Stock market volatility

Since the pension freedoms, more people have been considering investing some or all of their pension savings in 'income drawdown' products. This means that they are able to access their savings more flexibly but can still take an income regularly if that’s what they would like. How the money in an income drawdown product is invested – and whether this involves investment in stocks and shares - can affect the value of the total fund.

What do you need to bear in mind if you are thinking about investing your pension pot?

In this Retirement Matters video, Pete Matthew explains what stock market volatility is and how this can affect the value of your fund if you are taking income drawdown:

Why is it important to consider stock market volatility?

Movements in the stock market can be unpredictable. Because of this, if you have invested in stocks and shares it can affect how much your investment fund is worth. So when you invest in an income drawdown product (that includes stocks and shares in its investments), the usual risks that are associated with investment need to be considered.

How might it affect income drawdown?

How well the markets are performing will affect the value of your stocks or shares and if you are taking a regular income from your drawdown pension. This can have a significant effect on how long your income will last you. If there are a run of bad stock market falls, particularly if this happens early on in your retirement, then your fund might be severely affected as you might not have enough time to time to average out this loss. Pete explains this in the video above.

Is there anything else that I need to consider?

Yes. There is another way that investment volatility can affect your pension savings. Pete describes it as volatility drag in his video. What this means, is that if you lose money early on it’s more difficult to make it back. So for instance, if you have £100,000 in your pension pot but this falls by 15% in the first month. This would take your total down to £85,000. This means that even if it was to then grow by 15% in the following month, 15% of £85,000 would only take you back up to a total of £97,750. Over time this kind of volatility can all add up and your investment has to work harder to regain any lost funds.

What is mortality drag and is this important?

It can be. If you delay purchasing an annuity, or decide that you are going to secure a retirement income in some other way, your pension fund may bear a cost. This is sometimes referred to as ‘mortality drag’. The money that you are offered by the pension company for an annuity is subsidised across all of the people who would like to turn their pension savings into a guaranteed income for life. This is called ‘cross-subsidy’. Those who die earlier than expected then subsidise (or fund) those who live longer than the annuity company expect them to.

Cross-subsidy can work in your favour or not – it depends on how long you live. If you have decided that an annuity is not for you, you definitely won’t benefit from cross-subsidy. Plus, your drawdown fund will need to work harder and harder as time goes on in order to reflect the cross-subsidy value that you might be missing out on.

Of course, all retirement income routes have positives and negatives and are worth considering carefully. But if you are considering income drawdown, it’s important that you understand how these factors can affect your fund value over time.