The last three decades has seen the world has been rocked by a number of major crises. As with the covid-19 pandemic, each crisis permeates the national consciousness, and leaves everyone feeling like it may be the end of life as we know it. My second son was born in February 2009, right into the teeth of the credit crisis. Like any parent, I can remember the joyous moment vividly. It was also a welcome escape from dealing with the chaos in the markets.
However, the extent to which the crisis had come to dominate the zeitgeist was demonstrated when the midwife brought me back to earth with a bump by ushering my son into the world with the now-immortal words: “Welcome to the credit crisis!” Yet the experience of each crisis has reinforced my belief in three things. First, that this current crisis, like all others, will eventually end. Secondly, that keeping a long-term perspective is the only real way to take sensible decisions, and thirdly that panic generally leads to very poor decisions. While a crisis is the quickest way to learn these lessons, they provide extremely helpful guidance for thinking about investment generally.
Taking those in reverse order, we all recognise that it can be easy to panic in a crisis when markets are falling sharply. MRI scans have shown that financial loss triggers a similar response pattern in the human brain as the experience of physical pain.
When the biggest income paying companies are scrapping dividends, well known companies are collapsing and your portfolio has taken a big hit, it can be very scary to be an investor. The fear is even more acute if you are approaching, or already in, retirement when maintaining an income from a steady portfolio is top of your priorities.
A natural response is therefore to react to the unfolding crisis by becoming cautious and trying to avoid any further losses, particularly if your hard-saved for retirement pot is at risk. At a real extreme, reverting entirely to cash may seem very tempting to ‘stop the pain’.
It sounds crazy with hindsight but there were plenty of people who did exactly this at the trough of the market in early 2009.
Another response is to lose sight of the long term. In a crisis, fear is triggered and fear shortens our time horizons. This is a fantastic evolutionary response. But, as tempting as moving to cash may be, knowing what will come next for the market is impossible: if you sell now, are you really going to be willing and able to reinvest when shares are even cheaper?
Holding cash is particularly tempting when markets are crashing and your investment portfolio is one of your main sources of income but, with inflation rates comfortably above any available interest rates, cash holdings simply guarantee a loss of spending power over time. Stock markets have historically recovered over a long enough horizon. The loss in purchasing power from holding cash today is permanent.
Generating and maintaining an income
Maintaining a long-term time horizon and avoiding the temptation of cash as a retiree can be difficult. Traditionally, when the majority of people opted for an annuity to fund their retirement, the thinking was that a retirement portfolio should replicate a 100% bond allocation.
As a result, a culture where equity holdings are reduced to zero ahead of retirement became prevalent. However, pension freedoms since 2014 have given retirees the option to control their own portfolios and income. Coupled with the need to fund a lifestyle in retirement for far longer than our predecessors did, and the need for continued investment to ensure growth of a portfolio becomes all the more important.
Demographic trends suggest it is time to rethink the traditional approach. The latest data from the Office of National Statistics finds that a man aged 65 today can expect to live for another 20 years, and a woman can look forward to an average of 22 more years. For an increasing number of people, life expectancy could stretch even further into the future.
The ONS also found that a man aged 65 today has a 1 in 4 chance of living to 92, and a 2.9% chance of living to 100. A woman reaching retirement age has a 1 in 4 chance of living to 94, and nearly 5% chance of living to 100. The length you spend in retirement could – I would argue hopefully – stretch into decades.
Generating and maintaining an income for 20 years after retirement clearly still requires a long-term investment outlook. Traditional financial planning for retirement can end up leading to an investment approach that is overly conservative and one that is effectively invested in too short-term a manner, like a mild version of the panicked investor moving to cash at the bottom of the crisis.
Recognition that retirement today is quite probably a 20+ year horizon gives the freedom to stay invested, sensibly, in assets such as equities which will generate better long-term returns than government bonds, particularly at today’s rock bottom yields.
Of course, this is not a signal to simply rush in to high-risk assets, but is rather a call to reconsider the approach to risk we take in retirement. A diversified approach to equities could very well reap rewards over the 20 years you have to remain invested, and that is plenty of time to ride out market volatility.
Investing through past crises shows us that keeping a long term horizon and not panicking are the keys to avoiding big mistakes. With investing, that is often more than half the battle. So, how can we be confident that the first lesson above, namely that this current crisis will eventually end, is also true?
Well, the short answer is that we cannot be perfectly certain. But, the odds must be stacked in our favour. It may not feel like it but, compared to previous generations, we live in remarkably fortunate times. Not only is life expectancy post-retirement at a high, but we also have access to health technology that would have been unimaginable 20 years ago.
When that NHS midwife brought me back, with a bump, to the reality of the credit crisis, I learned that it takes a courage to remain invested through a crisis, but the trick is to remain obsessively focused on the long-term.
As difficult as that may seem to you or I, it is nothing compared to the challenges being faced by all those in the NHS fighting today’s crisis on the front lines. While we wait for this crisis to pass, the rest of us must simply remember to stay calm and be patient.