Most people understand the importance of saving into a pension but do not necessarily appreciate that it is also vital to know where and how these contributions are invested. Here, Natasha Etherton, a financial planner from Tilney, discusses what a default pension fund is, how they work and why it’s important that you know where your pension is invested.
Workplace pension scheme providers will automatically invest your contributions into a fund they have selected – a default pension fund. This fund might or might not be suitable for your personal circumstances and financial goals. Research suggests that 95% of people who have a defined contribution pension are invested in the plan’s default fund. Placing pension contributions into a default fund will keep your money invested in a fund that is not seen as particularly aggressive or risky while you decide if you want to invest your money elsewhere.
They can be a lower-cost choice for those people who choose not to have any involvement with the decision-making around their investments, and those who do not want to pay fees for professional financial advice.
If default pension funds were not available and you did not indicate where you wanted your money to go, your money would be held in cash and the growth rate on your contributions would be similar to a bank account. The growth rate on a default fund is usually higher than a cash account, so even if you stay within this fund, you are likely to see a better return on your savings. It is still important, however, to bear in mind that all investments carry an element of risk, so you could get back less money than you invest.
If you do not know where your pension is invested and keep it within a default fund, there could be a lasting impact on the amount of money you receive in your retirement.
A generic approach towards investments can be problematic when you have investors of all ages. The younger generation could miss out on significant growth if the level of risk applied to the default fund is too low for them personally, or for those who are closer to retirement, the fund might be too volatile.
By staying in a default fund that is not designed for your own specific needs, it is possible that you could lose out on a great deal of investment growth. If you do not check where your money is invested and pay into this fund throughout your career, when you come to retire you may find that your pension will not provide you with the amount of income that you need. Checking the suitability of your pension investments is not something that should be ignored.
The default funds contained within some older pensions tend to have a very narrow asset allocation and are usually UK-centric.
Therefore, some people’s pensions are wholly dependent on the UK stock market. Not only are they missing out on the growth offered by different global markets, but the lack of diversification could increase the volatility of their investment.
Multi-asset funds tend to be used as a default investment within newer pension schemes, which has led to greater diversification. It is, however, important to acknowledge that multi-asset funds may invest heavily in fixed interest assets and these may still not be entirely suited to your needs.
Every default fund is different, and each provider has different, and sometimes completely opposing, views on what is a good default investment option. It’s well known that every investment contained within a fund holds a degree of risk. This risk is measured by analysing historical performance, but this can vary, as it depends upon how far into the past a fund manager will look. There is no universally agreed upon time frame, meaning that how the level of risk is quantified is not uniform either.
In short, yes you can, but effective investment management requires specialist investment knowledge, dedication and a great deal of time. With busy careers and family life, many people are not in a position to make such decisions and end up keeping their pensions in the default fund.
Others seek help to make sure their investments are suitable for them. Unfortunately, pension providers cannot offer any guidance, but it’s worth checking with your employer to see if they work with a pension adviser who could help. If not, you could appoint a financial planner, who can look at your pension alongside the rest of your finances and personal circumstances to see where your pension should be invested. They may ask you questions like:
• At what age do you want to retire?
• When you retire, what do you want to do in life?
• Will your retirement be funded by just your pension, or do you have other savings and investments?
• How do you feel about taking risks with your investments?
• Would you like to leave your pension to your loved ones when you die?
Combined with their expertise, your answers can help them to see which investment fund or funds are most suitable for you. Often, this is not the default option. The financial planner will then liaise with your pension provider to make the changes and regularly review the choices to make sure that they continue to meet your needs.
Tilney offers a range of investment and financial planning services, and helps people make decisions about their pensions and retirement planning. If you’d like to discuss your options, book a free no-obligation consultation online.
Natasha Etherton is a financial planner from Tilney
Tilney Financial Planning Limited is authorised and regulated by the Financial Conduct Authority.
