Join our community of smart investors

Secure your retirement income with asset allocation

Having the right asset allocation is the key to ensuring your retirement income through the present crisis and beyond
Secure your retirement income with asset allocation

Choosing the right asset allocation for your self-invested personal pension (Sipp) is far from straightforward, even in normal circumstances. Your financial goals, level of risk tolerance and life expectancy and the state of markets are just some of the many factors that need to be accounted for when making decisions on what will have significant consequences for the health of your retirement savings.

For now, the impact of Covid-19 means that short-term events have taken over. Equity markets have suffered huge falls, with volatility rippling out into other asset classes. With the economic impact of the coronavirus lockdown looking both substantial and difficult to quantify properly, it could be some time until markets recover.

As we pointed out in the Money section in the issue of 6 March, the violent sell-off should allow those with a longer time investment horizon, including some Sipp investors, to invest in equities and other risk assets at seemingly cheap prices that should ultimately produce strong returns in years to come.

But the sell-off poses much greater problems for anyone who uses, or is about to use, their Sipp to generate some form of retirement income. In both situations you need to make some important asset allocation calls that may initially feel counterintuitive but avoid rash decisions.



Regardless of whether you require income, if you have a diversified portfolio it is most likely that your equity holdings have been hit particularly hard. Most assets have also suffered but certain parts of your portfolio, such as government bond and gold holdings, could be in better shape depending on when you invested.

Daunting as the sheer drops in equity markets appear, it is very important not to panic and sell out of this asset class because doing so will realise a loss and undermine your future returns and income sources.

“If you were fully invested and have now incurred considerable losses then you don’t have too many choices,” says Rob Morgan, pensions and investments analyst at Charles Stanley. “Rebalancing out of areas that have been hit hardest to go into safe havens or cash only crystallises a loss and that isn’t likely to be in your interests as a longer-term investor. In particular, selling out with the intention of buying back in at a later date tends to be counterproductive. If you miss the upswing you could put yourself in a worse position.”

Instead, investors should rebalance back to their original asset allocation, which is likely to mean taking some profits on winners such as government bonds and recycling this money into existing equity allocations. Provided you were happy with your original allocation, this should prove relatively simple, stop your positioning from being skewed by market movements and ready your portfolio for any future recovery in asset prices.

“Maintaining your asset allocation is really important as you are a seller of things that have done well and a buyer of things that have done badly,” says Mr Morgan. “Over time this is really effective in ironing out volatility and providing better risk-adjusted returns. Right now that means gradually moving out of government and high-quality bonds into equities.”

Dan Kemp, chief investment officer for Europe, Middle East and Africa at Morningstar, suggests that investors should generally maintain three asset “buckets”. These should include a short-term bucket made up of cash and short-dated government bonds, a medium-term bucket made up of government and high-quality corporate bonds, and a long-term bucket of equities. However, the exact proportions you allocate to each depends on factors such as your risk tolerance and how expensive equities look. Some investors may also want to consider assets other than stocks and bonds.

The cheaper equities look, the higher an allocation you should be comfortable with. But risk-averse investors might be better opting for a more cautious approach, as long as they are comfortable with the prospect of lower returns and greater difficulty in generating income over the longer term.



Income pressures

If you need to take an income, it is currently best to do so in a way that will minimise the damage to your portfolio and future finances. However, the options available will depend on your circumstances.

Having a cash reserve, either in your Sipp or separately, can be extremely useful when markets appear to be in freefall because it gives you something to live off without having to sell assets that have recently dropped in value. Recommendations on how far this should stretch range from a few months’ worth of outgoings to two or three years, depending on your risk tolerance and how much market exposure you are happy to sacrifice in return for some certainty.

Investors who have a good cash buffer should use this rather than selling down holdings for income. This should allow your asset allocations to remain static and investments to recover over time. If such activity depletes your cash buffer, you could look at replenishing it in calmer times if your portfolio produces particularly strong returns or a greater income than you need at some point in future.

“If you have emergency cash, this is exactly the time to use it,” adds Zoe Bailey, chartered financial planner at Tilney. “Don’t feel you can’t touch it during these times. If your pension income has suddenly reduced, for example, then use your cash reserves to top it up.”

Similar logic applies to those on the cusp of retirement who are considering selling assets in their Sipp to buy an annuity or taking their pensions 25 per cent tax-free cash entitlement from it.

In both cases, it is best to delay any such decision if possible. Firstly, the tumble in markets is likely to have depleted the amount you could cash in to buy an annuity, as well as the value of a 25 per cent tax-free withdrawal. Secondly, annuity rates are partly linked to government bond yields, which have collapsed following a rise in prices.

“If you are able to, delay purchasing an annuity, as the value of the income will be based on the value of your pension pot at the date of purchase,” says Ms Bailey. “You should also review the option of having a phased annuity, which you can take over time rather than locking in a rate today. This will help when markets pick back up, as we expect them to once the pandemic has receded.”

Tougher decisions face those who need an income, either now or very soon, but lack the cash reserve that would enable them to avoid dipping into their investments. If the 'natural' yield generated by your portfolio in the form of dividend and fixed-income payments does not meet your needs, as is often the case, you may be forced to sell something.

For those in such a situation, it makes sense to take profits on those holdings that have performed well, as much as this is possible. This would mean, for example, selling some holdings such as defensive bond and gold funds to finance your lifestyle for the time being. It would also make sense to check if your spending can be lowered on a temporary basis, to reduce the strain on your portfolio.

If you do have to sell down your more defensive holdings to such an extent that your overall asset allocation is skewed, this could mean that your portfolio is more exposed to gyrations in the equity market than you might wish. However, it may be possible to adjust this without crystallising a loss by rebalancing once equities have recovered.


Thinking ahead

Difficult markets can present buying opportunities for investors with a good time horizon and some money to allocate to beaten-up assets. Although growth assets may appeal, also consider income-producing investments. Because yields move inversely to prices, riskier bonds, dividend-paying stocks and the funds that invest in these might look attractive. At the same time, you may wish to explore alternatives such as property, infrastructure and absolute return funds, either to provide income or as a way of extending your portfolio diversification.

While this is a valid consideration, it is worth noting that some of the traditional diversifiers – government bonds and gold – have broadly held up, even though they have wobbled at points when investors have looked for easy ways to raise cash quickly. As such, the traditional approach of allocating some of your portfolio to equities and some to bonds, depending on your risk appetite, has fared relatively well.

Also pay attention to assets' fundamentals. With many industries struggling amid the coronavirus crisis, earnings and dividend payments from companies are far from assured. Other markets, such as property, are also in turmoil.

You should also fully understand what you invest in. And when it comes to asset allocation decisions, you should be especially careful that you understand what role a new holding will play in your portfolio in both good and bad markets.

“You have to invest in something you understand,” says Mr Kemp. “If it looks too good to be true it always is."

He adds that a mistake some investors make when considering alternative assets is to buy them on the basis of past performance while not understanding how they work, and just assuming that they will continue to make good returns.

Also remember that if require an income it doesn’t have to come from income payments from your holdings. If a portfolio is producing strong capital returns, you could generate income by selling down holdings, and if they are held within a tax-efficient wrapper such as a Sipp, the sale will not incur any capital gains tax.

See below for all our Sipps special content: 

Building financial security with your Sipp

Don’t let coronavirus ruin your retirement

Secure your retirement income with asset allocation

Unpick the costs of Sipp providers