Risks And Investment Strategies

Question 1

Outline what sequencing risk is

Answer 1

• A lump sum investment suffers ‘reverse pound cost averaging’ in a falling market
• If this happens in the early years it creates an additional drag on investment returns
• Withdrawals made in poor markets amplify the impact of poor returns
• The risk that the fund will be exhausted before death and will not provide the income needed throughout retirement increases.

Question 2

Outline strategies for reducing sequencing risk

Answer 2

• Invest in Funds specifically designed for use in decumulation which are designed to reduce volatility
• Maintain a cash reserve and draw income from this source in falling markets
• Reduce spending until markets recover
• Adopt a ‘rising equity glide path’ - a lower allocation to equities in the early years which increases over time to reduce the impact of any falls in the early years

Question 3

Explain what’s meant by longevity risk along with it’s impact

Answer 3

Longevity risk is the risk that someone might live for longer than anticipated. They can’t be certain when they might die and therefore can’t know for sure what rate of withdrawal will be sustainable from a given fund.

As a result they might: -

• Take too much from their fund and exhaust it before they die, losing most of their income and suffering financial hardship.
• Take to little income and end up with a lower standard of living than would have been the case if they hadn’t transferred their safeguarded benefits

Question 4

Explain what is meant by the Safe withdrawal Rate

Answer 4

The amount of money, expressed as a percentage of the initial investment, which may be withdrawn each year for a given quantity of time including adjustments for inflation, which will not lead to portfolio failure.

Portfolio failure being defined as a 95% probability of depletion to zero at any time within the specified period.

Recent research suggests the SWR for the UK is between 2.5% pa and 3% pa

Question 5

Outline the stress tests that can be applied when running a Cash flow forecast

Answer 5

• Permanent loss of an asset
• Need to increase income above forecast level
• Large ad-hoc withdrawals
• Inflation higher than forecast
• Living longer than expected
• Investment returns lower than forecast

Question 6

State the factors to consider when reviewing a pension (flexible benefits / money purchase) in payment

Answer 6

Income required
Tax free lump sum required
Any other income
Investment performance
Asset allocation
Health
Annuity rates
Changes to personal circumstances
ATR
Legislative changes
Tax allowances
Critical yield

Question 7

State the factors which would drive a need to change the fund allocation in a money purchase pension (in payment)

Answer 7

Changes to ATR
Rebalancing
Underperformance
Economic factors
Change in income needs
Liquidity of portfolio
New investment opportunities
Changes to non pension assets