Is lifestyling the answer to retirement?

Posted on: 09 February 2009 by Gareth Hargreaves

Peter McGahan asks whether clients should still look to use lifestyling investment strategies during volatile investment markets

I have been advised to change my pension to a plan that allows for lifestyling. I have been told that lifestyling is the best way for my pension to be managed during the last 10 or so years before retirement. Is this true?

I consider it a bit like painting by numbers, and a cop out for the financial adviser, but let me explain what it is before I carry on with that demolition.

There is a belief, or assumption, that different types of investments spread your risk so you can’t lose everything at the same time. The last three years have put quite a dent in that belief.

In scientific terms its called correlation - whether negative or positive - but in easy to understand terms, it means you buy shares in an ice cream company, sun cream company, as well as a Wellington boot and umbrella company.

In normal conditions most shares will do well. If however ‘global warming’ managed to eventually arrive (rather than us just paying the tax for it) and we had extreme conditions, two of these shares would balance the other two out.

An ice cream company would have a high negative correlation to a Wellington boot company, for simplicity’s sake.

Certain sectors of the market are considered low risk, but that’s a matter for some debate. For instance, how do you measure investment risk? Is it measured by fluctuation? In most cases, yes. It’s simply measured by how much the investment returns deviate away from the normal returns - standard deviation.

That is at best, half way there. Shares in large UK companies might have a medium to high deviation; overseas shares may have a high deviation, as would property shares, yet property and fixed interests have a low deviation.

But in this context does that mean they are low risk? Far from it - and that is where lifestyling falls over badly.

Lifestyling simply changes the percentage you have in equities, corporate bonds, property etc to slowly increase the amount you have in ‘lower risk’ assets the closer you get to retirement.

What a load of twaddle. In practise, it’s a cop out for the financial adviser who doesn’t know how to understand which assets to buy into during prevailing market conditions. It also does not take account of any scientific thought process other than - if you are older, get into property cash and fixed interests! My word!

Consider a 55-year-old who is now 10 years from retirement. Automatic lifestyling would begin the encashment of equities and moving into bonds cash or property at a time when equities are cheap, cash returns are near zero and property can only really get a lot cheaper. Each sector typically does well in different market conditions.

For example, fixed interests struggle in rising interest rate environments, yet you could automatically be forced into them when you least want to, just because of your age. Does it follow that every 55 or 60-year-old has the same risk parameters?

In any event the sole purpose I suspect of such arrangements is to decommodotise the pension product.

Insurance companies know there is little to differentiate between them. They don’t want cost to be the differentiator as that affects profit. The best way is to constantly come up with contrived arguments that urge you into debate with yourself about what aspect of their plan you think is correct for you. However with this approach you will conclude with their product either way.

The correct way to approach your retirement is to focus on what you want, and when you want it. Have a long conversation with your adviser about risk and the current state of the economy, and then conclude what your asset allocation should be.

If your adviser is recommending lifestyling, ask him why you are paying him, because it doesn’t involve him thinking. Ask for the commission he is being paid to be rebated if he isn’t doing anything for his money.

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