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Easy to stumble in front of the pension goal

Risk is always with us in everything we do but, for some reason, many people seem to have particular difficulty in managing their financial risk. If things go wrong because of mismanagement of financial risk, that damages the whole industry, regardless of whose fault it is.

I define financial risk as the possibility of a loss arising as a result of an uncertain future event. This is not rocket science although, in some circumstances, the evaluation of risk can become horrendously complex. Consider the stochastic modelling which life offices are now carrying out in order to calculate realistic reserves.

But, for most people, it is possible to understand and manage financial risk in a much less complex manner. There are three simple principles here. First, the fact that there is risk does not mean that the event leading to loss will actually happen. If I put £10 to win on the favourite in a two-horse race, I could lose my £10 but it is just as likely that I will get back that £10 plus some winnings.

Second, if a particular event would cause you a severe loss, you should take steps to reduce your vulnerability where you can reasonably do so. That is why people insure their houses against fire. Yet it would appear that many very clever and well-educated people routinely ignore this principle in their own financial affairs.

Consider the Equitable Life saga. Many lawyers and accountants appear to have put all their very substantial pension provision in an opaque fund with this one life office, without the benefit of independent financial advice.

The third principle is that there is risk in everything. Consider the range of investments available to provide for old age. The risk of equities is obvious to everyone after the experiences of the last four years. The risk of gilts is a little less obvious because people tend to focus on the security of the UK Government as a borrower. But conventional gilts can be hammered by a rise in inflation and index-linked gilts are vulnerable to a rise in real yields. Non-Government bonds have the same risk factors as gilts, plus the default risk. Even cash has risks, as BCCI depositors will confirm, and cash is also vulnerable to a rise in inflation.

The big retirement planning risk issue at the moment is property, in particular, residential property, whether in a pension wrapper or not. I do not have a strong view on whether house prices will collapse but I accept there is a real risk that they could. Against that background, it seems crazy for people to say that residential property is their whole pension. Often, they have financed their property with high levels of debt. Even if the chance of a major property market collapse in the next five years were as low as 10 per cent, such people might be betting their entire prosperity in old age on the risk equivalent of Aberdeen not beating Celtic at Celtic Park. Last month, Aberdeen won away at Celtic with a goal in the last minute.

A variant on this theme is the person who says: “My parents&#39 property is my pension.” This adds another dimension to the financial risk, namely, that something will happen before the transfer from the parent can take place. That something could, for example, be the cost of long-term care, the incidence of inheritance tax or the longevity of the parents being such that they need to release the equity to maintain their own living standards in retirement.

One of the biggest risks in retirement planning is that future Governments will change the rules. Past experience tells us that this risk is almost as certain to happen as death and taxes. Evaluating the risk is the hard part.

Perhaps the safest conclusion to draw from examining the political risk is that people who rely on future Governments to look after them in their old age are highly likely to condemn themselves to a poor retirement.

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