Why 'lifestyling' could destroy your pension pot

Lifestyling is supposed to mean that your pension pot becomes more secure the nearer you get to retirement. Yet your pension provider might be switching you to overpriced, and therefore riskier, investments.

Many retirement savers have chosen the 'lifestyling' option in their pensions.

This option sees their pension provider slowly and automatically take their funds out of shares and put them into other assets that are meant to be safer. However there are growing fears these other assets aren't so safe after all, and nor, therefore, is lifestyling in general.

A recent Axa Life Europe poll of financial advisers shows that the majority of them believe lifestyling pensions are more risky than they were a year ago.

The problem is that these funds typically move your money gradually from shares into bonds – and it's bonds that are currently the biggest concern.

So much for safety
Bonds are loans from pension savers and other investors to governments and companies. There is the risk that these borrowers will default but, on average, the short-term risks for bondholders are relatively low. The problem is, when the price of bonds is high, they can become far more risky to buy than shares.

Bonds have become expensive because too many people have been buying them, driving up their prices and making them ready for a fall. Worse, the government has been printing money and using it to buy bonds, which has raised prices even more.

You wouldn't want to buy goods on the high street at a high price, and nor should you want to buy investments at a high price either.

This is why advisers are currently concerned about lifestyling.

Don't just take their word for it
The problem of using bonds for safety today was recently highlighted by the greatest living investor. Warren Buffett, chairman and CEO of the phenomenally successful conglomerate Berkshire Hathaway, recently said that bonds are "terrible investments now... Bonds are priced artificially. You've got some guy buying $85 billion[-worth] a month and that will change at some point. And when it changes people could lose a lot of money if they are in long-term bonds."

Buffett's referring to the US and to the money-printing, bond-buying programme of the Federal Reserve (the US central bank). Nevertheless, similar conditions are occurring in the UK and many other countries. The Bank of England has printed money on an unprecedented scale and has bought bonds with much of that money.

Lifestyling is a dubious concept
The nub is that anyone who's automatically having their pensions lifestyled for extra safety are currently getting the reverse: they're moving into what now are probably more-overpriced investments.

This could be particularly devastating for those retiring soon. Potentially, some pension savers using lifestyling have unknowingly locked in their stock-market losses after the crashes in 2000 and/or 2008 when their pension providers automatically sold shares at those market bottoms in order to move into bonds.

Now bonds look overpriced too, making them more at risk of crashes. If bond prices collapse in the coming years, many retirees might be lucky to have a fraction of the pension they hoped they'd get in the late 90s.

An alternative to lifestyling
One alternative is to save for retirement more quickly. Once you have as much as you need for the future, plus quite a bit extra to account for potential inflation, you then get out of both shares and bonds altogether, moving your money into cash funds. You will miss out on future gains, but you've locked in the pot you believe you'll need.

There are significant dangers to this, such as underestimating inflation or your future needs. The largest problem, however, is that many – perhaps even most – people won't ever reach the retirement pots they desire, even if they stick with shares until their planned retirement date and there is no collapse in share prices immediately before.

As a result asking pension savers to save even faster is simply unrealistic.

Another alternative to lifestyling
Some people hope to keep on investing their pot after retirement, and take money from that pot when they need it to supplement their retirement and other state benefits. This is known as income drawdown.

This is a fantastic idea if you have the knowledge, experience and temperament for investing, but, even if you do, you still won't dramatically improve your living standards in retirement if your investment pot is too small.

It could well be that, unless you put a very large amount of money into your retirement plans, you're likely to be disappointed. This is the same whether you're saving in pensions, share ISAs, property or anything else.

Nothing can make up for a small pot
Most people are either unwilling or unable to save enough to provide the retirement income they think they'll need. Many don't even know how much they need.

All this puts them at even greater risk if their lifestyled funds go wrong.

The good news is that, while some are surprised how expensive their retirement is, many more find they need far less to live on than they thought.

The bad news is that, if you're not able to save enough by the time you want to retire, your only real choices are to live on a very stringent budget or to keep working, at least part time.

The universal solution
I think the best thing that anyone can do to prepare for retirement is to make mental preparations: get yourself used to the idea that you might have to work far longer than you currently want or expect. The earlier you prepare yourself psychologically for this significant possibility, and start thinking about how you can try to turn it into a positive experience, the less painful it's going to be when it happens.

The additional advantages are that this gives your pot time to recover if it crashes just at the point you wanted to retire, and your pot won't have to stretch for as many years when you finally do hang up your clogs.

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