Drawdown risk assessment – how to reduce risk in drawdown

If you’re planning to move into drawdown, or you’re already a drawdown investor, recent uncertainty might have left you less willing to take on risk.

Drawdown offers great flexibility, the potential of an increasing income and the chance to pass on more of your pension when you die. But, the value of your pension pot depends on the investments you choose and market performance. Unlike cash, all investments and the income they produce can go up and down in value, so although there’s the potential for growth and income, you could get back less than you invest.

But with some careful planning and regular reviews, you can reduce the impact of any unwanted results. We share our three top tips to help reduce risk in drawdown.

This article and tools aren’t personal advice. If you are unsure if a course of action is right for you, please seek advice.

1. Build a cash buffer

We think it’s always a good idea to set some money aside for a rainy day. But you also need to make sure you have enough cash to cover your essential spending as well as any planned income for the immediate and short term.

Having a cash buffer can help shelter you against falling markets. If the stock market crashes, the cash can act as a safety net and help to safeguard your income levels.

As a general rule, everyone should hold at least 3-6 months’ worth of expenses in easily accessible cash, most likely in a bank or building society savings account. Investors should also have some cash readily available for planned income (at least 2 years’ worth, or more preferably).

You could also think about keeping extra cash to fall back on, and how much you hold will probably depend on how you’re taking money from your pension i.e. if you’re taking the natural yield (the income from your investments) or if you need to draw from capital.

Although you can hold both cash and investments in a drawdown account, the extra cash doesn’t necessarily have to be held in your pension - just as long as it’s easily accessible for when you need it.

When you’re building a cash buffer, you don’t have to sell your investments to do so. You could think about building up cash over time by gathering together the income generated from your investments, rather than re-investing it. Remember dividends aren’t guaranteed and major events, like the coronavirus pandemic, can lead to some companies suspending, delaying or scrapping dividend payments.

2. Diversify and balance your portfolio

It’s no secret that diversification is a cornerstone of successful investing. The main reason to diversify your investments is to help reduce risk. We’ve all heard the expression ‘don’t put all your eggs in one basket’. And it couldn’t be more relevant when it comes your portfolio.

Depending on your own risk profile, a diverse and balanced portfolio might include a mixture of different asset types, like cash, funds, bonds and shares. Different types of assets, markets and sectors perform better at different times. This can give better shelter to your overall pension value during market falls and help provide more consistent performance.

The importance of diversification in volatile markets

If you don’t feel as though your current portfolio is balanced, this doesn’t mean you should necessarily sell, especially straight after a fall. You might want to think about gradually taking steps towards your rebalancing goal when you feel the time is right.

You should also periodically review your portfolio to make sure it meets your objectives and attitude to risk. You could consider options such as switching from assets which have done well into those which you think have strong potential and compliment your selections – this can help make sure the portfolio remains balanced and diversified.

3. Make sure your withdrawals are sustainable

We’re generally living longer than ever before. This is great but it also means our pension fund needs to last longer too. Retirement could last 30 years or more so it’s important your income withdrawals are sustainable.

By choosing drawdown, you’re accepting that your income isn’t secure so there’s a much higher risk. It’s not the kind of plan where you can just sit back and let it run itself. It’s essentially up to you to review your income withdrawals regularly to make sure they remain suitable for your needs.

By withdrawing too much too soon you could run out of money early on, which could have a huge impact on your lifestyle in future years.

Most retirees now have a great deal of choice over how they can take an income from their pension, and understanding these options is vital in helping you choose the right one.

FIND OUT MORE ABOUT MY RETIREMENT OPTIONS

For those thinking about drawdown, it’s often a sensible idea to request an illustration first. It will show:

• How your withdrawals could affect how long your pension lasts
• What different growth rates could mean for your pension value
• What might be left to pass on to your loved ones

Request personal drawdown illustration

If you’re a drawdown investor already, but you’re unsure how the income you’re taking will affect how long your pension might last, you may want to try our pension drawdown calculator. It could help you work out if the level of income you’re taking seems sustainable.

Pension drawdown calculator

What you do with your pension is an important decision that you might not be able to change. You should check you're making the right decision for your circumstances and that you understand all your options and their risks. The government's free and impartial Pension Wise service can help you and we can offer you advice if you’d like it.

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