How to shield your pension from the next market dip

Telegraph

2 days ago

No one wants to risk running out of money partway through retirement, but if you're not careful, a phenomenon known as 'pound cost ravaging' could wipe thousands off your pension.
This is the term given to the lasting damage you can do when you're in early retirement and markets are dipping. It affects those relying on the income generated by their pension.
If you're not careful, a combination of regular withdrawals and negative investment performance can wreak havoc on the funds you have to see you through your later years.
Pound cost ravaging has been thrust into the limelight amid ongoing concerns about the value of investments given recent market upsets in the wake of President Donald Trump's tariffs.
If it happens in the first few years of retirement, it can be especially worrying, as you could end up racking up hefty losses which you might never manage to recover.
Here Telegraph Money takes a closer look at what pound cost ravaging means, what you can do to protect yourself from it – and whether you can repair the damage if it's already happened:
What is pound cost ravaging?
Why you need to know about it
How can you avoid it?
Can you repair the damage if it's already happened?
What is pound cost ravaging?
Pound cost ravaging is essentially the reverse of pound cost averaging – the process of gradually feeding your cash into investments when valuations are lower, to smooth out volatility in purchase prices.
When you do this, you can buy more 'units' of an investment with the same amount of money.
By contrast, pound cost ravaging refers to the potentially damaging effect of regular withdrawals, meaning you risk compounding losses you could have made back if you had kept the money invested.
Becky O'Connor, director of public affairs at PensionBee, says: 'It's so-called because it's the more detrimental version of pound cost averaging. It refers to the impact on your pension pot if you take money out of it while the value of your pot is declining, usually in a market dip.'
She adds: 'Withdrawing money when markets are in a downturn means crystallising losses. The result is you have less remaining invested to help your fund recover when markets improve again.'
Why you need to know about it
While you may be familiar with the idea of pound cost averaging, the phenomenon of pound cost ravaging receives far less attention.
Jason Hollands, managing director at wealth manager Evelyn, says: 'Pound cost ravaging deserves discussion because it is a growing risk as old-style 'defined benefit' pensions have all but disappeared outside the public sector.'
This type of pension pays a person a retirement income linked to their former work earnings.
These days, most of us have defined contribution
Mr Hollands says: 'The Pension Freedom reforms of 2015 resulted in much greater flexibility in how pension pots can be accessed. Significantly more people have opted for income drawdown [remaining invested and making withdrawals], than using their pension pots to purchase an annuity.'
Annuities, available from insurance companies, provide a guaranteed income for life.
Mr Hollands adds: 'Given market fluctuations are a fact of life, how we sequence those withdrawals is important.'
Pound cost ravaging refers to the potentially negative effect of regularly withdrawing a fixed cash amount from a pension in drawdown, irrespective of what is going on in the markets – and of the changes in the value of the overall pot.
If you doggedly continue to draw a fixed amount of cash from your pension during periods when markets have taken a tumble – so-called 'corrections' and 'bear markets' such as the Covid crash – unchanged withdrawal rates will represent a bigger proportion of your overall pension pot,
This is because you will have to sell more shares in your fund to sustain the same cash withdrawals.
Mr Hollands says: 'That will inevitably erode the recovery potential and could risk the longer-term sustainability of your pension as you may end up burning through your retirement finances too quickly.'
The effect would be even worse in a situation where falling markets coincide with a period where living costs are rising and so people may be tempted to increase their withdrawals to cope with their immediate needs, not considering the longer-term damage this would cause.
How can you avoid it?
The good news is, there are a host of steps you can take to mitigate the risk of this phenomenon.
Don't panic
To avoid the ravaging effects, one of the best things to do is avoid panic selling in a downturn – while also refraining from taking out more than you need at any time. This is especially the case if markets seem uncertain.
Ms O'Connor says: 'Historically, market performance tends to even out over time. Leaving as much as possible in your pot gives you the best chance of maintaining your retirement fund for as long as you need it.'
Ring-fence a healthy cash reserve
There is a lot to be said for being prepared in advance – just in case you face market trouble a year or so into retirement.
Having a pot of cash on hand to draw on can be a big help while you wait for the market to settle.
