A cheeky half won't hurt, just to be sociable.....

We’ve all heard the urban myths about some poor unfortunate who’d saved diligently into a pension all of their life, investing it very cautiously, only for it to all but disappear in some stock market crash a week before they were due to retire. Well unfortunately there’s nothing urban or mythical about it. It can and does happen. The mystery is how something that they thought was so cautious and low risk could be so…..well, risky.

Risk is a funny old thing when it comes to your money. As in life, you need some risk otherwise there’s no reward. Even bank accounts carry risk; either that the bank will go bust or that the interest paid is less than inflation and consequently your capital can die a slow and painful death. If you want to make big gains then you need to head towards the higher risk investments like stocks and shares. The trade-off is that the volatility of these investments may not be for the faint hearted.

So, how can an investment that begins life as low risk, end up being high risk without you doing anything to it? Well, it’s a bit like a night out really. You start off all demure and sensible but left to your own devices for long enough and ‘I Will Survive’ on the Karaoke starts to seem like a good idea.

When you save in a pension, you are offered a choice of what type of investments you want your monies to go in to. This choice will stretch the full risk scale from very cautious cash accounts right through to potentially volatile stocks and shares.

If we draw a line down the middle of this scale then those to the lower end like cash, gilts and bonds we refer to as defensive assets. Those to the higher end like shares, we call growth assets. Property funds can be argued into either side depending on how many pints you’ve had.

A good pension will have a selection of funds spread across this spectrum, but weighted towards one end or the other depending on whether you want to be cautious or adventurous.

Lets say that you want a ‘low to medium degree’ of risk. We are going to ignore the fact that ‘low to medium risk’ is a subjective term as one man's merry-go-round is another man's roller coaster, that’s for another blog.

To achieve this you may have 80% of your monies in defensive funds and 20% in growth funds. Sounds pretty low risk for a 40-year strategy doesn’t it?

In terms of a night out, that’s the little pep talk you give yourself in the bathroom mirror before you head for the town. ‘Only have toast to eat before you go out, take the first three pints easy and do not under any circumstances, end up in a round with Big Dave’

Now, defensive funds are designed to protect their capital and make a bit of a return on top, hopefully sneaking a bit more than inflation. Growth funds on the other hand are designed to grow and make solid returns well above inflation in the longer term, but at times may be worth less than you invested.

So lets imagine the scenario at the end of year one for our cautious portfolio that we cobbled together earlier. The defensive funds have done fine and produced a 5% return. The growth funds have done even better, as expected and produced a 12% return. This means that the 20% growth bit of your pot has grown a little bit faster than your 80% defensive bit and overall your pot is now 79% defensive and 21% growth. It’s just decided to stop for a bag of chips on the way to the pub to ‘line its stomach’.

At the end of year two it is 78% growth and 22% defensive and it’s just ordered its second pint. After five years it is 74% and 26% and has just challenged Big Dave to a yard of ale race. You can imagine where it will be in forty years time…..

And so it goes on, getting more aggressive as every year passes. By the time you’re considering taking your pension which you think is a cultured glass of Pinot Grigio by the fire with some cheese, it is actually having a fist fight outside the pizza shop because somebody looked the wrong way at something called ‘wor lass’.

What you actually need is some way of taking those gains made by the growth assets and moving them into the defensive pot on a regular basis and thereby maintaining the equilibrium. In drinking terms it’s like having someone swop every second pint for a glass of water without you knowing and generally pointing out when you’ve had enough and are getting a bit leery. Unfortunately, pensions do not have wives but the same function can be achieved by a mechanism called ‘lifestyling’. This is an automated process which, year by year moves your growth gains into your defensive pot, maintaining the status quo.

So if you started a pension some years ago and vaguely seem to remember choosing low or medium risk but then leaving it unattended, it could well be that it is now lying in a gutter somewhere explaining to the nice officer that ‘no it wasn’t aware of the exact location of its pants but they couldn’t be far away’.

If this is the case you may want to rebalance the funds to a more appropriate risk level. This can be especially important if you are in the last five to ten years before your anticipated retirement and do not wish to end up as an urban myth.

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