INVESTMENTS & PENSIONS
Nobody wants to see the value of their retirement savings fall , no matter where they are in their investment journey . But the impact of losses for someone in retirement can be more acute than for someone still working .
Those still working and earning money have more opportunities to address a drop in their portfolio – including saving more or working longer . But if a retired investor ’ s portfolio heads south , there are fewer levers to pull . Put simply , a person ’ s financial resilience reduces when they retire .
FINANCIAL CAPITAL V HUMAN CAPITAL
Consider the difference between an individual ’ s ‘ financial capital ’ and their ‘ human capital ’. Financial capital refers to monetary and physical assets like savings , pensions , property , and investments . Human capital can be thought of as a stream of future income to be realised over time . It is built up through the acquisition of skills and abilities , which add to productivity , and pay off later in life . Combining these two metrics gives an individual ’ s overall wealth .
A young person is more likely to have low financial capital , but high human capital . This is because they have many years still to gain skills and experience , and to work , earn money and ultimately build savings – including their pension pot .
An older individual , on the other hand , is likely to have high financial capital but less human capital – they are no longer earning an income and have more obligations to meet that deplete their savings .
Source : BNY Mellon Investment Management . For illustrative purposes only .
ASSESSING RISK
It is important to consider this when assessing the appropriate level of investment risk to take in retirement . Individuals undertaking risk assessment have three factors to consider :
1 . Risk tolerance – How comfortable is the investor with risk ( and the potential impact on returns ) in the long term ?
2 . Knowledge and experience – How informed is the investor to make decisions that include risk ?
3 . Risk capacity – Considering cashflows , financial circumstances , goals / objectives , and time horizons , how resilient is the investor to risk ?
Generally , risk tolerance stays stable for most of an individual ’ s life . However , if for example , an individual switches jobs , gets a raise , or inherits money or assets – their financial circumstances change . This can alter an individual ’ s risk capacity .
As such , basing the level of investment risk purely on someone ’ s risk tolerance may not be the right answer .
A 20-year-old who is inherently risk averse has a low risk tolerance but the value of their human capital gives them a high risk capacity . They may prefer a cautious portfolio but with many years to accumulate wealth and overcome any setbacks , they can afford to take more risk . Conversely , someone in retirement may still be willing to take some risk but if they have limited assets relative to their income needs , they have a low risk capacity . The consequence of this is that they are less able to deal with losses and need to invest accordingly .
MAY 2024 | 17