Where is my pension invested?
…probably in a default fund.
In my previous blog I discussed your workplace pension and how you were automatically enrolled. Each month you and your employer contribute to this pot of money, it is then invested. It is the fund manager’s job to decide where and how this money is invested.
So which fund are you in?
Well unless you’ve logged into your workplace pension and selected a different fund, your pension will currently be invested in the default fund. The default fund is designed to almost be a ‘one-size-fits all’ investment. It will take a medium amount of risk, and not factor in any ethical or religious views. For the majority of people, a default fund is perfectly adequate. However, it might not necessarily be the most suitable for you depending on your own views. For example, you might want to take more or less risk.
What is investment risk, and how do you know how much risk should you be taking?
Typically a Financial Adviser is paid to help you arrive at this decision using various risk questionnaires, their own experience and having in depth conversations with you. However, as this is just a quick intro to the world of personal finance, I’ll do my best to explain using the following scenario...
Imagine you come home from work and there,sat on the doormat waiting for you, is the annual statement for your workplace pension. Because you haven’t changed where you’re invested, you’ve been sat in the default fund. The only problem, is that it’s actually the year 2008. Cast your mind back to a time pre Coronavirus. There’s a new fella playing in the Student Union bar, his name is Ed something and we find ourselves in amidst of a global economic crisis.
Financial markets have tanked, Gordon Brown is our unelected PM and the Royal Bank of Scotland has just been bailed out by the taxpayer (which FYI was at the time the world’s biggest bank, and was quite literally hours away from running out of money had it not been for an emergency loan from the Bank of England). It’s fair to say that things were pretty bleak.
Anyway, last year (being 2007) when you got your statement, your pension was worth £10,000. This year, despite 12 months of contributions,it’s only worth £7,000. Now, do you:
a) ‘Hit the roof!’? You try and find out who on earth is responsible for this so you can demand your money back, only to be told that it’s all clearly explained in that 40 page brochure you received a few days after starting a new job . Apparently there’s a bit in there stating that investments can go down as well as up. Don’t recall? Well, this fall in value really annoys you and has now made you concerned about your future. As you go to bed that night, you lie awake thinking about how you’ve lost £3,000.
b) Open the letter and think well that’s a shame, maybe I should actually log in and see where my pension is invested? In the grand scheme of things 12 months isn’t that long compared to the 35 years it’s got to recover in value. I mean a loss isn’t a loss until you’ve cashed out right? You go to bed that night wondering when the new ‘line of duty’ series will air and how it will unfold. That thought keeps you up for a little bit longer.
c) Open the letter and think fantastic, what a great time to ‘up’ my contributions because I buy low and sell high and the market is looking really low at the moment? You go to bed that night and nothing keeps you up because you are a machine who eats numbers and spits out results!
So if option a) ‘rings a bell’, the likelihood is your attitude to risk is probably on the lower end of the spectrum.
We are actually hardwired to have a degree of loss aversion. An equivalent loss bears heavier than the joy you’d receive for the same gain. If you aren’t comfortable with significant falls in value, you might want to come down the risk scale and opt for a cautious fund rather than the default. Don’t forget ‘though that by taking less risk, the likelihood is your pension won’t grow as much in value over the long term. Never mind, you can get to sleep at night, and your heart won’t sink every time you watch the news.
You may sway towards option c).
You now see this as a great time to invest, you’re happy to ride that wave of uncertainty safe in the knowledge that if it all goes ‘belly up’, it doesn’t matter because you’re going to win the lottery next week. This would mean you have a higher attitude to risk! Adventurous funds will be 100% invested in shares, meaning that if the economy is going up, then so is your pension, but in a market downturn, like 2008 and with the recent Covid 19 pandemic, it could fall in value by 40%.
As a side note, if you consider yourself to be the next ‘Wolf of Wall Street’ because you once read the Sunday Times money page and will simply switch the investment fund depending on market conditions to get the best of both worlds; then good luck. I’m sure if it works out you’ll relish in annoying your family and friends with stories of how well you have performed. The likelihood however, is that you’ll be out of the market for the best days and in it for the worst. This called ‘timing the market’, and is like trying to catch a falling knife. You’ll usually end up cutting off your fingers.
Most of us will ask question b) and have a balanced attitude to risk.
You appreciate there is no reward without risk, but don’t want to be on a roller coaster of ups and downs. A balanced fund would typically have up to 85% of your money invested in shares, but also have property exposure as well as cash and fixed deposits. This creates a diversified portfolio for long term growth. In 2008, an investment fund with this exposure to risk still fell 29% in value.
So that’s a brief explanation of risk.
There are other considerations you might have when selecting which fund you want to be invested in.
For instance, each month you might sponsor a charity which provides water to an impoverished village in Africa, yet simultaneously and unknowingly, invest every single month, in a company with a Chief Exec who believes that water is a commodity and not a right. This would be through no fault of your own. A fund manager will look to create long-term growth by investing in companies who consistently turn a profit. Some of these companies may have a different mind-set or moral compass to your own.
If this is a concern of yours, then your workplace pension will offer an Ethical or Socially Responsible fund. Now, the terminology for this area of investing is an absolute minefield. The criteria of funds differs dramatically.
For instance, a multinational cosmetics and household goods company may be considered socially responsible and therefore sit within a lot of ethical funds. This is because they can demonstrate things like equal pay, improving their carbon footprint, have many foundations for charitable donations etc… These are all good things, unless of course they are a cosmetics company who like to test on animals and this is something you feel strongly against. Like I said, it’s a mine field.
A lot of us people care about these things, and it’s an area which is changing considerably to cater for changing needs. This is why I’ve got an entire blog on ethical investing which I will share with you at some point!
So I hope this has provided you with some ‘food for thought’ and will enable you to go and reflect a little further on your pension investment fund.
The most important thing for you to do is to engage with it, log in, have a look at what fund(s) you’re in, what choices you have. All the funds will have a factsheet which explains the objectives of the fund, you can then take it from there.
Again if you have any questions just send me an email.