This article poses three straightforward questions
- Do you know how your pension savings are invested?
- Should you care?
- If you did care, how would you go about choosing the right investments to suit you?
If you have pension schemes which are ‘Defined Contribution’/’Money Purchase’(*) schemes (these days most of us do) then these are considerations which could make a significant difference to the quality of your retirement – and to your peace of mind in the meantime.
(*) If you’re not sure whether you have these types of pensions, then the above article about consolidating your existing pensions will help explain.
Do you know how your pension savings are invested?
Planning for your retirement, when done right, isn’t a simple business. It involves a wide range of factors to be taken into account, each unique to you. Some of them you’ve probably already thought about: When am I aiming to retire, and how much income will I need? What have I saved so far, and what shall I continue saving? Will that be enough to last me?
But few of us give serious thought to how our pension savings are invested – and even fewer take an active role in managing those investments. An August 2020 article from This is Money  reveals some alarming insights: Only 31% of UK adults are aware that their pensions are invested in the stock market. Amongst those that were unaware, a significant proportion were concerned the funds were being used for ‘something nefarious’, or by their employers.
This, of course, isn’t anyone’s fault – we’re not taught about this in school, and it’s certainly not sufficiently- interesting that it comes up often in friendly conversations. But it should concern us – because apart from the equity we might hold in our houses, this is probably the largest set of assets we’ll ever own. We’ll spend most of our working lives building up these savings. They’re a crucial part of our future financial stability.
Should you care about how your pension funds are invested?
Yes, without hesitation. Even if, after inspection, you decide to take no action then at least you should be sure that your valuable pension savings are:
- Safely protected – from theft, fraud, or mis-investment.
- Invested into assets that you understand the nature of.
- Invested in assets which suit your ‘attitude to risk’.
- Invested in assets which suit your personal or ethical preferences.
- Invested and managed by someone that you can identify and trust.
- Visible, so that you can monitor their progress and investment performance over time.
We’ll elaborate on many of these topics in the next section. But before we do, let’s just consider the impacts which investment performance can have on your pension pot. Investment returns can never be guaranteed, and investment decisions must be made carefully. But in principle it is easy to illustrate the significance of investment returns on your pension savings. Consider for example that you contributed £500 per month into your pension for 30 years – £180,000 in total:
- Assuming consistent 2% annual growth, these funds would be worth £246,000 after those 30 years.
- If that growth was 5% instead of 2%, they’d be worth £416,000.
- At 8% growth they’d be worth £745,000 – 3 times the 2% outcome.
These figures are examples only and they are not guaranteed – they are not minimum and maximum amounts. What you get back depends on how your investment grows and the tax treatment of the investment. You could get back more or less than this. But that’s a big difference. So how are your pensions invested today? Your pension providers can tell you this, and it’ll also be set out in the Pension or Benefits
Statements which you should receive each year. Most commonly though, the answers will be:
- You selected an ‘investment fund’ yourself at the outset, and that’s still where you are (unless you’ve changed it yourself since).
- You accepted the scheme’s default ‘investment fund’ selection – and again you’re probably still in that same fund unless you’ve switched it.
- You’re in a ‘Lifestyling Profile’. This is an approach which scheme providers use to move you automatically between several ‘investment funds’ as you progress through your working life.
How do you go about choosing the right investments to suit you?
Before we go any further, let’s just explain what we mean by ‘funds’. Because even in the course of this article we could use that single word to mean two very different things. We’ve already used the word ‘funds’ to describe ‘money’ – ‘your pension funds’. But the finance industry also uses the word ‘funds’ to describe ‘investment funds’. Those are completely different to ‘money’ – and so when I mean ‘investment funds’ during this article, that’s specifically what I’ll call them.
Investopedia describes an investment fund as “a supply of capital belonging to numerous investors used to collectively purchase securities while each investor retains ownership and control of his own shares”. Not a perfect definition, but it’s a good start. Investment funds are run by fund managers, who carefully select a range of investments which that investment fund holds, on behalf of its individual investors. This is good because it gives regular investors access to the fund manager’s expertise. And it also allows those investors to spread their risk, via diversification: An investment fund may hold shares in a hundred different companies, for instance. If you had £100 to invest, it would be almost impossible to spread that £100 across a hundred companies. But investing the £100 in the investment fund immediately achieves exactly that outcome.
