Personal finance: A spot of careful planning now can go a long way towards safeguarding your pension investments

By LORNA BLYTH
Published on Sunday 29 January 2012 00:00

THE rollercoaster ride endured by investment markets last year did little for confidence levels among pension savers.

Policy inaction from western governments over how to deal with the economic crisis shook investor confidence and led to sharp falls in equities. The result was considerable worry and pain for many savers trying to earn a decent return.

The biggest change that all investors are starting to appreciate is that the level of indices such as the FTSE All Share and Dow Jones is no longer determined solely by fundamentals such as asset type or company valuations. It also depends on the actions, or inactions, of policy makers.

It is this greater dependence on politicians and central bankers that has torn up the rule book and made the outcome much less certain. And if there is one thing that is guaranteed to upset the markets more than anything else, it is uncertainty. This explains the unprecedented high level of volatility that investment markets have been witnessing.

And, irrespective of how many European summits are held, or how much money is pumped into various economies, it doesn’t look as if we’ll be returning to a period of sustained economic growth any time soon. On that basis it’s likely that high volatility will continue.

So what does all this mean for someone investing money in a pension plan?

Clearly, sharp stock market falls can make people nervous about committing to long-term savings which they can’t access until they are at, or near, retirement. But if you want an income when you stop working, you need to save for it; and a pension is still one of the best, and most tax-efficient, ways to save.

This is particularly true if you are in a company pension plan because your employer will pay contributions which you wouldn’t otherwise get. Of course, the amount that is paid in is only one factor.

Others include the return you can achieve, the cost of administering your plan and the cost of any advice given. (If you are one of the fortunate people in a final salary pension scheme, your employer will meet these costs, and will also take responsibility for the risks associated with investment returns.)

The primary objective for any pension saver has to be to earn a return that is, on average, at least in line with inflation. This is because, over the longer term, inflation reduces the value of your money and can lead to lower standards of living in retirement.

So-called risk assets, such as company shares and direct property investments, offer better protection against inflation than others. So anyone looking to earn a return above inflation should consider including some of these assets in their pension plan.

It also makes sense to include other types of assets such as cash or bonds. By holding a broad spread of investments, if one investment performs relatively poorly the chances are that another one is performing better, so you won’t be as badly affected.

It all comes back to the adage about not putting all your eggs in one basket. And, regardless of the state of the market, the best way to safeguard against volatility is to have a diversified portfolio, with a range of different asset types and a range of different underlying investments.

And don’t forget that volatility can actually be a good thing if you are making regular payments into a pension plan. This may sound strange, but when markets fall, investments become cheaper, meaning your regular payment can buy more investments or units. This helps smooth out the effect of market falls over the longer term.

However, market volatility does become a real issue if you have only a short time left until you retire. And the effect can be dramatic. To deal with this issue most pension plans now offer a “lifestyling” option. This automatically moves your savings into less volatile assets as you get nearer to your planned retirement date.

This means you can benefit from higher-performing, riskier assets in the early stages of saving, when you can afford to take more risks. Then, as you approach retirement, your exposure to the stock market is reduced, building in protection for the gains you may have already accumulated, at the very time you are looking for stability and security.

In terms of the cost of a pension, most individual plans will have a standard charge of 1 per cent a year. This will usually allow you access to off-the-shelf investment options, such as those mentioned above.

Some more exotic investment options may also be available, but will typically be more expensive. Any extra costs should be disclosed up front so you know how much you are paying. And, depending on how much you have saved in your pension pot, you might qualify for a discount on the basic charge.

An important point to recognise is that large market falls can make good headlines. So while you often hear about how much the stock market has lost in a particular day’s trading, you very rarely get the same amount of coverage of how much the stock market has gained in a day.

But if you take the period between August and December last year, when market volatility was particularly high, the FTSE had its biggest fall on 17 August, when it lost 4.6 per cent, and had its biggest gain on 5 October, when it went up 4 per cent. Anyone who had sold out of the stock market after the drop in August would have missed out on the subsequent gain.

It’s worth remembering that a pension is a long-term investment. Its final value will take into account movements in the value of all your investments over the whole term of your saving.

Perhaps the best thing to do in the face of all the noise and uncertainty is to remember that, sooner or later, common sense will prevail and normal market service will be resumed.

• Lorna Blyth is investment marketing manager at Scottish Life

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