Recent research from Standard Life shows that the UK retirement market will see nearly £700 billion come through the system in the next ten years. In April and May alone of this year nearly 250,000 payments were made to customers from their pension pots, worth some £1.8 billion. The new pension freedoms are acting as a catalyst for adventurous investors to turn their backs on standard annuities in search of alpha from higher risk investments; the most popular of these being income drawdown solutions with £1.3bn invested in over the same period.
Interestingly, figures from the ABI also show that 52% of the income products purchased were bought from a different provider than the one managing the pension fund – which means that half of investors were shopping around for new income solutions. The risk is that people, released from the shackles of their annuities, could inadvertently select a provider without the right guidance and suitability consultation, leading to inappropriate choices.Choosing an unsuitable solution is not the only danger faced by investors who choose the non-advised decumulation route. Many investors who don’t wish to be ‘tied down’ to an annuity often remain in the dark about the risks and challenges posed by drawdown solutions – the biggest of which is the unpredictability of market conditions. During periods of market stress, taking regular withdrawals will not only prove a challenge but can also significantly erode the investor’s capital –which is where active management and careful financial planning add significant value.
In an article on yourmoney.com, Andrew Pennie from Intelligent Pensions elaborates on such risks highlighting the dangers of non-advised drawdowns:
Sustainability risk: On average, Pennie explains, life expectancy is underestimated by 8 years. Without guidance and education from professional planners, investors are unlikely to have an unrealistic view of the amount of accumulation that is essential to see them through life post retirement.
The stochastic investment forecaster example below from FE Analytics projects the likely return of a pension pot across different time horizons. The example below shows two portfolios (one advised and one non –advised) with a sample £55,000 invested with a withdrawal of £2,000. The forecaster reflects future values plotting the likely returns across an average retirement span of 26 years and shows that the advised portfolio is likely to provide more consistent returns. 
Inflation risk: Inflation has a significant effect on the value of income generated from a static pension pot, if left unchecked without regular rebalancing. An inflation rate of 3 percent a year can cut the value of income in half in real terms in less than 25 years.
The chart below from FE Analytics demonstrates the level of a client’s pension portfolio against inflation. If left uncorrected in mid-2010, inflation would have eroded the value of the portfolio pot.
Investment risk: Sequencing risk is arguably the biggest threat to the health of an investor’s pension pot. The risk of needing to take money out of a portfolio when markets are down – thereby crystallising a loss. With active management, investors can enjoy the benefits of diversification into helping to mitigate this risk.
The chart below from FE Analytics plots an actively managed adviser model portfolio against a client’s existing holdings. With £200,000 invested into both portfolios over the same time period – the adviser model has not only provided consistent income (£1500 withdrawn each month from both portfolios) but has also provided consistent capital return. The client’s portfolio however, has eaten into its underlying capital within the first five years.
It is common knowledge that risk is central to investment success, but understanding the nature of risk and adopting the appropriate levels during both accumulation and decumulation requires expertise and skill. As such, Investors would be well advised to seek help from regulated financial advisers to get investment advice, ongoing review and a suitable exit strategy, if required.