OK, so you have opted for the extra flexibility that a SIPP gives you investing for retirement, but how do you go about using it? Choice is a very useful thing, but it can also be rather daunting, especially where saving for retirement is concerned. You don't want to approach your retirement date and suddenly discover that your pension fund is not worth nearly as much as you anticipated.
So prudent management and regular reviews of the state of your SIPP are called for. One established rule of thumb that financial advisers have traditionally used to encourage investors to think about retirement planning is to suggest that they hold a proportion of their portfolios equal to their age in relatively secure investments, such as fixed-interest securities. So, for example, if you are 25, you might have 25 per cent in bonds and 75 per cent in equities, but at 50, the split would be roughly 50 per cent in each.
The idea is to maintain a sensible balance between higher risk equity investments and lower risk bond holdings that alters over time to reflect the approach of retirement. At 25, when you may still have 40 years in which to invest, a split of 75 per cent in equities and 25 per cent in bonds is reasonable because, over 40 years, shares should produce significantly greater returns than fixed-income investments, and there will be plenty of time for your investments to recover if there is a short-term fall in the stock market.
A wider range of options
This is, of course, a rather crude approach to financial planning, not least because it doesn't take account of the much broader range of asset classes available to investors these days. But the basic principles that you should spread your risk across a wide range of investments and seek to reduce the overall risk level as retirement approaches is still generally applied.
Peter Thomson, chief investment officer at Taylor Young Investment Management, says that 'You have to take notice of the life cycle of the investment. Depending on the age of the investor when they start, you will typically move from “wealth creation"? mode to “wealth preservation"?, then what we term “immunisation? and finally to “income generation"?, for example, if you are in drawdown. The important thing is gauging where people are in that cycle and understanding how the requirements of that cycle change with age.'
He adds, 'I suspect that, generally speaking, people take too much risk in the approach to the immunisation and income generation stages. They probably have most of their funds in equities 18 months to two years before retirement. If their fund then drops 25 per cent over that period, it will have a dramatic impact on the rest of their lives and a lot of people do not realise how much risk they are taking.'
Portfolio management
However, not everyone agrees that age is necessarily the key factor.
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