You’ll also have heard the word ‘Portfolio’ used in this context. Think of a portfolio as a basket of assorted investment assets – perhaps several different investment fund holdings along with other specific assets such as individual company shares, property, or commodities like gold.
Now that’s clear, let’s consider some of the factors which should be taken into account in choosing the right investment funds for you. You can use these to guide your own investment decisions, or you can obtain the services of an investment or financial adviser who’ll help you apply them and arrive at suitable choices:
Your Attitude to Risk:
Investments are not 100% safe – they always carry some risk. In principle it’s the act of accepting this risk for which the investor is being rewarded – via returns which are greater than basic interest rates. Generally, you should expect, over the long term, that a higher risk investment will yield a higher return but with greater volatility in the shorter term. A lower-risk investment meanwhile should offer lower long-term returns, but also with lower short-term volatility. Most people have an initial instinctive inclination towards either lower or higher risk. You should listen to that inner voice – but also consider challenging it. For example:
- Time horizon – pensions will often remain invested for several decades. If you know that you’re not going to access pension funds for this long, then in the immediate term you could select a higher risk position. The higher volatility isn’t going to affect you whilst you remain invested – you’ve got time to ‘ride it out. And you may get better long term returns as a result.
- Approaching retirement – if you adopted the above strategy, then as you approach retirement it may be time to make a change. To reduce the impact of volatility when you actually start drawing on pension funds, it could be a good move to switch your investments into lower-risk investment funds at that point.
- Your other assets, and ‘capacity for loss’ – if you have substantial cash savings in addition to your pensions, then you could use those to ride out any periods of adverse volatility in/at retirement. And so you might be able to tolerate a higher risk position as a result.
We touched on this earlier whilst explaining investment funds, let’s expand it a bit. A good investment fund will aim to mix together a wide range of different investments. For instance:
- Different asset classes, by which we mean equities/shares, corporate and Government bonds, cash, commercial property and so forth. The main driver for this is diversifying across the economic cycle. Bonds for example tend to perform better whilst equities are suffering during a recession.
- Different geographical and economic areas – UK, European, North American, Asia Pacific, emerging markets for example. This provides some diversification against localised economic or political trends. Similarly:
- Different currency zones – to diversify exchange rate risk.
Holding a portfolio which contains a blend of several different investment funds can also diversify the risk of being associated with a single fund manager or firm.
Personal & Ethical Preferences
Often now referred to as ‘ESG’ (Environmental, Social & Governance) or ‘SRI’ (Socially Responsible Investing), this is an area of ever-increasing importance to investors, fund managers, corporations and Governments. There are recognised standards to which fund managers can choose to subscribe, these are published and often used by investors in making selections. It’s a wide-reaching topic – but one to consider if you’re concerned about:
- The environmental responsibility taken by firms you might invest in.
- Avoiding investing in certain industries, such as armaments, tobacco, oil.
- Good corporate governance factors, like diversity and equality.
What to do next?
If you’d like to learn more, then you can contact Paul Mayhew, of Paul Mayhew Wealth Management, Associate Partner Practice of St. James’s Place Wealth Management. He’ll be pleased to help, with a no-obligation consultation:
tel: 07920 888284.
There are also a couple of associated articles in this series which you might find interesting:
Introduction to pensions for Limited Company owners.
- Should I consider consolidating my existing pensions?
The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select, and the value may therefore fall as well as rise. You may get back less than you invested.
The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.
St. James’s Place guarantees the suitability of the advice given by members of the St. James’s Place Partnership when recommending any of the wealth management products and services available from companies in the Group, more details of which are set out on the Group’s website at www.sjp.co.uk/products.
Paul Mayhew Wealth Management is an Appointed Representative of and represents only St. James’s Place Wealth Management plc (which is authorised and regulated by the Financial Conduct Authority) for the purpose of advising solely on the Group’s wealth management products and services, more details of which are set out on the Group’s website www.sjp.co.uk/products.
The ‘St. James’s Place Partnership’ and the titles ‘Partner’ and ‘Partner Practice’ are marketing terms used to describe St. James’s Place representatives.
Reference  – British workers have ‘no idea’ how their pensions work as only a third realise workplace schemes are invested in the stock market, Sarah Davidson for thisismoney.co.uk, 25/08/2020
Q: How is your pension invested? A: My pension is invested in the stock market: Answered by 22% of women, 40% of men, 31% all.