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How To Prepare Your Pension For The Next Big Crash. Blog 186

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How To Prepare Your Pension For The Next Big Crash. Blog 186

27th September 2021

Paddy Delaney

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It’s coming, and it’s going to be a whopper!

I’m not being dramatic here, just stating fact. It’s not because of all the media coverage of the death of EverGreen or EverGrande, or the start of a new World War or Climate War, it’s simply that equity markets across the world temporarily decline by about 35% on average of every five years. On average, they have intra-year declines of over 14%. When we see that the MSCI is up 15%+ on average every year for the past 5 years, or 12%+ every year for the past 10 years, we realise that it’s just been too easy a ride (how quickly we forget last March!).

The next market crash is never far away, so knowing how to prepare yourself and your pension portfolio is critical for us long term equity investors. This week we share practical tips to help you prepare for the next big market crash, under the following headings;

  • Why we really should do a ‘Premortem’ on ourselves and our pension investment strategy
  • Preparation if you are accessing the pension within the next 10 years
  • Preparation if you are accessing the pension in 10years+

Why we really should do a ‘Premortem’ on ourselves and our Pension investment strategy

We all know what a Postmortem is but how about a Premortem!? Looking at an event or issue before it arises to determine what we could or should do to mitigate it. A very useful exercise in all walks of life, and investing is no different.

On 6th June 2017 I shared a piece titled ‘The Crash Is Coming‘. In it I suggested the reader imagine it was 2020, and markets were in a decline of 30%, that property prices crashed through the floor again and unemployment was spiking. While two of the three did actually occur in 2020, they occurred for such a short period of time that we hardly had time to process it, before the market decline started correcting itself. The next crash will likely be very different, and far more sustained.

Bear in mind that looking at all Bear Markets in the S&P over the past 100 years we see the following; The average duration it has taken the S&P 500 to fall from peak to trough has been 1 year. The average duration it has taken it to recover from that low to it’s previous high has been 2 years. Importantly, please remember that it has always recovered and exceeded previous old highs.

Let’s assume it is Jan 2024 (not a prediction!) and your pension declines in value from €1m to €600k (40% decline) between January 2024 and January 2025. You are not please at all, particularly as you had planned to retire and start taking lump sum and income from this pot in 2028.

In line with long term averages, your pension value remains at that level, sometimes marginally up and sometimes marginally down, but hovers around that €600k level for the next 2 years. So your statement through your inbox in Jan 2027 reads that your pension pot is valued at €700k. Still 30% down on where it was bloody 3 years ago. Some thoughts on action you may have had over that 3 year period from 2024 to 2027:

  • Should I cash it in entirely and pay full rate tax on it because my portfolio will never recover from this?
  • I’ll be financially ruined and not have enough money to comfortably survive when I retire
  • Get the number of a ‘good lawyer’ (assuming such a thing exists!!?) and try sue my advisor for this?
  • Maybe I retire a little early so I can take a tax free lump sum before it falls any further?
  • How about I move into Bonds now actually and then when it falls further I’ll then buy back into Equity for the recovery?
  • Actually, should I move my funds into Chinese Equity & Crypto Funds (assuming such things exist in 2026) because I read online that they might go really well over the next few years?
  • Should I talk to 5 new advisors until I find one that tells me with surety that they’ll put me into something that offers ‘all the returns I need but with no potential downside’? That’s the right thing to do yes!
  • Should I stop contributing into the pension because the value of this thing is falling, makes no sense right?!

The short answer, historically speaking, is that none of those things were the right course of action. The right course of action has always been to keep going, and to resist the Siren’s Call. It’s OK to feel the fear but not OK to react to it.

Looking at all of the above possible courses of action, each of them would most probably have converted your concerns into actual capital loss. FACT. Doing any of those things would have resulted in you missing the subsequent recovery, or mistimed it significantly. You would have done yourself out of money and only compounded your woes. Doing nothing ensured your troubles were non-material in nature only.

You might be saying “That’s and fine and well Paddy, I won’t do any of those things of course, but what should I do?”. That is the second key aspect to a Premortem, knowing what you could potentially do to mitigate an undesirable outcome.

Preparing your Pension if you’re accessing it within the next 10 years

This is a big concern for many people, they have a future date in mind when they will retire, and in their heads that also coincides with the date at which they will start drawing their pension lump sum and regular income. Not so.

