The Unforeseen Pitfalls of Lifestyle Funds
Introduction
The bond market, once considered a haven of stability, has recently proven to be a rollercoaster ride for unsuspecting investors. Hindsight, with its razor-sharp clarity, reveals the uncomfortable reality for those who unwittingly found themselves entangled in the bond market in recent years. Yields have surged to 15-year highs for gilts, while capital values have taken a nosedive, leaving savers with defined contribution pension schemes grappling with the consequences of their investment choices.
The Trap of Lifestyle Funds
In the intricate world of investments, the allure of one-size-fits-all solutions, particularly in the form of lifestyle funds, has proven to be a double-edged sword. These funds, whether chosen by default or preference, follow a rigid approach to asset allocation. For younger savers, heavy exposure to equities promises long-term growth, while older investors are funnelled into bonds to secure gains. However, as recent market turbulence has shown, the outcomes can be far from the intended results.
David Hearne, a chartered financial planner, sheds light on the issue: "I see many clients that have four or five pensions from their working lives, and typically two of these have been lifestyled." This mass migration into bonds, particularly at record-high prices, has left mature savers questioning whether their lifestyle funds will indeed finance the retirement they envisioned (FT, 2023).
The Stark Reality
The disparity between the outcomes for younger and older savers in lifestyle funds is significant. For instance, a simplified lifestyle fund split 80/20 between equities and bonds designed for a younger saver has seen a remarkable 30% increase since the beginning of 2020. In contrast, a corresponding fund for an older counterpart divided 60/40 between bonds and cash has incurred a 12% loss over the same period.
Necessary Evil or Outdated Approach?
Default allocations to lifestyle funds are deemed a "necessary evil" by pension managers handling thousands of investors, according to Laith Khalaf at AJ Bell. However, he notes that the one-size-fits-all approach is increasingly incompatible with the diverse range of retirement choices available today. The evolving landscape of pension options demands a more tailored strategy, acknowledging the individual circumstances and preferences of savers.
The Impact of Pension Reforms
The UK's pension reforms in 2015 marked a significant shift in retirees' financial landscape, granting them greater flexibility in their choices. Prior to these reforms, annuities were the primary option, with bond-heavy funds acting as a hedge against liabilities as retirement approached. Since 2015, most defined contribution pensioners have opted for flexible plans, allowing them to draw down cash or income. This shift extends the investment period, making a compelling case for greater exposure to equities, especially for those in the early, active years of retirement.
The Hidden Danger
While the "safety first" approach advocated by compliance departments may drive savings companies to funnel money into low-return lifestyle funds early on, recent market volatility has cast doubt on the safety provided by bonds, especially when interest rates are unpredictable. Savers risk being steered towards these funds at precisely the wrong time, undermining the very purpose of their retirement savings.
Conclusion
As investors grapple with the fallout from the bond market's rollercoaster ride, the limitations of one-size-fits-all retirement funds become increasingly apparent. The shifting landscape of pension options, coupled with market unpredictability, underscores the need for a more nuanced and personalised approach to asset allocation. It's time for pension managers and savings companies to adapt to the evolving needs of retirees, steering clear of the pitfalls that hindsight so often illuminates. In the dynamic world of investments, a tailored strategy is the key to weathering the bond market's twists and turns.
We are on a mission to make finance simple and accessible for all. For more content please follow and subscribe to our other channels here:
Disclaimer: This blog post is for informational purposes and should not be considered financial advice. Always consult a financial adviser for personalised guidance.
