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Are lifestyle funds still fit for purpose?
Lifestyle funds have failed to do what they were supposed to do – shield savers from risk in the run-up to retirement.
For many years, lifestyle funds were a popular option with savers in stakeholder, personal and many defined-contribution workplace pension plans. The funds invest your money relatively aggressively while you’re younger, channelling your contributions into equities with the aim of building as large a pension fund as possible. Then, five to ten years before you’re due to retire, your provider automatically begins to switch your money into assets conventionally considered less risky: bonds and gilts, in particular. When you finish work, your fund will be almost entirely invested in these assets.
The principle of a lifestyle fund is that savers closing in on retirement should not be exposed to the risk of a sudden drop in the value of their fund since they won’t have time to make up the shortfall. Bonds, which have traditionally offered much less volatile returns than other asset classes, therefore appear to be a good option.
The problem is that in the past two to three years, bonds have not lived up to their promise of low volatility. As interest rates have risen to tackle inflation, bond prices have fallen sharply. Some bond funds have suffered losses of 30% to 40% over the past year alone.
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That has proved disastrous for savers with lifestyle funds who are just coming up to retirement. Their savings have crashed at the worst possible moment – exactly the danger that these funds were supposed to avert. And while savers may be furious, they have little redress. Their money has been invested in line with the premise of the lifestyle fund. They have simply been caught out by unusual market conditions.
The problem is that bonds have not lived up to their promise of low volatility
It’s not all bad news. Higher interest rates also mean increasing annuity rates. So, for savers now intending to convert their savings into regular income by buying an annuity, there will be some compensation from the fact that their money will go further. However, for most lifestyle fund savers, the additional annuity income now available will be nowhere near enough to compensate for the fall in the value of their savings. They now face difficult choices. Do they delay retiring, or at least cashing in their pension, in the hope of a bond-market recovery? Another option might be to delay and shift funds into more aggressive assets, but that will lock in the bond fund losses and add even further exposure to risk.
The story is a painful reminder of the long-term nature of pension planning and the importance of checking regularly to see whether your strategy remains appropriate. For many years, lifestyle funds worked very well and provided important protection – but the financial environment then changed.
There will be many savers in lifestyle funds who have yet to be affected by this issue because they are young enough still to be invested predominantly in equities. But it is important that they learn from the problems suffered by less fortunate older savers – a savings strategy that automatically shifts your money around, rather than requiring direct and considered intervention, is always going to leave you exposed.
There is, in any case, a real question mark over whether lifestyle funds are fit for purpose in modern times. The concept was designed for an era in which most savers bought an annuity at retirement, ending the savings period of their retirement planning. These days, most savers prefer to draw an income directly from their pension funds, which are left invested. In which case, shifting all your money into bonds may make no sense at all.
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David Prosser is a regular MoneyWeek columnist, writing on small business and entrepreneurship, as well as pensions and other forms of tax-efficient savings and investments. David has been a financial journalist for almost 30 years, specialising initially in personal finance, and then in broader business coverage. He has worked for national newspaper groups including The Financial Times, The Guardian and Observer, Express Newspapers and, most recently, The Independent, where he served for more than three years as business editor.
