Over the last few years, one trend that came into vogue in retirement planning (particularly corporate pensions) has been so called ‘lifestyling’.
This is where the pension provider’s investment strategy works towards a target retirement date (or perhaps a default date across the scheme nominated by the sponsoring employer). Early in the career of the pension investor the bias of the fund and ongoing contributions are directed towards equity investment and rightly so as this is historically where long-term growth will come from. Lifestyling comes into play usually when the investor comes within 5-10 years of their nominated retirement date. At that stage, the investments are gradually phased out of equities and into traditional safe-haven assets – usually bonds or cash. A solid strategy at first inspection.
This has held well for many who have used it since it became chic. The lifestyling strategy works on the premise that annuity purchase is the favoured retirement option and so serves to guard long-term profits in the final few years ahead of retirement. The danger of this strategy however against the current macro-economic backdrop of low interest rates and low inflation is that phasing into traditional safe haven assets such as bonds at the moment is not without risk. Bond funds have performed very well lately; falling yields have meant rising bond prices and this is reflected for many in the current value of their pension funds. The trouble comes when bond yields rise and bonds prices conversely fall. As inflation starts slowly to creep back in, interest rates (and so bond yields) may also start to follow suit – suddenly handsome gains are handed back. If the strategy deployed to protect an asset in the few years ahead of retirement is contingent upon returns from bond funds at that point, then the situation has the potential to be badly damaging to the retirement the investor is ultimately able to secure.
Generally, apathy rules in the world of pensions. Many investors have been shoe-horned into default lifestyling strategies without paying much attention at a time perhaps when investment in bond funds was not as fraught as it has the potential to be in the future. As a concept, lifestyling is solid in theory when looking at financial history. The trouble is that if retirement is planned for the next few years, divesting a reasonably managed, long-term equity portfolio in order to seek out the perceived protection of bond funds may prove to be perfectly poor timing. Furthermore, so too will the annuity purchase on which lifestyling is based.