actual outcome tells a different story.

For instance, Investor C depleted their initial capital by taking income when returns were poor, while Investor B, with the exact same income strategy, ended up with a larger pot than they started with.

Sequence effect on fund value. Compound Annual Growth Rate 5%, annual withdrawal £5,000.
Investor A: Steady 5% Investor B: Good Returns First Investor C: Poor Returns First
Year Return Value Return Value Return Value
1 5% £100,000 14% £109,000 -8% £87,000
2 5% £100,000 13% £118,170 -2% £80,260
3 5% £100,000 11% £126,169 2% £76,865
4 5% £100,000 7% £130,000 4% £74,940
5 5% £100,000 6% £132,800 5% £73,686
6 5% £100,000 5% £134,440 6% £73,108
7 5% £100,000 4% £134,818 7% £73,226
8 5% £100,000 2% £132,514 11% £76,280
9 5% £100,000 -2% £124,864 13% £81,197
10 5% £100,000 -8% £109,874 14% £87,564

Figures are for illustration purposes only

How to Mitigate Pound Cost Ravaging

Investing is unpredictable. History shows that you can’t expect your money to consistently increase because financial markets can be turbulent.

Diversifying your investments by spreading your money across different types of assets is a wise move. This helps reduce the impact when some investments perform well while others do poorly.

Being flexible with your withdrawals is crucial. During tough times, consider taking out less money from your investments to ensure you don’t deplete your savings too quickly. This is especially important if you’re withdrawing a significant amount, as pound cost ravaging has a greater impact the higher withdrawals are.

Keeping some cash on hand is a practical choice. This way, you won’t have to sell your investments at an unfavorable moment. However, be mindful that having too much cash for an extended period might result in missed opportunities for growth.

Alternatively, you can rely on the income generated by your investments for your expenses, leaving your initial investment intact. However, this approach might limit your choices and result in variable income depending on the performance of your investments.

Effectively managing your money for retirement isn’t just about growing it; it’s also about ensuring you can access it when needed. Therefore, having a well-thought-out plan for withdrawing money is as important as your investment strategy.

Should I Consult an Adviser?

When accessing your pension, you’ll be making decisions that will affect not only the rest of your life, but also any funds left behind for your family. This is an increasingly complex area, but a good financial adviser will be able to offer expert advice. For instance, they can set up your preferred pension plan on your behalf. They can also offer practical advice to help maximise retirement income, while minimising your tax liabilities.

If you are considering seeking financial advice here are some related articles which may be of interest:

How to choose a financial adviser

Is my money safe with a financial adviser?

How much does a financial adviser cost?

Is financial advice worth it?

Financial adviser vs. financial planner – is there a difference?

This information is based on our current understanding and is subject to change without notice. This article is for general information only and does not constitute advice.  Whilst information is considered to be true and correct at the date of publication, changes in circumstances, regulation and legislation after the time of publication may impact on the accuracy of the article.

The value of investments and the income from them can go down as well as up and you may not get back the amount originally invested.

HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.

We have local offices in Edinburgh, Falkirk, Glasgow, Livingston and Stirling and provide Financial Advice throughout Scotland. If you would like to speak to an Independent Financial Adviser (IFA) then book your free initial consultation.

Sean Gilbert

Chartered Financial Planner

Chartered Financial Planner at Select Wealth Managers with 14 years of Financial Services experience. Before working in Financial Services, Sean…

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