Beware the dangers of turning to cash

For a long time, conventional wisdom suggested someone approaching retirement should switch out of risky assets and place funds in cash or short-term bonds. Then at retirement they would have a cash pot which would be used to buy an annuity.

This approach is unlikely to work for income drawdown.

Someone aged say 60 or 65 may well live for another 20 or 30 years and will need to generate an income for that period. Many will need to challenge their attitude to risk which, as I see it, falls into three main areas:

First, volatility – how widely an investment fluctuates up and down in value; second, inflation risk; and third, the risk of income running out too soon.

Unfortunately, many clients focus exclusively on the first risk and believe they are being sensible by keeping money in what they perceive as no or low-risk assets like cash. They may well protect capital in the short term, but are unlikely to grow.

When advising, we would discuss in detail the risk of the various asset types and consider how much income is needed in the short, medium and long term. Many clients will want to maintain their living standards and perhaps spend more in the early years of retirement, rather than later on.

So we would devise a portfolio with a variety of asset classes. Cash and short-dated bonds may be used for early withdrawals from the pension. For medium-term investments we may consider fixed-interest assets such as gilts and corporate bonds, and also multi-asset funds that help to provide greater diversification. For the longerterm investments, short-term fluctuation in capital values becomes less important.

Instead, maintaining value and producing returns higher than inflation is the priority. Commercial property exposure, for example, can be used to provide steady returns above inflation. For longer-term investments emphasis would be on equity markets that historically have proved to outperform other asset classes over time. Here we would use both UK and overseas funds.

I have always been a strong supporter of investment trusts. A number that we use have long track records, strong cash reserves and have managed to increase their dividends every year for well over 40 years. Having this increasing income, as well as capital growth potential, is very important in dealing with future inflation and protecting the pension assets.

The withdrawal facility being extended to more savers and giving them control of their money is to be welcomed. There is as much danger in withdrawing money and squandering it, as in being too cautious and leaving it in seemingly safe investments that will not support a long retirement.

Wayne Evans is a financial planner at Heron House Financial Management

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