Undergoing the phase change from an accumulation portfolio to a pension

Conventionally, when an investor ceases to be an accumulator and starts a pension, advisers frequently recommend a sudden portfolio change, as the investor ceases to be a "growth" investor and starts to draw as a "low growth" investor.

This is unsatisfactory for several reasons. First of all it leads to a substantial risk in terms of timing. An investor that converts a growth portfolio to a more conservative one is essentially a hostage of the stock market. If the pension or annuity is begun just before a major market fall, the investor may be left with a substantially higher amount of money than one that begins just a few weeks later after such a drop. The latter investor sells a large portfolio of shares and buys bonds right at the time when a more logical approach would be to increase exposure to shares to take advantage of the low prices on offer.

Perhaps an adviser with some foresight might change the portfolio of the investor to a more conservative one several years before the pension is commenced, but this itself has disadvantages because there will be transaction charges and capital gains taxes as a result of this portfolio switch. Another approach, not commonly used, would be a more gradual and natural progression toward the ideal asset allocation, as determined by the techniques mentioned above.

As you get closer to your retirement it is not necessary or advisable to suddenly start selling down growth assets in order to change the portfolio constitution from completely growth oriented to interest oriented. A simpler solution would be to cease dividend reinvestment and use all income generated by the rest of your portfolio to buy only defensive assets.

Here is what will happen to a portfolio over ten years if you have an investment that produces a 5%pa capital growth and a 4%pa income stream, ceasing reinvestment in the growth assets and accumulating the rest as interest paying securities, which itself compounds at 5%pa.

There is nothing hard about implementing this strategy, you simply stop reinvestment and have your dividends accumulate in a cash trust or direct it to be invested into mortgage trusts or bonds.

It is a good way to change your portfolio because it doesn't involve any capital gains tax by selling things unnecessarily. As there will be no need to suddenly sell your investments on your retirement then you don't have to worry about short term movements in the days prior to your leaving work.

By allowing the portfolio to change itself over the course of a number of years, transactions are reduced and the portfolio is able to gradually ease itself into a more conservative mode. This strategy is most suitable for longer term planners as it allows the pension portfolio to be set up in the years ahead of retirement, not in a sudden flurry of activity that immediately precedes retirement as is more common.