In his latest Best Advice column for Money Marketing, Informed Choice chartered financial planner Nick Bamford looks at the importance of investment diversification within a SIPP portfolio.
Q: I have a SIPP in which I select the investments. At this time, I am invested in a range of shares across UK banks and insurance companies and also some collective investments in the US and Europe.
In the next couple of years, I intend to start to draw income from this fund. How should I invest the fund in the future?
A: Having examined your portfolio, I imagine that you would have experienced a roller-coaster ride in the past. There would have been really good years when the value of your SIPP increased and during some time periods increased quite rapidly and then other times when it would have fallen sharply in value. That is the way it is with equities.
But now you reach a different stage in the life of your SIPP. The equities that you have selected are very focused on the UK. European and US equities that you hold are a relatively modest part of the total.
Until now, you have been in the accumulation stage, where what you wanted was for the SIPP fund to grow in value. Now you are about to enter the decumulation stage, where you want the money to work for you in a different way.
What we often find is that clients who want to keep their pension fund invested are seeking a combination of sustainability of capital and income generation.
I assume you have determined that for whatever reason you do not intend to use your pension fund to buy an annuity. Annuity purchase should not be ignored because for many people it is the right thing to do. However, for the purpose of my reply I assume that an unsecured pension is the right way forward.
I strongly recommend that you diversify your portfolio. Maintaining a 100 per cent equity portfolio is a strategy filled with risk.
Imagine you start to draw income from the fund and then we enter another market crash. The capital value of your SIPP will go down. This fall in value will be exaggerated by the fact that you continue to take income.
It is possible that this combination of market falls coupled with extracting income might mean that your SIPP portfolio will never recover to its starting position and you need to ask yourself if you have the capacity to accept that loss.
If, for example, you have other sources of income and are not entirely reliant upon the income that you might generate from your SIPP then you might accept that the risk is worth taking.
A diversified portfolio might protect you against the worst of the downside and certainly our experience is that those people who have unsecured pensions are more concerned about protecting themselves from the downside rather than chasing the best gains.
But even a diversified portfolio of cash, fixed interest securities, equities across the globe and commercial property can still result in a potential for capital loss.
You might consider, for example, keeping the first few years of income you need in cash so that you do not have to disinvest more actively invested assets at an inappropriate time.
What you will need to seeking is a yield on your investment portfolio that supports the level of income that you need together with covering the cost of ongoing investment management and to some degree inflation.
Add these together and the challenge is likely to be a tough one. You may conclude depending upon your circumstances and financial planning goals that an annuity does not look particularly unattractive.
