In for a penny, in for a pound – the importance of pension planning. | Insights from the experts

When the markets are down, you purchase more units of an investment; when the markets are up, you purchase fewer units for the same amount of money. This method is referred to as pound cost averaging.

Experts typically advise drip-feeding money into investments, to lessen the impact of market volatility. This is effective because it removes the need to time the market. Instead, you make recurring (typically monthly) contributions to your investments.

So, let's look at this the other way…

The process of flexibly withdrawing income from your pension while keeping the remaining funds invested is known as drawdown. Drawdown has advantages such as allowing your pot to experience long-term growth and providing you the freedom to control withdrawals according to your requirements.

Drawdown does, however, carry certain risks. Imagine you are taking sizeable withdrawals in your early years of retirement and your investments see a significant decline. It is much more difficult to make up lost ground. This is the evil twin brother of pound cost averaging and goes by the name of pound cost ravaging (boooo!). Also known as negative pound cost averaging.

Here is an example:

Consider Charlie and Jill, two 67-year-olds whose pensions are both worth £100,000. Each is withdrawing £7,500 in the first year, with an annual increase of 2%. To keep things simple, we apply each year's investment return and then take that year's withdrawal.

In the first five years, Charlie's investments generate returns of -10%, +4%, +4%, +4%, and +4%. At the end of that time, his pot is worth just over £63,000.

While Jill receives exactly the same returns, they happen to her in a different order: +4%, +4%, +4%, +4%, -10%. Her pot is worth almost £67,700 over the same period.

In other words, simply by suffering the bad year at the start rather than the end, Charlie has been left with a pension worth around £4,600 less than Jill — despite identical returns and identical withdrawals. That is the "sequence of returns" risk in a nutshell.

This is one of the reasons it is crucial to regularly assess your drawdown plan and be ready to modify your withdrawals as needed. This will assist in ensuring that your retirement income strategy stays on course. For more on the flip side of this coin, see our guide to pound cost averaging, and if retirement is on the horizon, 10 ways to make the most of your pension and the value of early pension planning.

Hope that helps.