Mr Cook says: 'In the medium term, utilising other assets, such as savings accounts and cash Isas can make good sense while markets recover.'
This might provide an option which allows you to pause or reduce your income withdrawals from your pension.
Mr Cook adds: 'If you have cash savings or other assets you can afford to live off which haven't been affected by the stock market fall, this can be a really useful option to help you avoid a situation where you end up compounding losses in the pension.'
Only draw natural income from your pension
Another option during periods when markets are down is to cease taking a regular cash amount – which might involve selling investments in your pension funds at depressed prices. Instead, just withdraw the dividends and interest generated by them.
Mr Hollands says: 'This will, of course, involve you having to accept a variable amount of income, potentially much lower than 'normal', but will mean you are not selling investments at low prices and thereby reducing exposure to a recovery.'
Such an approach might work in conjunction with holding a cash reserve.
Establish a 'gilt ladder'
Gilts, which are bonds issued by the UK Government, provide highly predictable returns if held until maturity.
Mr Hollands says: 'Currently there are many gilts due to mature over the next few years which can be purchased well below the prices that they will mature at, and therefore a known gain will be made.'
With this in mind, it could make sense to own a selection of gilts that will mature over each of the next few years.
Known as a 'gilt ladder,' this will provide a very predictable return that can be used to fund short to medium-term retirement costs, even if equity markets take a plunge.
Diversify your assets
Having a diverse range of holdings – including alternative assets – also makes sense.
Mr Cook added: 'This means your pension pot isn't beholden only to the outcome of global equity markets, and will therefore give you different return and income streams.'
Add more to your pension pot
If you have the money available, adding more to your pension pot could help restore your income sustainability to its previous level.
Mr Cook says: 'These days, it is important to have a pension pot that can survive 30 years, if not more. As a result, you need to still have a good exposure to equities over the long-term, so it may be worth considering topping up or drip-feeding into the market to boost your pension.'
But before going down this route, it is vital that you check your annual allowance.
If you have already started 'flexi-access drawdown' you will be subject to a reduced 'money purchase annual allowance'. This will cap the amount you can pay into your pension with tax relief.
Can you repair damage already done?
If you've already fallen victim to pound cost ravaging, don't despair.
Ms O'Connor says: 'Consider re-investing in your pension if you are able to, and if you still have other sources of income. Also consider whether your pension investments are optimised for what you need them to do.'
Diversification, she points out, can help cushion losses.
fees you are paying for your pension are reasonable and not unnecessarily eating away at your funds.'
Delay your retirement
A further option you may want to think about is whether it's worth prolonging your career.
Increasingly, we are seeing people 'phase into' retirement gradually, as opposed to seeing it as a cliff-edge to stopping work.
Mr Cook said: 'Shaving a few years off your retirement date removes the immediate-term worries about cashing in your investments to generate income during a dip in the market.'
Should you buy an annuity?
Another of the big decisions you might also want to consider is whether to buy an annuity.
As annuity rates are highly linked to gilt yields, they were until relatively recently very low.
Mr Hollands says: 'In the aftermath of the 2008 global financial crisis, we experienced a prolonged period of ultra-low interest rates and correspondingly low gilt yields. Combined with the 2015 pension freedom reforms, this has driven most retirees towards drawdown instead.'
However, since interest rates have climbed in the aftermath of the pandemic, annuity rates are more attractive. As a result, Mr Hollands suggests that those who have overlooked annuities previously might want to reconsider.
'The decision between buying an annuity or drawdown is often perceived to be an either/or one, but that need not be the case,' he said. ' A hybrid approach can also be sensible.'
You could, for example, opt to use part of your pension pot to purchase an annuity, which, alongside the state pension, might provide a known, predictable level of income that covers basic costs.
Drawdown warning
Industry experts have repeatedly voiced concerns that many people who have opted for drawdown – and who haven't sought advice – may have little idea as to whether their pension is going to last.
This is where seeking independent financial advice can make a lot of sense.
A good financial planner will use cash flow modelling tools to project whether savings and investments are going to be sufficient to meet future outgoings.
If you want to be sure that your savings will last the distance, then planning for market volatility – and particularly in the early years of retirement – is key.