YOUR appetite for risk, and your subsequent choice of pension fund has a profound impact on your income in retirement.
Unfortunately for some, the impact the financial crisis has had on them is preventing them from moving forward with investing in accounts that over time would have created much bigger funds for them in retirement.
And the ‘some’ I’m referring to are those born between 1981 and 1990 and are commonly referred to as the Millennial generation.
A recent study revealed only 23% of millennials believed the stock market was the best place to invest money, and because of their fear of losing money, 30% would choose to keep money in cash, which is a bigger percentage than any other age group.
There are good reasons they’re feeling this way, because some have been through not one, but two market crashes. Older millennials were impacted by the dot com crash in the early 2000s, and worse was to follow in 2008/09, when they saw their fund values decrease by as much as 50%.
Because of this and nearly 10 years on since it happened, a large majority of this generation are still feeling a bit shell-shocked and are reluctant to invest in equities and choose to invest in cash instead.
The overall objective of many has thus become to protect what they save and have accumulated, and while this is understandable, and protecting your capital is important, if you are excessively risk averse, you could come up short when retirement is upon you.
The bad experiences some of their parents may have suffered can also foster negativity which serves as a reference point for decisions they make today and in the future, leading them to under-invest in equities, or in some cases, not invest at all.
This is a big mistake, particularly if you were born after 1980 and have c. 30 years to retirement. Yes, there will be times when things are volatile and go down in value, but the comfort you have, is that over a 30-year span, markets are very predictable in what they will do and what they will return.
It’s one thing being risk averse when you are older and close to retirement age and the smart play is to reduce your exposure to the stock market and invest in more conservative options like cash and bonds. But if retirement is three or more decades away, you have time to ride out the inevitable highs and lows that will occur.
You need to create as big a fund as you possibly can in retirement and being overly cautious and investing in just cash is unlikely to generate enough of a fund for you when you retire. The problem is when people focus too much on not losing money, they forget about the risk of outliving it.
Inflation will eat into your cash fund and the amount you have to spend will buy you less when your needs begin to increase because everything will cost more. So even if your experiences of the past are telling you not to invest, part of the solution to having a fund big enough fund to support a good quality of life when you are older, is having to invest some of your money now into equities. Let me show you why.
If you’re 35 years old and, let’s say though your personal and employer contributions, €500 is being deposited into your fund each month. If you choose to play it safe and invest in a cautious fund where say 20% of your fund invests in equities, your likely return will generate a fund, in today’s terms of c. €268,241 when you are 65. It’s not bad but wait until you see what it could be if you choose a more aggressive approach.
Let me first tell you what this fund of €268,241 will pay you each year and how long it will last for. If you have to take an income of 10% from it each year and continue with your conservative investment strategy where it’s all invested in cash, there is a 100% chance you will run out of money in 10 years.
If you adopted a more aggressive strategy i.e. where a greater % is invested in equities - say you started off with 65% of your fund investing in equities - the fund you could end up with in retirement is €556,084.
If you withdrew the same amount each year as you did from the previous smaller fund i.e. €26,824 and continued to invest in equities but at a much smaller rate, there is a 100% chance you will never run out of money, unless you live beyond the age of 108.
If you continue to ignore the opportunities of taking a little more risk than feels comfortable to you, you may not be able to grow a fund that will last long enough for the amount you need to draw from it each year.
So, if you are one of those who are feeling that way and have stayed away from equities and invested in cash over the past number of years, you may need to rethink your strategy. The good news is that you have still time on your side.
Liam Croke is MD of Harmonics Financial Ltd,
based in Plassey. He can be contacted at firstname.lastname@example.org or www.harmonics.ie