Introduction
In order to discuss pension considerations in the world right now, it’s even more important to understand why we are here. Context is everything in this situation. Without it one runs the risk of making rash decisions and this could prove to be financially detrimental in certain scenarios.
In Part I of this two-part series, we will look at some of the factors surrounding why pensions may be affected by Covid-19 and some of the decisions you may need to consider during this time. This article will take an in-depth look at some of the pension fund options and risk management tools that may be used during a market correction.
Part II will compare previous recessions to the pandemic led recession we are witnessing right now and highlight where they may compare / contrast, as well as showcasing some of the most notable lessons learned from these past events. We will also take a look at individual pensions – v – pensions schemes – how they may be affected during this time, tax relief benefits to all pension paying customers and the part that auto-enrolment will play in our lives, should it be introduced in 2022, as planned.
Covid-19 – A global pandemic
For those of you reading this who may have just come out of hibernation and don’t realise what’s going on in the world, we are living and breathing through a global viral pandemic. We are operating our lives in an isolated manner right now in order to keep our loved ones safe and darkness away from our door. We have stood by and watched real-life superheroes take charge and help us during this difficult time, whether it be in the front line of a hospital or your local Tesco. We could not be more grateful to those champions right now.
The more potentially unsung heroes in this pandemic could be our government. Our Taoiseach described only recently as ‘badass’ by Hollywood actor Matt Damon for his offer to work on the front line – the cynics among us quoting this as ‘all for PR’, but nevertheless a kind and supportive gesture during a global crisis. Those people who made these important decisions to keep us healthy and well during this crisis deserve our thanks. They have been recognised globally for their efforts and the proactive nature with which they jumped into the hot seat of leadership, during what was potentially a confusing time for all involved following the outcome the early 2020 elections.
A ‘pause’ in the global economic sphere
It is however those decisions made by many a government worldwide, that has led to what we can only describe as a ‘pause’ on real life economics. Many shops, businesses, services all around us were forced to shut in order to keep this virus at bay and protect our most vulnerable. What began in China and slowly circulated the globe, this pandemic caused mass destruction to life as we know it, from so many angles. One would have to wonder, will our lives really ever be the same again?
The stoppage which ensued caused a direct impact on our global economy leading many top economists across the world to predict a global recession – many saying its magnitude may be as profound as the Great Depression, or even worse.
But this is not our first rodeo. We have witnessed and lived through recessions before now. The effects of the 08/09 great financial crisis still simmers in many a mind and for some has burnt a large hole there, or potentially in their wallet! It is the type of recession that we are in, which should dictate how we will come out.
So how does this effect the couple of hundred quid I put into my pension every month?
How has my pension been affected?
During any recession, an economy will suffer, none more so than the Covid-19 crisis. One of the most dominant behavioural effects among a population going through a recessionary period is that of fear-induced saving. This cut-back on spending among individuals and businesses can become the order of the day for many because the fear of the unknown will often trump the want to purchase an unnecessary item. The problem with this softly-softly approach to spending is when money is not circulating around an economy, businesses will feel the pinch. The value of those businesses can then also suffer and ultimately the country’s indices (Ireland’s is the Iseq index) which represents the valuation of some of the largest market leading companies in that economy, will fall. It comes back to basic economics, lack of demand results in reduced prices and thus a decrease in value of the underlying product or asset.
Due to the fact that the majority of people’s pensions in Ireland are invested in some description of an ‘equity’ based portfolio, more commonly known as stocks and shares i.e. companies, this trail of events will cause the value of those pensions to fall.
A typical pension fund, with more than 5 years to go to retirement, will be invested between 60% to 80% equities because for the simple reason, equites have proven themselves to be the best performing asset class time and time again, over the long term. A good advisor however will have diversified that equity mix to include a number of different geographical regions, industries, sectors, currencies etc. This diversification is one of the most beneficial cards you can play in your pension portfolio and will serve you well in both the good times and bad.
What part of your pension could benefit during a recession?
