It’s been a challenging few months for pensions generally. State Pensions have been hit by the government’s recent suspension of the triple lock, and soaring inflation is creating a squeeze on the general cost of living. Added to that, stock market volatility is unsettling for people relying on private pensions to fund a comfortable retirement.
It may seem tempting to stop pension contributions until stock markets stabilise again. But Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown, strongly advises against this. She believes that “What goes down comes back up, and if you stick with it in tough times, you could actually benefit from the impact of short-term fluctuations.”
I’m going to look at the impact of past stock market crashes, together with the benefits of making pension contributions in a market downturn.
[top_pitch]
What can we learn from past stock market crashes?
A stock market crash is usually defined as a fall of 10% from its year high, over a matter of days or weeks. Some market commentators believe that there’s a natural stock market crash or ‘correction’ every seven to ten years.
To see whether that’s true, I’ve analysed the impact of the largest crashes in the last 40 years:
|
Event |
Fall in FTSE 100 (peak to trough) |
|
1987: Black Monday |
34% |
|
2000: Bursting of the dot-com bubble |
48% |
|
2007: Global financial crisis |
48% |
|
2020: Covid-19 pandemic |
32% |
These crashes look painful. However, in reality, the FTSE 100 returned to its previous high only two years after the Black Monday and Covid-19 pandemic crashes. It took longer for the other two crashes, although a significant proportion of losses were recovered in the subsequent three years.
How can stock market downturns affect your pension?
Hargreaves Lansdown analysed the impact of historic market downturns on someone retiring today aged 65. They assumed:
- A starting salary of £25,000 in 1978, with 2% annual wage growth
- 8% of salary invested in a pension between the ages of 22 and 65
- Annualised returns data for the FTSE 100
|
Period |
Notable events |
Value of pension pot (£) |
|
1977-1982 |
Early 80s recession |
13,695 |
|
1982-1987 |
Black Monday |
39,619 |
|
1987-1992 |
Early 90s recession & Black Wednesday |
102,520 |
|
1992-1997 |
Global stock market crash due to Asian crisis |
246,060 |
|
1997-2002 |
Bursting of the tech bubble & 9/11 |
220,636 |
|
2002-2007 |
Stock market downturn |
445,691 |
|
2007-2012 |
Global financial crisis |
506,212 |
|
2012-2017 |
Global sell-off & Brexit |
810,497 |
|
2017-2021 |
Covid pandemic |
918,621 |
This highlights the benefits of long-term pension contributions. Despite some major stock market crashes, this person would have accumulated a substantial pension pot of nearly £1 million at retirement.
[middle_pitch]
Why is a market crash a pension opportunity?
Pensions are a long-term investment by nature. Making a regular investment allows you to average out your purchase price. When the market falls, you’re able to buy more units with your money. As a result, you stand to make a larger gain when the market recovers.
Helen Morrissey from Hargreaves Lansdown also advises against reducing contributions in market downturns. She points to the risk that “If you reduce your contributions during difficult times, you don’t remember to increase them again, which can damage your pension prospects.”
Diversification can also help to shelter your pension pot from market downturns. Best Invest estimates that 95% of people are enrolled in a default workplace pension scheme. These are usually invested in a wide range of different assets to reduce the risk of one class underperforming.
If like me, you have a self-invested personal pension (SIPP), it’s worth looking at different asset classes to shelter your pension. Most of my SIPP is invested in funds and investment trusts rather than individual company shares. Our guide to SIPPs sets out the information you need to know about investing.
What else should you consider before investing in a pension?
If you’re considering making pension contributions, it’s worth bearing in mind the following:
- There are significant tax benefits from pension contributions, even for non-taxpayers. Taxpayers can get 20-45% tax relief on their contributions.
- Long-term pension contributions benefit from the power of compound growth. Our investment calculator shows that a monthly investment of £50 would grow to nearly £68,000 over 30 years (based on an 8% annual growth rate).
- Pensions can’t be accessed until retirement age. A stocks and shares ISA also allows you to benefit from investing over the long term. To help, our experts have compiled a list of our top-rated ISA providers.
Take away
It’s hard to predict whether there will be a stock market crash. However, UK stock markets have historically bounced back from these. Continuing to make pension contributions allows you to benefit from long-term growth, as well as a short-term reduction in your unit purchase price.
The content in this article is provided for information purposes only. It is not intended to be, nor does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
