Hello and welcome to the Morningstar series, "Ask the Expert." I'm Emma Wall and I'm joined
today by Annabel Duncan of JP Morgan.
Hi, Annabel.
Hi, Emma.
So, we're here today to talk about Pound Cost Averaging. It doesn't sound like a very sexy
topic. What does it mean?
So, the reason why this is important and what it means, now that we have these new pension
freedoms, the challenge for people is going to be thinking about when they take their
money out. The thing about pound cost averaging or ravaging is that it can be very important
when you take your money out. If you take your money out in times of market stress,
for example, then you'll be in a position where because the markets are slower you're
having to sell more assets to generate the same level of income. That then leads you
to a position where you have less assets overall and this may weaken your returns going forward.
So, the impact for your pension pot and your savings, particularly if this happens in the
early years when you first retired, can be really significant and you may never recover.
So, there's two things there, isn't there? There's the fact that basically you need to
prioritize capital preservation because your earning power is dramatically reduced. In
fact, it may have gone entirely, some people will retire and have absolutely no other income
and then there's the market fluctuation. So, how do you marry those two things? How do
you marry keeping your pot as large as possible with something that can't actually be predicted,
the market?
Yes, it's a real challenge and I think particularly with the new freedom for people who are thinking
about doing income drawdown. So, as you say, they will need some income but they will still
also need some capital growth at that time. Now, really there are two options. So, for
the lucky few who have a pot that's large enough who can maybe have other assets, maybe
have ISAs or other wealth or other sources of income, they will have the opportunity
to maybe delay taking money out, particularly in times of market stress and they can postpone
that for a while.
Otherwise, what you really need to be thinking about is your diversification and the mix
of assets that you are invested in. For example, if you're invested mainly in fixed income,
in bonds and rates rises, we're expected they may do, and then prices fall and you're selling
these assets to maintain that level of income, you'll obviously be selling them at a lower
price and that will impact your overall portfolio. You'll have to sell more of those assets to
generate that same level of income.
I suppose it's worth pointing out though that some capital depreciation is not the end of
the world. In fact, that's the whole reason you were saving in the first place. Obviously,
retirement is lasting considerably longer than it used to be. It used to be you save
for 30 years, you spend for 10. Now, it looks more like, you save for 30 years, you spend
for 40 years. So, getting the balance right, obviously making that money last is important,
but don't be scared of some capital depreciation because that's the point, right?
Absolutely. You've worked really hard throughout your life and this is your opportunity to
enjoy your retirement. You're quite right that there is that balance between enjoying
your retirement but also being prudent and thinking about how you're invested. I think
something that we've seen is that a lot of people underestimate exactly how long they
are going to live. So, it's worth thinking that you may live longer than you expect and
that money may need to last you a little bit longer.
So, as well as diversification, what can people do to sort of mitigate these risks, these
problems?
I think the biggest thing really is in the earlier years save as much as you possibly
can. It's tough because obviously everyone has other expenditures and things that are
going on in their lives that drain their ability to be able to save. But to put you in the
best position possible so that you do have options at retirement is really to focus on
getting your savings levels as high as they can.
Annabel, thank you very much.
Thank you very much.
This is Emma Wall for Morningstar. Thank you for watching.