A normal run-of-the-mill feature of any recession is that once investors / fund managers get a whiff that there is something untoward coming, they often flock to the more safe-haven assets such as government bonds, cash, gold etc. which can improve the price/performance of those assets greatly during a recessionary period due to the demand shown for them – we’re back to our previous economics lesson! Often, many multi-asset type pension funds have downside risk management tools built into their investment strategy so that when volatility strikes consistently over a period of time, it will automatically prompt those higher equity based funds to reduce their risk of exposure by sliding into one of these less riskier assets. Similarly, active fund managers may just make the decision to change the funds strategy, based on their intuition of what is going on in the world and the likelihood of how long we’ll be in that rocky territory. Again though, good diversification in a portfolio will normally have a portion of someone’s pension already sitting in these type of safe-haven assets and therefore they will benefit from the boost in their valuation during a time like this.
Are Government Bonds always a booster to a pension portfolio?
Another step normally taken during a recession in order to boost an economy and its circulation of money is that central banks may lower interest rates in order to get that money flowing again. When interest rates are lowered this causes bond prices to rise but inversely the yield (return) which a bond produces, will fall. While a bond holder may benefit from a rising price, someone moving to a bond may have to contend with paying a higher price than normal and therefore receiving a lower yield (return) in the long run.
Should I do a fund switch to cash during a time like this?
Ultimately this is one of the core questions that pop up among many investors and advisors during a market correction. It means switching all or some of your pension money to a ‘safe house’ like cash or low-risk government bonds, until the mood music in the economy is more joyful! The problem with this switch to ‘cash’ is that people rarely get into cash at the right time and also similarly, more often than not, don’t come out of it at a favourable time either. Our advice, which would be supported by many in the industry is, if you have more than 5 years to go to retirement, simply staying invested and riding out the storm has often proven to be the best course of action over the long run but it’s also very important to get financial advice before making any long-term investment decisions.
The words of ‘The Clash’ often ring in our ears when we talk about this predicament of moving to Cash – ‘should I stay or should I go?’ Sometimes a picture can paint a 1000 words…
Market ‘bounce-back’ uncertainty
The market can move in funny ways. Being there (invested) for the bounce-back is crucial for any type of investment, pension or otherwise.
I mentioned previously that the type of recession can often dictate the recovery. There are 3 to consider:
- Structural
- Cyclical
- Event Driven
In 2008/2009, what we witnessed was much more of a structural recession, hitting right into the heart of the banking system and it took us almost 5 years to recover. Some areas / regions / countries will say that they are potentially still recovering from the scale of that particular recession.
What we are going through right now is an ‘event-driven’ recession. History has shown that these tend to produce a circa 30% drop in the market and last for, on average, 9 months – in terms of the peak to trough of negativity.
Evidence of the uncertainty that can be attached to a rebound was never as prevalent in a market downturn as this time round. In this Covid-19 crisis, by 23rd March 2020, we witnessed a 33.8% drop in world equities from February 20th. On 24th March the world markets rallied to improve those ratings by 14.3% in the space of 3 days.* Were there any signs on the eve of 23rd March that this racing rebound rally was coming? None. None whatsoever. So a move to cash in this instance, with the intention to come ‘back into the market’ once things had eased off / prices improved, would not have fared out well for those who switched, simply because this bounce-back came much sooner than the majority of economists, investors and advisors had foreseen.
It is important to say though that we are living through something uniquely unknown in terms of this particular event. For that reason we believe there will be more volatility to come in the months ahead and you should speak with your financial advisor for guidance on future investment decisions.
What are the factors that make a switch to cash/safer type assets the right thing to do?
- What age are you? If you are within 3 to 5 years of retirement, safeguarding your pension pot is key and while you may not choose to switch your entire portfolio to cash, it could be wise to downgrade the risk level of a portion of your fund. Risk classifications run from 1 to 7. Most pensions in Ireland sit somewhere between 4 and 6, depending on portfolio size, age of customer and their general attitude to risk. What you plan on doing with your fund at retirement however, needs to be considered when making this decision.
- Is it keeping you awake at night? Understanding our customers and what might trigger their worries and concerns is very important to us in Trust Matters. We know how hard clients have worked to earn the money that eventually will go into their pension. If the thoughts of losing some of it is causing distress, then no matter what age you are, we will work with you to reduce the risk involved in the portfolio straight away.
*Source – New Ireland Assurance Fund Centre
If you’d like to discuss this blog or learn more about your options, please get in touch.
By Jo Ryan, Senior Financial Advisor, Trust Matters Financial Planning – www.trustmatters.ie
