You don’t know what you’re doing

DAVOS/SWITZERLAND, 29JAN10 - David Cameron, Le...

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The doleful cry from the stands, or in Yeovil Town’s case the terraces, implies that there is a stock of referees who are competent. Quite who these referees are is not clear – we sing the chant to them all . We are as certain of the referee’s inability as that we follow  “by far the greatest – team the world has seen”.

Such delusions are not confined to football . They are no more extravagant than some Government thinking on pensions , in particular an imagination that people can manage their accumulated pension fund to match their weekly cashflow requirements through later life(through what is known as income drawdown).

Working in a firm of pension actuaries, I am aware of how difficult it is to manage a pension fund to pay “the right money at the right time to the right people”.

This is what occupational pension schemes find hardest.

The easy solution for them is simply to outsource the problem to an annuity provider  who will guarantee to meet the pension promises in full in return for a fat wedge upfront. “The fat wedge” is usually considerably more than the trustees of a pension fund have anticipated or can afford which is why most pension schemes haven’t chosen this route.

Instead trustees generally choose to do the job themselves but to do so they have to recognise that they need to be extremely careful. They cannot afford to be reckless and risk the value of the fund falling suddenly, especially when they need to draw money out of their funds to pay their pensioners. Put simply, if a pension fund invests recklessly and sees its value drop dramatically, it has to cash in assets at a low price to pay its pensions, this creates a hole in the fund and no matter how the fund may recover when things get better – the damage has been done.

Trustees, understanding this , avoid investment strategies that are volatile. They do not invest recklessly. To some extent they have no choice, their behaviour is monitored by their advisers who can report them if they are behaving stupidly to the Pensions Regulator who can force them to behave sensibly.

Behaving sensibly means investing in low volatility assets like Government and perhaps Corporate Bonds. This way means sacrificing the prospects of long-term growth for the certainty of steady of growth. Even though they are adopting a “risk-based ” approach – not all trustees manage these cash flows right – many schemes have failed and many more will fail.

So if it’s hard for the experts – the professionals what chance for the rest of us? What chance have the “mass affluent” to get it right on their own?

Earlier this year, the Coalition – and David Cameron was central to this – took away the need for people to buy-out their accumulated pension fund (using an annuity) and we are now allowed to do the cashflow management ourselves. Philosophically this is in line with “small Government” and allows people greater choice and greater flexibility in how they manage their affairs.

But do we “know what we’re doing”? I’m not at all sure.

If it’s hard for the trustees with the help of professional advisers, then it’s darn near impossible for us to manage our individual funds into the income streams to meet our monthly requirement needs. What’s more – the financial advisers I know, know very little about the risk management techniques to manage volatility and give regular secure income. Most financial advisers are wealth managers whose principal interest is capital accumulation and not liability driven investment.

The mass affluent are delusional about their pension funds. Take a look at this recent research from Sun Life of Canada.

Almost half (49%) expect to generate between £20,000 – £40,000 from their pension and other savings (21% expect an income of over £50,000).

Yet 59% of respondents have less than £300K and 33% less than £200K saved. 

So their expectations of likely income from their pension savings are unrealistic.


Certainly unrealistic- the Government Actuary who is the principal supervisor of the process of drawing income from an individual pension fund reckons that it costs some £30 to give a £1’s worth of inflation linked retirement income, so a £300,000 retirement pot is likely to yield an income of not much more than £10,000 pa. 

There was a time when we could reasonably expect a 10% return on our assets and could expect to get a £1’s worth of income from £10 out of our pot – in fact I’ve got some of that money – guaranteed by an insurer. But that was in the days of high inflation and lower expectations of life expectancy. Those days are long gone.

I suspect that many of the mass affluent are still subliminally believing in the 1 for 10 rule and still believing that equities will grow by 10% per year as they did in the 80s and 90s.

Worse still, I think that many advisers have not moved on from these assumptions.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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2 Responses to You don’t know what you’re doing

  1. @sipphound says:


    For once I have to take issue to some degree. Not so much that I disagree with what you have said, more that I think some balance is needed.

    First off, let’s be clear that while drawdown has been available to all since 1995, and while it has been a boon to SIPPs in particular, most people have bought an annuity with their pension savings, just as they did before drawdown was introduced.

    Few of those people buying annuities take advice and consequently few take the open market option, greatly damaging their income in retirement in many cases. Drawdown, on the other hand, is generally entered into on an advised basis.

    Fair enough, you draw attention to the risks of volatility and in particular the timing of volatility – early capital losses can potentially be a blow a fund never recovers from – and make your point about liability driven investment.

    What you don’t do is acknowledge just how many experts “got it wrong” in finance when it came to their risk modelling, assumptions, mathematical models and so on. In 2008 the financial blow-up was not just in the face of a few dim-witted Joe Averages but very much in the financial experts’ faces too.

    That’s not something new either: you acknowledge that you managed to get £1-worth of income from £10-worth of pension pot, guaranteed by an insurer. An insurer whose actuary perhaps over-estimated long-term investment returns and under-estimated longevity? Sounds familiar to Joe Average!

    What will be the next investment calamity? Will it be those risk-based strategies that see funds invested in government bonds? Some of the public and some (high-profile) economists believe that the government is engaged in a Ponzi scheme of its own, printing money to buy its own bonds and that it will all end in bloodbath in the bond market. We don’t know if they are right or not but it’s quite possible that history will make “safe” bond investing look akin to the “safe” AAA-rated bundled mortgage-backed securities that blew up in the States.

    Lastly – I’m nearly done, honest – it should be acknowledged that the government is proposing a choice between “capped drawdown” which will restrict the income that can be drawn to reduce the risk of the fund being depleted prematurely and a freer version only if the individual can meet a “minimum income requirement”. These don’t obviate disaster and don’t guarantee that individuals won’t have to make unplanned financial compromises later in life. But in a world where the fat can eat more fat, the indolent can smoke and those with medical conditions can ignore their doctor’s advice and not take their medication, surely people can make their own financial decisions too.

    None of which is to say that I disagree with what you’ve written, Henry, just to say that I think there’s more to the picture. There are risks to drawdown and you do people a service drawing their attention to them. We should know what we are letting ourselves in for when we make such big decisions in life.


  2. Pingback: Drawdown or annuity: do folks know what they are doing? | SIPP Hound's space

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