Many individuals planning to retire within the next decade may be unaware that their pension funds are undergoing a process called 'lifestyling,' which could lead to substantial losses, according to new analysis. This strategy automatically shifts pension pots from higher-risk, higher-return investments like stocks into more conservative assets such as bonds and cash as retirement approaches.
The intention behind lifestyling is to protect retirement savings from market volatility in the crucial years leading up to withdrawal. However, experts warn that this gradual derisking can diminish potential returns when compounding could otherwise significantly increase the fund's value. Adrian Murphy, chief executive of Murphy Wealth, stated that while the approach sounds sensible, it can be riskier than initially perceived.
"Because your pension fund will be at its largest in the later years, this is when compounding can have the greatest impact – a difference of just a few percentage points in annual returns could mean tens of thousands of pounds," Murphy explained.
Lifestyling typically involves moving funds out of stock markets and into bonds and cash. While bonds are historically viewed as safer than equities, they are not without risk. The events of 2022, where rising interest rates caused bond values to collapse, served as a cautionary example. Murphy noted that what was considered "low risk" proved otherwise for many in lifestyle strategies that had already begun to de-risk.
Murphy's analysis modeled the impact of remaining invested for 40 years versus a lifestyled approach for individuals contributing varying amounts monthly. Assuming a conservative 6% annual return for stocks and a 2% return for bonds and cash, the figures highlight significant differences in final pot values. For example, someone contributing the equivalent of auto-enrolment contributions (£132.80 a month) could see their pension pot reduced by £163,000 if lifestyled, compared to remaining invested. Higher contributors could face shortfalls of over £400,000.
Murphy advised those within ten years of their scheme's normal retirement age to check if their fund is being lifestyled, de-risked, or target-dated. He emphasized the importance of understanding the implications and ensuring the investment strategy aligns with individual retirement goals.
While exact figures for individuals enrolled in lifestyle pension funds are not published, the majority of the UK's 22 million workplace pension savers are likely in default funds. Many of these default options employ a lifestyle strategy, automatically shifting investments as retirement nears. Some newer strategies may maintain a blend of lower-risk assets rather than fully derisking into cash, but these are less established.