The hidden cost of ‘pound-cost ravaging’ for retirees

Transitioning from saving to spending requires careful planning for your clients. Avoid pitfalls like pound-cost ravaging and secure your financial future confidently.

• Be strategic: Decisions in the first years of retirement, like managing withdrawals during market downturns, can greatly affect how long their savings last. Setting aside a cash reserve and staying flexible with withdrawals can reduce risks.
• Avoid pound-cost ravaging: Withdrawing funds during a market downturn early in retirement can compound losses, shrink their portfolio and limit future growth.
• Balance your retirement spending: Overestimating returns or underestimating longevity can strain finances, while excessive frugality may limit enjoyment. A tailored financial plan, supported by expert advice, helps strike the right balance.

Having spent years working hard and saving carefully to build long-term financial security, your clients retirement marks the start of the decumulation phase – a time to transition from growing your wealth to using it to support the life they have always envisioned.

The actions of your clients in the first few years of retirement can have an outsized impact on how long their money lasts.

Even with careful consideration of factors such as longevity and inflation, it’s easy to get caught out by negative pound-cost averaging, or ‘pound-cost ravaging.’ This occurs when you need to sell larger portions of investments to maintain a steady income during times when markets are falling. This can reduce the overall value of investments more quickly.

With various income sources available, such as a general investment account, self-invested personal pension, ISAs, offshore bonds and more, receiving expert advice on where to draw funds from is a key part of your ongoing discussions with your clients.

The actions of your clients in the first few years of retirement can have an outsized impact on how long their money lasts.

During their working life, they will probably have benefited from pound-cost averaging – the strategy of investing regularly regardless of market conditions. This helps to smooth out market volatility.

Pound-cost ravaging, on the other hand, occurs when you withdraw funds from investment portfolios during a market downturn. Since investments are worth less, you need to sell more units to generate the same level of income. Those extra sales crystallise losses that might otherwise have been recovered if left untouched. If this happens early in retirement, there is also a compounding effect, with less capital available in your clients portfolio to benefit from growth over time.

This erosion can be especially harmful in the early years of retirement, when their investment horizon still stretches decades ahead.

“If markets fall in the first year, it can create a hole in retirement plans that can grow over time,” says Rob Burgeman, wealth manager at RBC Brewin Dolphin. “A bad first couple of years can make all the difference, as people who retired in 2007 or 2019 may have been unfortunate enough to find out.”

The chart below illustrates the impact pound-cost ravaging can have on your retirement portfolio, revealing the remaining value of a £500,000 portfolio after 25 years of 5% annual withdrawals, depending on whether markets rose or fell in the first year.

First year up: Assumes markets rise 10% and fall 5% in alternating years over 25 years – averaging out at an annual return of 5.23%, net of any costs or investment fees, and making 5% withdrawals of the original sum every year (£12,500). First year down: Assumes the same scenario but markets drop by 5%, following the same pattern of rising 10% and falling 5% in subsequent years over 25 years.

Source: RBC Brewin Dolphin.

The effects of pound-cost ravaging can subtly impact even the healthiest portfolios. However, with the right steps and the support of a skilled investment manager, you can safeguard your clients financial future.

Pound-cost ravaging is not the only factor to consider when planning retirement spending. Overestimating investment returns, underestimating longevity, or ignoring inflation can all have long-term consequences, while failing to account for unexpected expenses such as healthcare, family support or home repairs and renovations could also leave finances strained.

To avoid pound-cost ravaging, it’s wise to keep an eye on markets and avoid sticking too rigidly to a fixed withdrawal plan. While consistency can feel reassuring, in retirement, flexibility is your ally. Setting aside a cash reserve to help adapt spending year by year can extend the life of savings without meaningfully compromising your clients lifestyle.

Depending on conditions when they retire, it could also be worth considering delaying retirement, deferring state pension payments, or using other income sources where possible, before tapping into investments.

All these options could give portfolios more time to grow by avoiding the need to make withdrawals during volatile periods.

Pound-cost ravaging occurs when you withdraw funds from investment portfolios during a market downturn.

With the right central retirement proposition in place, your clients can enjoy a financially secure and fulfilling future. We can partner with you to take care of the complexities for your clients: developing a personalised retirement plan, stress-testing income assumptions and offering expert guidance through both the financial and practical aspects of retirement – along with the reassurance that your clients financial future is in both of our capable hands.

The value of investments can fall and you may get back less than you invested. This does not constitute tax or legal advice. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future. Information is provided only as an example and is not a recommendation to pursue a particular strategy. Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness.