Strategies for protecting against pre-retirement stock market crash

Sportacus

My employer has a default plan where 10 years before your retirement date half your fund is moved to bonds, then 5 years before the rest of it is moved (with similar adjustments to future contributions). This seems rather coarse to me, and these bonds funds have proven to be anything but safe these past years.

I do have some flexibility with this defined contribution pension scheme, and they do have a 'cash fund' - which actually does seem to earn interest and invests in bonds, the 'bond funds' seem to track bond indices (probably why they've lost money in recent years).

I'm 14 years from retirement, my current thinking is to keep it all in the global developed world tracker fund it's in now, and when I'm ten years before retirement, each year start moving 10% of the fund (and future contributions) to the cash fund.

As I understand it, there has never been any stock market crash that hasn't recovered within 7 years when you take dividend reinvestment into consideration, is this correct? I'm tempted to take some more risk and only start switching to cash 5 years before retirement (20% a year).

kempiejon

Whatever helps you sleep at night but I think the idea of your age influencing your investment is guff. There was a suggestion that 100 minus your age is the percentage you need in stocks. I think it's been discredited. I've been near 90% equity for all my investing and will probably stay around that mark into retirement. You can manage the crash risk with cash or bonds but it also reduces overall return. I have a plan to hold about 3 years of expenses to mitigate stock market wobbles. I also anticipate my investment income to be about 10% above expected expenses. Being mortgage free is another valuable safety net. Some retirees might need to draw from their investments for 30 or 40 plus years, bonds hold back potential gains so an even bigger pot is needed.

Gary1984

It depends what you're using the money for? If it's for drawdown then you'll still want a reasonable portion of equities to ensure future growth and to protect against inflation. If you're risk adverse you'd want some bonds in the mix too.

If you're buying an annuity then you should be moving into bonds as this hedges against annuity price changes.

If you plan on spending some money on something specific when you retire (pay off mortgage, world cruise, campervan etc) then moving the designated funds to cash would make sense.

So generally moving into 100% cash probably not a great move but it depends on your plans and appetite to risk.

Mark_d

How you manage your pension fund needs to consider how you want to take your pension.  Moving to cash before retirement age might make sense if you have a fixed retirement date and want to buy an annuity.  Personally my plan is to take uncrystallised lump sums to fund my retirement, so I have no plans to move anything to cash

Tryinghardtosave

who is your pension provider? as some take a rather large slice of interest from any cash holdings - on top of their fees !!!

Sportacus

L&G, and I'm planning to get an annuity.

Pat38493

Sportacus said:

My employer has a default plan where 10 years before your retirement date half your fund is moved to bonds, then 5 years before the rest of it is moved (with similar adjustments to future contributions). This seems rather coarse to me, and these bonds funds have proven to be anything but safe these past years.

I do have some flexibility with this defined contribution pension scheme, and they do have a 'cash fund' - which actually does seem to earn interest and invests in bonds, the 'bond funds' seem to track bond indices (probably why they've lost money in recent years).

I'm 14 years from retirement, my current thinking is to keep it all in the global developed world tracker fund it's in now, and when I'm ten years before retirement, each year start moving 10% of the fund (and future contributions) to the cash fund.

As I understand it, there has never been any stock market crash that hasn't recovered within 7 years when you take dividend reinvestment into consideration, is this correct? I'm tempted to take some more risk and only start switching to cash 5 years before retirement (20% a year).

Personally I would agree with you that these kind of automated lifestyle approaches are a pretty blunt tool, and the fact that you have figured this out, probably means that you should consider taking control of the investments yourself and planning your own approach.  Also you are right to say that arguably the adjustments start too early and are too conservative (unless you are planning to buy an annuity with your whole pot).

Again personally, I would not be reducing my equity exposure 10 years out - 5 years is already plenty.  In fact I have just made some adjustments and I am planning to retire in the 7-20 months, and I am still over 70% in equities.

There are gazillions of books and papers on the myriad ways you can structure it, but a long series of research blogs by ERN (early retirement now) posited that keeping your investments as 80/20 throughout you will be fine.  Any improvements you can make by adjusting things are pretty marginal and he seemed to find that you should certainly not be less than 60-70% in equities at any time if you are looking for optimal long term outcomes.  

Of course if you are very risk averse and you are unable to cope with seeing your investments reduce in value and take a pragmatic long term view, you may come to a different conclusion.

10 years out I would remain 80% or more in equities but that's just my opinion.  I heard an IFA video where he mentioned that the first thing they advise their clients to do is switch off lifestyling so that they can take control of the mix proactively.

It also depends partly on your drawdown strategy but if you are 14 years out you probably won't know that yet anyway.

SVaz

Well some cash will be needed, unless the underlying investments provide enough dividend income.
I’m building a cash ( from dividends) and MMF ‘pot’  to use for early retirement,  hopefully in 3 years time.
 All contributions will be into the MMF from the end of this year so no other investments will need to be sold at the point of retirement.  

Cash/MMF will account for around 30% of our total pensions by the end of 2027, assuming no major crash occurs of course.  
That might impact growth but will negate a market crash, which, given the fact that I’ll be taking 10% a year from my main pot for 3-4 years,  seems like the wise thing to do. 

At SP age,  we’ll drop to 2-3%,  just to replenish savings rather than spend. 

leosayer

Cash is not a great place to be if you are targeting an annuity.

If interest rates drop then so will annuity rates so you'll get a double whammy. 

Linton

I would not be too worried about using safe bonds for diversification leading up to and beyond retirement.  The events over the last couple of years arose from the rapid rise in interest rates following a continual fall to near zero over the previous 40 years.  That is almost impossible to happen again in our lifetime.

There are two downsides with a cash account.  Firstly the interest on those available from SIPP providers is generally lower than that available from bonds and secondly they will closely follow the then current interest rates without any corresponding capital price change.  On the other hand  with bonds if interest rates fall which seems likely in the medium term,  bond prices will increase fairly quickly whereas bond interest in £ terms will take longer to respond.

However I do suggest you avoid long term bonds since they are very much more volatile than shorter dated ones.

If you are planning to buy an annuity when you retire then moving to a high % in bonds makes sense.  If you are planning to drawdown the answer is less clear.

 If you are planning on withstanding a 7 year crash you logically only need 7 years income protection starting the year you retire. Say you are planning on 30 years retirement that would imply increasing your bonds from 0% to say 25% over the 7 years leading up to retirement.

Another way of looking at things is that you presumably know your strategy for dealing with equity volatility when in retirement.  Why not move to that allocation over the corresponding years prior to retirement?

leosayer

Even if your entire pension is in cash, you will only be able put 75% of that into an annuity.

Do you have immediate spending plans for the remaining 25% tax free lump sum? If not then holding it all in cash may not give you the best long-term outcome.

Why you are targeting an annuity rather than drawdown?