The recent global bond market sell-off, which has seen $450bn (£287.8bn) wiped off in the past few weeks, is putting retirement incomes under increasingly serious threat.
The turmoil is exacerbating the deficits in UK defined benefit company pensions, which have already ballooned to more than £370bn in recent months. But it also affects those in defined contribution pension schemes, who may be more exposed to the bond market than they realise due to ‘lifestyling’, whereby they buy more bonds within their pension funds as they become closer to retirement. The aim of this progressive method is to protect portfolios from intense stock market swings.
Being perceived as lower risk than shares and considered safe havens, demand has spiked over the past few years for bonds and gilts, which has resulted in higher prices and lower yields.
It still remains unclear whether or not the three-decade bond market rally is finally coming to an end. But there are now real and growing concerns that as economic conditions continue to improve, the fall in bond prices could be considerable and sustained. If this happens, lifestyled defined contribution pension funds will, inevitably, lose investors in perhaps significantly larger sums than expected.
While lifestyling has undoubtedly sheltered thousands over time from the brunt of stock market volatility and instability, it has never really been put to the test in a bond bear market. Will investors be prepared for falls in the value of their funds as they approach retirement?
It is our experience that individuals typically feel assured that their pension plans – whether DB or DC – are secure. This may have been justified when they first signed up to the scheme, but with today’s unstable bond market and soaring pension deficits, there is currently a very different outlook. It is therefore vitally important that people are fully aware of the present position of their pension scheme.
The problems facing many DC schemes are already well known. Longevity is making a mockery of actuarial assumptions, with retirees living longer than expected. But the fall in bond markets would be a further blow, creating a still larger gap between many funds’ assets and their liabilities and putting a question mark on their viability. As a result, it is our job as advisers to urge people not to hesitate in assessing their company pensions.
Of course, proactivity is always essential when it comes to retirement planning, but it is perhaps more important than ever now for pension members to be aware of the risks attached to their pensions, and consider the various ways in which they can be mitigated.
A basic step for savers in a DC pension would be to eschew the lifestyle default option and to consciously build a diverse portfolio that does not become overweight in one particular asset the closer you get to retirement.
It is also, of course, highly recommended to seek expert advice. Much as people undergo regular medical check-ups, or service their cars frequently, they must also habitually seek independent financial advice, preferably every quarter, to fully ensure they understand their pension and are aware of how much income they should likely receive when they retire. Retirement is, after all, far too important a matter to not give the utmost attention to, sooner rather than later.
