It’s been over three years since the April 2015 pensions changes which scrapped compulsory annuities and gave pensioners greater choice over how to take their retirement income.
This historic change to UK pension legislation opened up a range of investment opportunities for pensioners. With increased control of their pension, investors can seek to position their portfolios to deliver the income required, while retaining – and perhaps even growing – their invested capital.
Generating income in a low interest rate environment
While the changes offer many opportunities, generating investment income remains difficult – particularly in view of low interest rates.
As the chart shows, the Bank of England’s target interest rate had been stuck at 0.5% for more than eight years. It was cut to 0.25% in August 2016, then increased to 0.5% in November 2017, then 0.75% in August 2018. Meanwhile, the income that can be earned through holding UK government bonds – a traditional staple instrument of low-risk, income-focused investment portfolios – has shrunk from over 5% before the 2008 financial crisis, to 1.3% in August 2018.
Equity markets risk income stability
The chart also shows that the dividend income available on UK equities has risen somewhat, making them an attractive proposition for many investors.
However, income-seekers should be wary of rushing headlong into equities in search of the returns that have been eroded in other asset classes. Investing in equities comes with a degree of risk, particularly for those relying on their investment portfolio for their means of living.
Should equity markets suffer a setback, retirees may find their pension fund reduced in size and incapable of generating the necessary income.
Taking a diversified approach
A robust income strategy should not be overly reliant on a single asset class. But making a decision on which asset class to hold is tricky – the top performer changes regularly and the returns can be volatile.
Investors who are over-committed to one asset class run the risk of disproportionate losses should that asset class underperform.
An alternative approach is to take a much wider view and consider other potential sources of income from a broader range of asset classes and capital structures, across many different countries and regions.
Taking a more diversified approach means that a drop in the value of one asset may then be offset by increases in other asset classes, leading to smoother overall performance – and a potentially more stable source of retirement income.
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You should not use past performance as a reliable indicator of future performance. It should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise. You may not get back the amount you originally invested.