Pension Investment: Choosing Wisely

Choosing the right investment options for your pension can be a tricky decision. It's important to understand how and where your pension fund is being invested by your pension provider, especially as you get closer to retirement. There are several factors to consider when deciding how to invest your pension, including the type of pension you have, your risk tolerance, your investment style, and the level of involvement you want in managing your investments.

The first step is to understand the different types of pension plans available, such as workplace pensions, personal pensions, and self-invested personal pensions (SIPPs). Each type of pension plan offers different investment options and levels of flexibility in choosing how your money is invested. For example, with a SIPP, you typically have more control over how your money is invested, while a workplace pension may offer a default investment fund.

Another important consideration is your risk tolerance. This will depend on factors such as your age, financial situation, and investment goals. Younger investors or those with a higher tolerance for risk may opt for a different portfolio of assets than someone closer to retirement who prefers a low-risk pension fund.

Your investment style, or how actively you want to manage your investments, is another factor to consider. You can choose between active funds, where a fund manager actively selects investments, and passive funds, which mirror the performance of a specific market index. Active funds typically have higher fees but aim to outperform the market, while passive funds are simpler and have lower costs.

Finally, you should also consider how involved you want to be in managing your investments. If you don't have the time or expertise to actively manage your investments, you may want to choose a ready-made option or seek the advice of a financial adviser.

Understanding your risk appetite

• Time Horizon: The length of your investment time horizon is a crucial factor in determining your risk appetite. If you are investing for the long term, you may be more comfortable taking on higher risks as you have more time to recover from potential losses. On the other hand, if you need quick access to your funds or are closer to retirement, you may have a lower risk appetite and prefer more stable and liquid investments.
• Comfort with Negative Returns: Your comfort level with negative returns or potential losses is an essential aspect of risk appetite. Some investors are comfortable with market volatility and the possibility of negative returns, while others may feel anxious about it. Understanding how you feel about potential losses can help you gauge your risk tolerance.
• Investment Experience: Your investment experience can also shape your risk appetite. Investors who have navigated market ups and downs may have a higher risk appetite as they have a better understanding of market dynamics. On the other hand, less experienced investors may prefer a more conservative approach.
• Investment Objectives: Be clear about your investment objectives. Are you investing for retirement, a holiday, or a deposit on a home? Different goals will influence your risk appetite. For example, if you are investing for retirement, you may have a longer time horizon and be more comfortable with higher risks.
• Income and Financial Capacity: Your income and financial capacity play a role in your risk appetite. If you have a higher disposable income, you may be more willing to take on riskier investments. Additionally, consider your financial capacity and stability. Diversifying your investments and having multiple sources of income can provide a buffer in case of losses.
• Risk-Return Trade-off: Understanding the relationship between risk and return is crucial. Higher-risk investments offer the potential for higher returns, but they also come with a greater chance of loss. Consider your comfort level with this trade-off and whether you prefer a more balanced approach.

To help determine your risk appetite, you can use tools such as risk profiler questionnaires or seek guidance from a financial adviser. By assessing your risk appetite, you can make well-informed investment decisions that align with your financial goals and tolerance for risk.

Diversifying your investments

• Different asset classes: Spread your investments across different asset classes such as stocks, bonds, property, and even alternative investments like commodities. For example, you could invest in company shares, bonds, cash, property and other assets across the globe, depending on the plan you choose.
• Different types of investments: Invest in a mix of different types of investments such as company shares, property and bonds. This is known as diversification and helps to protect against a particular investment falling in value.
• Alternative investments: Consider alternative investments such as tangible assets (e.g. art and wine) or financial assets (e.g. cryptocurrency and private equity). These fall outside the purview of traditional investments like cash, bonds and stocks, and can provide uncorrelated returns and portfolio diversification.
• Geographic regions: Invest in different geographic regions or countries to reduce the impact of market conditions in any one location.
• Risk profile: Choose investments that match your risk profile. If you have a low aptitude for risk, invest in lower-risk assets. If you have a high tolerance for risk, you can afford to invest in higher-risk assets for potentially higher returns. A balanced approach combines higher and lower-risk assets.
• Time horizon: Consider your investment time horizon. Younger investors can afford to take on more risk by investing in riskier assets like company shares, while older investors may want to shift towards more stable assets like bonds and cash as they approach retirement.
• Ethical and socially responsible investing: Some pension providers offer funds that focus on ethical, socially responsible or Sharia-compliant investments. These funds may appeal to investors who want their money to align with their values.

Diversification is a powerful tool for managing your pension investments. By spreading your money across various assets and investment types, you can balance risk, take advantage of opportunities across the market, and improve your chances of achieving consistent growth over the long term.

Choosing between active and passive funds

Active and passive funds are the two primary investment strategies for pension plans. The main difference between the two is that active funds are hands-on and fast-paced, while passive funds are laid-back and slow-paced.

