Retirement: How to meet challenge of walking fine line
Workers can balance pension funds to their risk profile but most choose a default option, which could cost a fall in their returns, writes Jeff Salway
PENSIONS savers are leaving themselves at risk of losses or income shortfalls in retirement by rejecting the chance of a say in how their money is invested, experts have warned.
Millions of workers ploughing thousands of pounds a year into their company pensions are in the dark as to how their contributions are being invested for them, according to new research from Standard Life.
Almost 90 per cent of people in company pension funds tick the default option when they join the scheme, the Edinburgh-based insurer revealed.
In other words, rather than decide what kind of fund they want their contributions to be invested in – high or low risk, equities or bonds, UK or global – most settle for what all too often turns out to be an unhappy compromise.
In reality, only a minority of workers will feel comfortable making their own fund choices.
However, the range of investments available to workplace pension savers has widened dramatically in recent years, with the choice now greater than ever.
That reflects a rapid growth in the number of people in “defined contribution” (DC) pension schemes, where the outcome is largely dependent on the amount paid in and the performance of the funds in which their money is invested.
Bob Hair, head of financial planning at Turcan Connell, said: “With the decline of final salary schemes, most individuals lucky enough to have access to a pension scheme will have a number of choices open, providing flexibility for those who wish to make investment decisions themselves through their employer or personal pensions, and a default option for those who don’t.”
Yet 88 per cent of savers in these pensions do not know the funds in which their contributions are invested – and on which their retirement plans may depend.
Despite that, half claimed their investments accurately reflected their attitude to risk.
Yet while companies take investment advice in selecting the default fund or funds for their pension scheme, those funds are inherently unlikely to be suitable for every member, pointed out Steven Dunn, head of pensions at Anderson Strathern.
“Many employees receive little or no financial advice beyond an explanation of the choice of funds available. It is unsurprising that studies suggest default funds are frequently chosen by employees who are uncomfortable with making investment decisions or unfamiliar with the different investment classes.”
But most default funds fail to match the needs of savers in terms of their risk profile and asset allocation, Cass Business School warned last year. It said that companies would be jeopardising their employees’ retirement prospects unless they improved the quality of default funds.
So if you opted for the default fund when starting out with your company pension, how can you find out if it is the best choice for you?
It is worth going through this with a financial adviser, if you have one. If you have not, start by digging out some paperwork. The literature your employer or pension provider has sent you should include details of the funds they invest your money in. If it does not, call and ask for that information.
Many employers will also have websites where you can access in-depth details of your pension, including its current value, where it is invested, how it is performing, how much you’re paying for it and other information. The list of funds your money goes into may allow you to click through for further details, including its risk classification, top holdings, asset split and performance.
If you are worried your money is going into funds that put you at risk of losses, or, conversely, that could mean your fund is not growing as quickly as you’d like, check how much is invested in shares.
There are significant differences in the amount that default funds invest in equities, with some keeping market exposure to a minimum while others a wholly invested in equities.
The kind of shares in which it invests is relevant, too. While emerging markets, such as China, offer perhaps the best chance of good long-term growth, some pension savers may prefer to see more familiar holdings, such as UK income funds and investment trusts.
Over the long run, this affects not only the risk of incurring losses, but it can make a huge difference to the amount of growth your contributions can achieve.
By selecting the “easy option” of the default fund you run a distinct risk of your pension investments failing to match your expectations, said Dunn.
“Cautious investors may find that the default fund operates with an exposure to risk far greater than they would have chosen for themselves; older investors may find their fund has no exposure to equities and that they have missed out on potential investment growth.”
One detail to take an interest in as you approach retirement is whether your default fund has a mechanism to reduce the risk to which you’re exposed.
The most common approach is what’s called a lifestyling option.
“Typically those with five or more years to go before their selected retirement age will have a fund which will use equities as the main investment asset class, and this will be phased into government bonds and/or cash as they get closer to the relevant date,” said Hair.
The idea is to ensure you don’t suffer losses if the market plunges as you’re on the countdown to retirement – a point at which you may have too little time to recover those losses.
However, this might not be suitable for everyone, according to Dunn.
“Individuals, of course, have different views on the level of investment risk they are prepared to accept and at different stages in their lives they may value investment growth over security or vice versa,” he said.
For all the pitfalls, however, the default option isn’t necessarily a bad thing, especially for those in need of guidance but reluctant to take it directly.
But with so much potentially riding on the performance of the funds in which your savings are being invested, advice could be the smartest outlay of the lot, particularly if you’d like to make changes to your pension investments.
“The important thing is to regularly review how much risk you are comfortable taking and if your investments are on track for retirement, to make sure you are still investing in the right range of funds,” said Ann Flynn at Standard Life.
“That’s why, like many financial decisions, it is worth seeking professional advice.”
• Visit www.unbiased.co.uk to find an independent financial adviser near you
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