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Your pension might be the most important investment you ever make. Your retirement plan should help you achieve your goals and maintain financial security in your later years. Pensions are more flexible than they have ever been, and can provide lump sums, variable income or even a legacy for your family.
It’s vital to choose the right investment options for your pension given how central it’s likely to be to your retirement plan. But depending on your pension scheme, you could have several thousand investments to choose from. Where should you start?
Investment Options for Your Pension
In theory, pensions can invest in just about anything. This is, of course subject to HMRC rules and the rules of the scheme.
Most pensions will invest in funds. These, in turn, invest in different asset classes behind the scenes, for example:
- Equities, or shares
- Bonds, or fixed interest securities
Single Asset Funds
Many funds will invest in one particular asset class, or even a subsection of that asset class, for example UK Equities or Global Bonds. The different asset classes have varying levels of risk, with equities being the most volatile (but with the highest growth potential), and cash being the most stable.
A multi-asset fund invests in various different asset classes with the aim of creating a diverse portfolio within a single fund. This is a simple and effective option for many investors, as the heavy lifting of asset allocation, stock selection, and rebalancing is done behind the scenes. Most pension plans will offer at least one multi-asset fund.
Many pensions, particularly those offered by an insurance company or through an employer, will include a Lifestyle fund. This type of fund aims to hold higher risk investments in the earlier years, transitioning into lower risk assets as you approach retirement. This strategy is most effective if you have a fixed retirement date in mind. It may not be suitable if you plan to leave the majority of your pension fund invested after you retire, or if the higher volatility in the earlier years makes you nervous.
The investment choices available will depend on the type of pension you have. The main types of pension and investment choices are summarised as follows:
- Workplace pension – these are available through your employer and are usually simple to operate with low charges. Most workplace schemes offer a limited selection of funds to make it easier for employees (who may not be active investors) to manage their pensions. This will often include a Lifestyle option.
- Stakeholder Pensions – these are usually available through insurance companies and will offer a range of funds across different asset classes. Most of the funds will be managed by the pension provider, although newer plans in particular may also offer a few options from external managers.
- Personal Pensions – this is an all-encompassing term. A personal pension from an insurance company may offer a few hundred funds. A platform-based personal pension could offer several thousand. Some might even offer shares or other direct investments.
- Self-Invested Personal Pensions (SIPPs) – a SIPP can invest in any permissible asset available in the market. This could include:
- Funds from the UK and abroad
- Shares or other direct securities
- Platform or stockbroking accounts
- Discretionary investment portfolios which are managed on your behalf
- Private Equity
- Commercial Property
In recent years, the lines between Personal Pensions and SIPPs have blurred. A flexible, platform-based personal pension can normally invest in many of the same assets as a SIPP, with only a few niche exceptions (such as physical property).
Of course, with greater choice comes greater responsibility. It might seem like a good idea to use your SIPP to invest in overseas property projects or unregulated funds, but these can lead to heavy losses with little recourse to get your money back.
With so many investment options, it’s important to plan carefully.
What Do You Want to Achieve?
As with any plan, you should start with the end point. How would you like your retirement to look? For example:
- Do you envision a fixed retirement date and value a regular, guaranteed income?
- Do you see yourself spending more in the earlier years of your retirement while you travel and enjoy life?
- Or are you happy with a frugal existence, but are mindful of the potential need to pay for care later in life?
- Will you need a lump sum, for example to clear your mortgage or help family?
- Is it possible that you won’t need access to your pension fund and that its main purpose will be to provide for your family?
A detailed cashflow plan can allow you work out where your pension should fit into your retirement plans. This, in turn, can help inform the investment strategy.
Your Life Stage
The most suitable investment strategy will also depend on where you are in your retirement planning journey. A young professional starting a pension for the first time will have different investment needs from a multi-millionaire approaching retirement.
There are no fixed rules for this, but as a rough guide:
- In the early years, you can take more risks with your investments as they have time to recover from any volatility. Regular contributions benefit from pound-cost averaging, which means even a falling market can benefit you (as you can buy more shares at lower prices). Choose a wide range of assets (for example within a multi-asset fund) and keep an eye on costs.
- As your fund grows, you may want to seek out a wider range of investments to ensure that your money isn’t over-concentrated in one place.
- A business owner or sophisticated investor might wish to use their pension to invest in more specialised assets such as physical property or private equity. This normally requires a substantial fund. These options are usually only suitable as part of a diverse portfolio, due to higher risks and limited liquidity.
- As you approach retirement, it may be appropriate to reduce risk and even set aside some of your fund in cash to provide you with an income. At this point the investment strategy will depend on whether you wish to buy an annuity, in which case, reducing risk to avoid losses is paramount. However, more retirees are opting for drawdown these days, which means taking an income from the fund while the majority remains invested. In this situation it’s rarely appropriate to move the whole fund into cash.
- Alternatively, you might find that your other investments can provide you with a comfortable retirement, and that you may never need to draw on your pension. As pensions can be passed on in the event of death, some investors find it more efficient to use their pension as an estate planning tool. In this situation, there is little reason to ‘de-risk’ the fund in later years as it’s more important to maintain growth potential.
A good financial plan can help you make these decisions and adapt to your changing circumstances.
There are four main components to deciding on a risk level for your pension:
- How much risk can you cope with on an emotional basis? Do fluctuations make you nervous or are you happy to let the market take its course?
- What level of return do you require? If your goals depend on your pension fund achieving growth of 5% per year, a balanced, moderate risk portfolio is probably the right choice for you. A cash fund would be unlikely to achieve your goal, but you don’t need to take substantial risks with the aim of achieving high returns.
- How much can you afford to lose? If you are twenty years from retirement, a loss probably won’t impact your retirement plans too much. You will have plenty of time for your funds to recover, or even to make small adjustments to your contribution rate if necessary. On the other hand, if you are retiring next year and are reliant on your pension fund, a loss could derail your whole retirement plan.
- How experienced an investor are you? While this does not directly affect your risk level, it’s important to only invest if you understand the nature of the fund and what you expect it to do for you. An experienced investor may cope better with ups and downs because they have seen it all before.
5 Key Rules for Investing
When choosing your investment strategy, there are five main principles to keep in mind:
- Always diversify. Holding a wide selection of assets avoids concentrating risk while ensuring that you can benefit from market growth.
- Keep costs under control. Every additional 0.1% in charges will reduce your eventual retirement fund. Always be clear on what you are paying for and that it delivers value for money.
- Investing is for the long term. The longer the timescale until retirement, the more risk you can afford to take.
Stick with the plan. Tweaking the investment strategy continually or trying to time the market can result in expensive mistakes. A good investment strategy works in all weathers.
- Avoid bias. It’s natural to want to make investment decisions based on worry or the desire to make more money. But it’s important to remain objective and follow the evidence. Seeking advice and outsourcing your daily investment decisions can help with this.
If any of the subject matter in this article concerns your own financial plan, then our team would love the chance to have a conversation with you to see how we can help. Book a free call with a member of our team today, without obligation. We look forward to speaking with you.