With the fall in China’s equity market, Henry Tapper examines the impact on our pensions in the wake of the retirement revolution.

    The falls in the world stock markets since April appear huge, our own market has fallen 15%, market in Asia, much more. But the equity market that has fallen the most is China. The great fall of China is being billed as a ‘re-calibration’ – in other words, market experts would have us believe that the original valuations of Chinese company’s worth was wrong and the fall in values really is a matter of better accounting.

    A more pessimistic view is that global economists have been lulled into a false sense of security, relying on growth from China and other emerging economies to drive up valuations of European and American companies.

    Whichever view you take, and I suspect the truth is somewhere in the middle, this has been a crappy six months for people whose pensions have been invested in shares.

    Is your pension invested in shares?

    Most people have no idea where their pension is invested, but they will – especially if they are in a defined contribution scheme, most likely be invested in shares. This is because most people in pension schemes (rather than drawing pensions) are some way from retirement and the default settings for their investment strategies have them 100% invested in shares until they are at least fifty.

    So if you are under 50, you are probably mostly invested in shares. And as you get older you are less invested in shares and more invested in bonds. Bonds aren’t supposed to go up and down like shares, the value of bonds depends on the outlook for interest rates and the financial strength of the organisation issuing the bond (which is an i.o.u.).

    If you are Paul Lewis, then your pension isn’t invested in shares or even bonds, but in what is invested in cash.

    My comment is fair. Paul is (hopefully) in no need of taking all his pension as cash and is likely to live at least 20 years (he was born in 1948 making him 67 – I think).

    Paul can crow for the moment that he’s unaffected by the ‘great fall’, but with cash yielding little more than 0%, Paul is using his pension as an expensive cashpoint.

    Most people who have pension pots and are over 55 are not invested in cash, but in real assets – shares and property, mixed up with debt (bonds) and cash. This is the default strategy for most people in drawdown and in lifestyle strategies.

    If you are not in drawdown, you have a guaranteed income and you have no worries (at least about market crashes) – your income is guaranteed. You could be getting a pretty crappy income in the first place mind! (Unless you bought your annuity when interest rates were high or were in a DB scheme a decent time).

    Does it matter if you are invested in shares?

    It matters more as you get older. If you have 20 years to go till the point your pension starts paying you, then you will go through many ‘great falls’ and you should shrug, keep calm and carry on.

    If you are approaching retirement and thinking of spending your pension, especially if you are thinking of taking all or a big chunk at once, then being in equities over the past six months will be bad news. You have two choices, bite the bullet and cash out (tough) or hang on and wait. If you are cashing out of equities right now - it’s going to be painful - especially if you are looking at a statement dated from earlier this year!

    Similarly, if you are currently drawing down from your retirement pot each month and you are in shares, then this dip could really hurt you. You could become a victim of what has been called ‘pounds cost ravaging’.

    What this means is that the monthly amount you are drawing is meaning you are cashing in your shares at a very low price, depleting your retirement pot far too fast. The payments you are currently taking could deplete your pot to such a level that you will have to adjust your payments (downwards) in the future.

    This is why Paul Lewis says that someone in his sixties should not be invested in shares.

    What does the great fall of China mean to those with a pension?

    To youngsters - it’s a blip that will be forgotten like all the other blips (including 1987 and 2008) by the time they start spending their money.

    To the middle aged it could be a pain, if there’s a plan to cash out all or most of the pension.

    To those in later life (who don’t have income guaranteed), this fall of China could be bad news. It could mean them having to take a haircut on the amount they pay themselves for the rest of their life.

    Why is Paul Lewis wrong?

    Paul Lewis may be right for Paul Lewis, but he is not ‘everyman’. Most people cannot afford to have their pension pot in cash the last 20 years of their life. They need to take some risk to get some reward.

    Over the long term, a diversified approach to investment that intelligently mixes up shares, bonds, property and cash is the most sensible way for most people to be invested to have a secure income.

    Insurance companies invest this way with their mega-funds and so do the big public and private defined benefit funds. Go abroad and look at what the big sovereign wealth funds do – it’s the same. They invest across a range to get a smoothed investment return.

    What’s more, because they are investing collectively, the cost of investing for the big boys is much lower than for you and me.

    Finally, these big funds are investing on behalf of everyone and can manage payments much more easily – it makes sense that if you are managing for millions of Paul Lewis’ (so to speak), you can run a fund for the Paul Lewis’ that die young and those that live a long time (without the fund going bust).

    If you are a DC investor in Holland or much of Scandinavia, you get the protection of collective investment. It doesn’t seem worth much when markets are going up, but when times are tough (as they are now) collective investment protects people from pounds cost ravaging and allows them to continue to draw a stable income.

    Paul Lewis is wrong because he is only Paul Lewis, he should be in a collective fund with lots of people like him, he should be invested in a diversified way (not just in cash) and he should have protection against being a super long-living Paul Lewis (which he very well may be).

    The great fall of China

    So what does this massive fall in the value of world shares mean for pensions as a whole? It means that for the first time since the Pension Freedoms came in (in April) that people’s pension pots are likely to have fallen in real terms. Sooner or later, all the people who have chosen not to buy an annuity but to drawdown from equity portfolios are going to get a nasty letter from someone saying they are going to have to take a drop in drawdown or risk their money running out.

    These people are going to moan, they will moan like crazy. They will moan at fund managers, insurers, advisers and they’ll moan at the government.

    And people will start asking questions about the pension freedoms. First of all, they will ask why they stayed in equities, then they will ask why they didn’t get protection and eventually they will ask why nothing is being done to provide a collective way to spend their pension pot. Put another way, why there isn’t a default spending option.

    The answer’s coming (slowly)

    Unless the government cans CDC, it can legitimately claim that it is building the conditions for a default spending option for people who want and need to be invested in real assets and cannot afford the ‘risk free’ option of annuities or the Paul Lewis cash option.

    CDC won’t be around for a few years yet, this is because there is precious little resource being directed towards building the detailed regulations that allow it to be integrated into our already complicated pension system.

    It may be that the changes in taxation of pensions make the progress to CDC quicker (if pensions become simpler) but I think this is more dream than reality.

    A solution to the problems that people will face from the great fall of China is on its way, but won’t be here till the end of the decade (IMO).

    The pain that many people over 55 will suffer as a result of the slump in stock market valuations will come soon and with it a call for reform. In a perverse way, the pain of a stock-market crash is probably what we need, to provide a lasting solution to the problems we face spending our pensions.

    Start the discussion

    Add a comment