If you have already saved all the money you think you will ever need then you might wonder why you should invest and put up with all the volatility.
Why invest your money and see periods where the value falls significantly when you can just keep it all in a cash bank account and take out what you need each year?
You will never see the value of your cash go down. Or will you?
The four main reasons you should invest your retirement savings
So let’s say you are 60, now retiring with a £1million pension fund. You predict that you will live to age 85 so work out that you could withdraw £40,000 per year.
You decide that £40,000 per year is more than enough for you so you believe you don’t need to invest. You don’t want to see your money go down, you have enough cash to cover you without needing to invest.
The biggest risk you are going to face in your retirement is inflation eroding the purchasing power of your money. What costs £1 today is going to cost a lot more in the future. So this means your withdrawals will need to increase just to buy the same amount of stuff you did as before.
We have tested the scenario above using the actual historic global capital market data over multiple rolling 25 year periods starting in January 1915 all the way up until the end of 2021. This includes actual examples of inflation during these periods.
We have lined up over 900 different 25 year retirement periods and picked out the best case, median and worst case scenario.
You can see in the above chart that if you did decide to keep all your money in cash your balance will run down to zero in real terms by age 77 in the median scenario and 71 in the worst case scenario. In fact, only 4% of the scenarios tested did you actually make it to age 85 without running out of money.
This is why you need to invest. Even if you want to just stand still and not grow your money in real terms you still need to keep pace with inflation. If not you’re almost guaranteed to fail.
Let’s have a look at the same scenario above but this time investing the pension into a fairly balanced portfolio of 60% equities and 40% bonds.
This time you can see that even in the worst case scenario your money should last until age 85 and in 99% of scenarios tested you would have been OK.
It’s not just inflation you need to worry about though. You don’t actually know how long you will live for.
Many people predict their life expectancy based on their parents lives but actually, the genes you inherit only account of around a third of your potential health situation in the future. Lifestyle improvements and medical advances mean you may live a lot longer than you think.
You need to ensure your money outlives you and you can only do that by growing it over time.
The two other main reasons why you should invest are related to the level of withdrawals you need to make.
For one you need to factor in different tax rates that may be applicable to the withdrawals you make. This will mean you actually need to withdraw more than you need to spend to cover the potential tax due. Remember, tax rates on different products change all the time so growing your funds to combat this and making use of all the tax allowances available to you is really important.
Secondly, whilst you might be excellent at budgeting and know what withdrawals you need to make each year, there are some things you can’t budget for.
Home repairs, children and grandchildren support and health spending are all things you can’t predict but could be very expensive and cause a serious dent to your retirement savings. You always need more than you have budgeted for.
You should invest knowing the truth
When it comes to choosing the right investment for you there are three different types of risk you need to be aware of.
Firstly, there is the risk of permanently losing all of your money. The absolute worse type of risk as there is no chance of getting your money back.
This can only really happen if you concentrate your investment into one thing. For example, you pick a company to invest in and that company goes bust.
It is easy to combat this risk by diversifying your investment across all the great companies of the world via a careful selection of investment funds. If every company in the world goes bust then we probably have something more scary to worry about than money!
Secondly, there is inflation risk. As we have seen earlier, inflation is very damaging to your money over the long term which means we have to invest in assets that are likely to give us a ‘real’ return over time. A return that is above inflation otherwise we are not really investing.
Finally, there is volatility. This is the change in price of an investment day by day. Sometimes share prices go up and sometimes they go down. When they are down you haven’t actually lost anything. It’s usually just a temporary fall in value and it can recover as time passes.
Volatility is the price you pay for great long term returns.
So even if you think you have all the money you will ever need you should invest to ensure it remains all the money you will ever need.
If you are not sure what to do with your pensions at retirement then please get in touch for a free no obligation 15-minute call. We would be happy to review your position, explain where you stand and what you need to do to get the outcome you desire. We have created hundreds of happy retirements over the years. This could be you too.
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.