If you are planning to draw your pension benefits within the next 10 years (which is considered a relatively short period for us long term equity investors), here are some things to consider, do and know:

  • You do not have to draw your pension benefits as soon as you retire (potentially allowing them recover from a nasty decline at the time you retire)
  • It can often make more tax sense to use some of your other liquid cash/assets, on which you have already paid tax on in the initial years of retirement income needs
  • The later you can leave your pension untouched, the higher the probability that it will outlive you instead of your outliving it!
  • If you have an ARF (drawing income) and leave behind a partner/spouse, then they assume your position and receive the income subject to Income Tax. However, if you die before you started drawing your pot, the full pot can pass to your spouse tax free and they can determine how to draw it
  • If you are determined to take your tax free lump sum (up to €200k) from your pension at a certain date, then get your head around the fact that that withdrawal may coincide with a temporary decline in the value of your pot, and so you will have to accept selling an asset at a knock-down price!
  • If you are flexible, then you could consider not taking a tax free lump sum (read our article on this if you haven’t yet), or at least delaying that lump sum withdrawal
  • Consider allocating a certain portion of your portfolio (say 20-30%) to an asset class or fund type that you would not expect to fall much in value if Equity were in a decline. If your withdrawal of the lump sum were then taken from that portion you theoretically won’t be selling assets at a discount, though that 25% may be a lower euro value
  • The fact remains, with a start pot of €1m, invested in a well diversified global equity and bond portfolio of 80% Equity and 20% Bonds, assuming 1% fee per year, has been worth at least €1m after 5 years in 91% of all 5 year rolling periods between 1926 and 2021. So, historically there is a less than 1 in 10 chance that your portfolio will be lower than it is now, five years from now, and a 9 in 10 chance that it’ll be worth the same or more in 5 years, even assuming zero contributions:
  • Oh, and if your timeframe is 10 years, the historical probability was that in 9 out of 10 cases your portfolio was worth €1.3m or more after the 10 years of the same portfolio and fee composition. Put that in your pipe, and smoke it!
  • Speaking of pipes, friends of ours found a clay pipe in their garden while digging up a patio recently, dated back to the Victorian times; to around the same period to which the above data range commenced! Clay disposable pipes which were apparently single-use! Take a few puffs when having your elevenses while digging ditches, and toss the thing into the soil, from whence it was born!

Preparing your Pension if you’re accessing it in 10 years+

Applying the logic from the above section, really there is no basis for doing anything other than the following when the next temporary market declines hit your portfolio:

a) Ensuring the basic principles are in place within your pension

b) Stick to your plan, and stay the course when the next market declines visit us.

Basic principles being:

  • Make sure you are invested efficiently and are actually getting the returns of the market, and not just the returns of an over-engineered and often sub-optimal insurance company or aloof fund manager pension product. We see far too much gap between market returns and the returns that investors in these products actually get
  • Avoid anything that doesn’t have total transparency on fees. If you can’t see the fees, then you can’t be sure of the fees. If they aren’t at least documented clearly in a binding Key Investor Document (KID) or even better, visible on the transactions of the account, then it can’t be trusted
  • If you are seeking the returns of the market, then you really should not be paying anything more than 1% for the pension. If paying for a financial planner on top of that that’s another thing, but don’t be paying 2% and 3% for a basic product that gives access to the markets, or their poxy investment product
  • I’m biased of course, but it makes financial sense to hire a trusted investment counsellor/Financial Planner to help you develop a plan, tweak the plan over time, and ultimately to help you stick to the plan when. They’ll likely pay for themselves many times over with a combination of reducing your worries, reducing the time you need to spend on this stuff, reducing the effort you need to put into this stuff, and improving the long term outcomes you will achieve. They’ll ultimately help you not react in your darkest hours, when every sinew in your body (and brain) will be telling you to do something totally counter-productive to your long term wealth and preparedness.

You now know what not to do, and what to do. It might sound simple, and that’s because it is. But easy it certainly is not. And that’s a direct result of the fact that those who stay the course tend to do so well over the long term, while those that can’t, tend to do so very poorly. Make sure you are in the right camp dear reader, and can put the feet up comfortably with that lovely pipe and comfy slippers, if that’s what you seek!

Paddy.

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