The opposite — pound cost ravaging — is where a client ends up having to cash in more investment units, in this example, when markets are falling in order to maintain the same level of income.
And then there is volatility drag. A 15 per cent loss in year one requires 18 per cent return in year two just to return to the original value. Making withdrawals when a portfolio is down essentially locks in those losses for good.
Faced with such a prospect, a client might be prompted to review their retirement plans, accept a lower level of income, or even keep working in an effort to fill the hole in their pension pot.
Sequencing risk and volatility drag are also risks for advisers; when portfolios — and therefore their assets under management — see significant falls then recurring income will (usually) fall too.
In a fix
This all means that, for clients in decumulation it is important that their CRP can deliver sustainable income in order to reduce longevity risk — the possibility that they will outlive their investments and run out of income.
But there are widely practised strategies for mitigating sequencing risk in the later phases of accumulation and the early years of decumulation retirement.
Typically, that would mean migrating to a higher proportion of fixed interest investments in the final years of accumulation.
Fixed interest investments can be an important part of a diversified investment strategy because historically they provided a reliable income stream at a relatively low risk, though, reflecting that the level of return is often lower than equity investments.
But recently high inflation and rising interest rates have been bad for bond performance. So, is it time to stick (and wait for values to rebound) or twist (and sell up to invest in alternative assets)?
Smoother sailing
One option is a smoothed investment solution such as with-profits funds, which are designed to reduce day-to-day market volatility.
They typically aim to provide steady growth by investing in a diverse range of assets, including UK and International shares, fixed interest stocks, property, cash and other related investments.
But returns are smoothed using a mechanism that reduces the impact of short-term price fluctuations.
So, when the with-profits fund is performing particularly well, not all returns are passed on to investors straight away.
Instead, some are held back, to be released to investors during times of poorer performance to help cushion any fall in value.
