Use the snow to your advantage

The after effects of heavy snowfall have presented many people with an unexpected opportunity to remain indoors, the treacherous conditions prompting them to take a couple of days off work.

But the novelty value soon wears off. Unable to venture outdoors unless equipped with Torvill & Dean-style grace and ice skates, most folks find the alternatives are limited to catching up on household chores or succumbing to that least challenging of options, watching daytime TV – incredibly marking its thirtieth birthday this month.

A snowdrift meant I avoided a potentially awkward journey and ‘worked from home’, a euphemism for drinking far too much coffee and nibbling on those small, remaining pieces of Christmas cake. Yet as the bitterly cold, wintry scene outside served to confirm what a good idea it was to remain indoors, I put my enforced downtime to good use by mulling over a variety of retirement options, in particular the likely medium-term performance of bonds.

I did this after reading that up to half a million people nearing retirement risk losing up to a third of the value of their investments as the funds in which they’re invested automatically increase their exposure to bonds.

How could this happen?

People who invest in what are known as ‘lifestyling funds’ may not realise that as they get older, fund managers increase their exposure to bonds, a strategy  which, for decades, has been considered sensible because bonds were deemed considerably safer than equities. Today, however, such an approach is being challenged as bonds are no longer considered the safe haven they once were, a change which has potentially enormous implications for those nearing retirement.    

This unusual situation has arisen in the wake of the credit crunch as investors, ironically, sought safety in government bonds, otherwise known as gilts. The problem is that everyone was thinking along similar lines; accordingly, many smaller investors opted to take their money out of shares and put it into bond funds. The effect was immediate – yields, which fall as underlying values rise, have been pushed lower and lower ever since.

The problem has been exacerbated by quantitative easing (QE), a policy of questionable value, which has seen the Bank of England print an extra £375 billion of fresh money in an attempt to boost the economy. The reasons why this policy has failed to work need not concern us here – they warrant another blog at the very least – but the result has been a further reduction in 10-year gilt yields which are now well under 2%, having fallen from around 3.5% in 2009.

This matters to those of us mindful of the ‘R’ word as we move closer to the end of our working careers and (hopefully) towards spending more time enjoying the effects of sunnier climes.  

Why? Well, although it remains conjecture at the moment, there is a sense that bond values will fall over the next couple of years as interest rates inevitably (?) rise and investors, equally predictably, execute one of their periodic shifts out of bonds and back into equities.

At present, the Office for National Statistics estimate that pension funds hold gilts worth approximately £100 billion. Any significant reduction in their underlying value would, therefore, impact upon pensions payable to investors reaching retirement age.

According to some commentators, an investor with a pension fund worth £100,000 could, over the next five years, see it decimated by up to 30% should gilt yields return to their pre-credit crunch levels of 4.5%.

It has been suggested that a number of self-employed people in particular, who might be perhaps 5-7 years away from retiring and have built their pension funds to such levels, may wish to consider moving into funds that seek to preserve cash. Other people, within say, 3 years of retirement, have been asked to consider the possible merits of moving into cash, while employees aged over 50 have another option. Many are currently contacting their pension scheme managers to find out whether the funds in which they’re invested automatically default to the ‘lifestyling’ option as they get older. It is possible to prevent this by asking the managers not to adapt such a strategy, although it’s important to consider the alternatives to an approach which has worked well for decades.

In short, plenty to consider during the current enforced absence from work.

posted on 22 January 2013 15:25 byPJS