How to protect your investments in the final years before you retire

Economic data indicates the longest bull run in history may be ending soon — a potential disaster for retirees heavily invested in the markets

FILE PHOTO: A trader works as a screen shows market data behind him at CMC markets in London, Britain, December 11, 2018. REUTERS/Simon Dawson/File Photo
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It is every retiree's worst nightmare. You spent decades saving for retirement, building a pot of wealth in shares and funds, only for the stock market to crash shortly before you stop working.

Bouncing back can be hard at this point in life, especially from a major crash, where the market can drop by 25 or 50 per cent.

If that happens you could suddenly find your pension pot is worth hundreds of thousands of dollars less than you hoped. The danger is you are then forced to carry on working, even if you don't want to, or have to scrape by on a depleted pot.

Many may be worried right now, as economic data looks increasingly gloomy and fears are growing that the longest US bull market run in history is finally coming to an end.

A crash is a much bigger threat as retirement looms when instead of paying money into your pension pot, you are preparing to withdraw it instead.

However, if you plan carefully, you can head off most of the risk.

Professor Stephen Thomas, associate dean, MBA Programmes at Cass Business School in Dubai and London, says a crash is less of a worry if you are in the early stage of wealth building, and retirement is years away. “If you are 25 years old and the market falls by half, you have 40 years to make up any losses,” he says.

You can even turn a stock market sell-off to your advantage, by seizing the opportunity to pick up stocks or funds at a reduced price, then sitting back and waiting for them to recover.

A crash is a much bigger threat as retirement looms when instead of paying money into your pension pot, you are preparing to withdraw it instead.

Traditional financial planning had an answer. In the five or 10 years before you retire, financial advisers reduce your exposure to any crash by steadily shifting your money out of stocks and shares and into less risky investments such as government and corporate bonds, which pay a fixed income and offer greater capital protection.

Some pension schemes did this automatically, a process sometimes referred to as “lifestyling”. So-called "target-date investment funds” also apply the same strategy, shifting into more conservative investments as retirement looms.

However, Mr Thomas says target-date funds came unstuck in the wake of the financial crisis, when bond prices fell sharply. “Some investors suffered losses of up to 30 per cent as a result,” he says.

There is now a growing trend for people to keep a greater proportion of their money invested in the stock market after they retire, despite the added risk this brings.

Near-zero interest rates are a prime driver, as they have destroyed the returns on traditional safe havens such as cash and bonds.

Yields on 10-year US Treasuries are falling again as the global economy slows, and have just hit a two-year low of 1.53 per cent. At this level, Mr Thomas says you need a lot of bonds to generate a little income. “Bond prices also look expensive and could lose a lot of value if the price falls," he adds.

Rising life expectancy has also boosted the case for shares at the expense of bonds, he adds. "People could spend 20 or 25 years in retirement and if you exit the stock market altogether you could miss out on three or four equity cycles in that time.”

Rates on annuities, the income for life people used to buy with their pension pot, have also plunged since the crisis.

Many now leave their money invested for growth, and live off the dividend income, while taking lump sums as required.

This remains a risky thing to do. If you are forced to withdraw money after markets crash, you will deplete your pot, and any withdrawals will be locked out of the subsequent recovery. The longer the bear market lasts, the more damage it will inflict.

Stuart McCulloch, market head of The Fry Group Middle East, says there are several things that can reduce the dangers.

One option is to continue working later in life, on a part-time basis if you prefer, to reduce the pressure on your pension pot, or even better, continue to increase its size by investing in it.

Another option is to keep a store of cash that you can dip into after a market crash, to avoid raiding your investment portfolio at the worst possible time.

Mr McCulloch said you should also review your portfolio five years before you plan to retire and take some of your riskier investments  off the table.

A well diversified portfolio covering the major asset classes such as shares, bonds, cash, gold and property can help shield you against stock-market volatility, he adds. “Government bonds and investment-grade corporate bonds still have a role to play in this," he says. "However, don’t be seduced by high-yielding bonds, as the risk of default is real.”

While exposure to the stock market can keep your money growing Mr McCulloch says it should be "clear, controlled and linked to your capacity for loss”.

As people live longer than ever, running out of money in retirement is now a real concern. This has been aggravated by the decline of the annuity — which guarantees to keep paying you a regular income for life, no matter how long you lived.

Now you have to take on the longevity risk yourself. Get it wrong, for example by withdrawing too much in the early years, and you could run out of money before you die. “As well as delivering enough income to see you through retirement, you will also want to pass something on to the next generation as well," Mr McCulloch adds.

Stuart Ritchie, director of wealth advice at AES International, says the run up to retirement is a key financial moment in your life and you should consider independent financial and tax advice, even if you have successfully managed your own money so far, because you have so little time to rectify any mistakes.

However, Mr Ritchie says this brings its own dangers, as unscrupulous sales-focused advisers descend on UAE residents as they near retirement, and push them into investing into high-risk investments with punitive fees and commission charges. “Be particularly cautious of anyone who talks of investment guarantees or capital protection," he warns. "No reputable adviser will do that, because nobody knows for sure what markets will do or how an investment will perform in the future.”

Getting tricked into a high-charging, inflexible investment plan at this stage can destroy your wealth and leave you no time to recover, Mr Ritchie adds. “Having a globally diversified portfolio, with a spread of low-cost exchange traded funds that is in tune with your attitude to risk, is the best ‘guarantee’ any investor can have.”

Mr Ritchie says investors should also be wary of what he calls “the silent pension killer”, inflation. “Leaving money in cash may seem less risky, but it's not a viable option, particularly if you are planning a long retirement, as inflation will erode the real value of your money over time," he explains.

Investors need to get involved in their retirement planning, making sure they understand exactly how their money is invested and why it is invested that way, he adds.

If you are lucky, you will spend a couple of decades in retirement. That means at some point, the stock market is likely to crash. If you plan carefully and diversify your investments so you are not completely invested in shares, you should still be able to sleep peacefully at night and avoid those financial nightmares.