For many people, the State Pension will prove to be inadequate in retirement. It currently amounts to £164.35 per week, which is less than 30% of the average wage in the UK. This means that many people may be unable to enjoy the financial freedom they are hoping for in older age – should they be solely dependent upon the State Pension.
Fortunately, there are a variety of products available, such as ISAs and SIPPs, which can make the process of planning for retirement easier. However, deciding how much risk to take can be a challenging area for many people, with it being difficult to obtain the right balance between risk and reward. Through doing so, though, it may be possible to enhance an individual’s retirement income.
Risk
For many people, investing in the stock market is viewed as being a risky pursuit. Share prices can fall heavily, and this can lead to a decline in an individual’s financial outlook.
While this may be the case, should an individual have a long period in which to invest, shares could offer an appealing risk/reward opportunity. The FTSE 100 and FTSE 250, for example, have track records of delivering high single-digit total returns over the long run. Certainly, they have experienced major bear markets in the last couple of decades, and could decline in value in the short run, but over the long run they may be able to deliver relatively high returns that provide a sizeable nest egg for an individual in retirement.
Reward
In contrast, investing in products such as a Cash ISA or even some investment grade bonds can lead to disappointing returns in the long run.
Should an individual have a short period until retirement, such assets may make financial sense. However, if someone has over a decade until they aim to retire, they may have sufficient time for the stock market to post a recovery even if it experiences a challenging period in the short run. And with a Cash ISA, as well as some investment grade bonds, having the potential to underperform inflation, they may fail to generate a nest egg that is sufficient to provide a second retirement income.
Accessing returns
As mentioned, products such as ISAs and a SIPP make it relatively straightforward for any individual to invest in shares. They provide tax benefits, as well as relatively low fees. There are also tracker funds available, which provide a low-cost means of gaining exposure to a wide range of shares, while reducing company-specific risk. And for investors who do wish to try and beat the wider stock market, the cost of buying shares has fallen significantly in recent years.
While taking risk may seem to be something to avoid, for investors thinking long term, it may prove to be a sound strategy when undertaken in moderation. Otherwise, the returns available on lower-risk assets such as a Cash ISA or investment grade bonds may be disappointing, and could mean that an individual is more reliant on the State Pension in retirement than they would ideally like to be.