Active funds involve a fund manager picking and choosing investments with the aim of outperforming the benchmark. Fund managers use their knowledge and expertise to adjust portfolios based on market trends, which could bring a higher return. However, active funds are usually more expensive due to the higher fees that active fund managers require. They can also carry a higher risk, as you are more exposed to market volatility and potential losses.

On the other hand, passive funds are a low-cost investment option that tracks the performance of market indices such as the FTSE 100. These funds are simpler and do not require you to pay a fund manager for research, trading costs, or analysis. Passive funds are more diversified, as they track a broad market index, and typically have a low annual management fee. However, they might have limited potential, as there isn't anyone overseeing them, and they may underperform their index once costs are taken into account.

The choice between active and passive funds depends on your goals, attitude to risk, and personal circumstances. If you are new to investing, passive investments could be a good way to start. However, it's important to remember that all investments have risks and potential losses, so seeking advice from a financial adviser is key when making decisions about your retirement strategy.

Selecting a financial adviser

• Know what type of advice you need: The key to finding the right financial adviser is understanding the type of advice you require. For example, are you looking for help with investing in a pension, navigating retirement, finding insurance or a mortgage, or simply keeping your finances on track? Knowing your specific needs will help you identify the right type of financial adviser.
• Personal recommendations and trusted sources: One way to find a financial adviser is through personal recommendations from friends or family. However, it can be challenging to judge their performance in the short term. Alternatively, you can seek recommendations from trusted sources such as unions, affinity groups, or your workplace pension scheme, if they have selected advisers they work with or recommend.
• Online services: There are online services available that can help you search for a financial adviser based on your location and specific needs. These include Unbiased, Vouchedfor, and the Personal Finance Society.
• Regulation and qualifications: In the UK, financial advisers are regulated by the Financial Conduct Authority (FCA). You can check if an adviser is registered with the FCA by searching for them in the Financial Services Register. Qualified financial advisers will have achieved minimum qualifications, and many will have additional certifications such as the Chartered Financial Planner or Certified Financial Planner qualifications. They may also hold specific qualifications related to their specialisation, such as long-term care, equity release, or pension transfers.
• Free initial consultation: Most financial advisers offer a free initial meeting or consultation. This provides an opportunity to understand their working methods and determine if you feel comfortable working with them. During this meeting, you can also ask to see their qualifications and certificates.
• Advice fees and charging methods: Financial advisers must be transparent about their fees and agree with you in advance on how they will be paid. Some advisers may offer a range of options for paying their fees. It is important to understand the cost structure before deciding to engage their services.
• Range of product providers: Consider choosing an adviser who can offer a wide range of product providers for the product they are recommending. This will ensure you get the broadest choice possible. However, the quality and suitability of the advice should be the primary factors in your decision-making process.
• Independent vs restricted advisers: Independent financial advisers (IFAs) can recommend all types of investment and pension products from across the market without restriction. Restricted advisers, on the other hand, may have limitations on the types of products they offer or the number of providers they work with. It is important to understand the type of service they offer and their level of independence before deciding.
• Specialist knowledge: If you have specific needs or requirements, look for advisers with specialist knowledge or qualifications in those areas. For example, if you are seeking advice on pension transfers, advisers with specific qualifications in this area will be better equipped to guide you.

Monitoring and reviewing investments

Monitoring and reviewing your pension investments is an important part of managing your pension. Here are some key considerations for monitoring and reviewing your investments:

• Frequency of reviews: While there are no specific requirements for how often you should review your pension investments, it is generally recommended to do so at least once a year. This can include checking your annual statement, which will provide information on the value of your pension pot and any associated charges. More comprehensive reviews can be conducted less frequently, such as once every three years.
• Performance review: Compare the actual portfolio returns against agreed-upon benchmarks or peer group indices. Look beyond the numbers to understand the nuances and drivers of performance. Consider if positive performance came at the expense of higher volatility and increased risk.
• Investment management fees: Understand the investment management fees you are paying and assess if they are reasonable and aligned with the active management and expected outperformance of your investments. Excessive fees can impact returns over the long term.
• Risk assessment: Evaluate the risk associated with your investments and ensure it aligns with your risk tolerance and investment goals. As you approach retirement, consider moving towards lower-risk options to minimise the impact of market swings on your portfolio.
• Diversification: Diversifying your investments across different types of assets, sectors, and geographic regions can help manage risk. Review your investment portfolio to ensure it is well-diversified and make adjustments as needed.
• Seek professional help: If you are unsure about your investment choices or need personalised advice, consider seeking help from a professional financial adviser. They can provide guidance and recommendations based on your individual circumstances and goals.
• Keep track of your pensions: It is important to keep track of your pensions, especially when changing jobs or moving homes. Ensure your contact information is up to date with your pension providers to avoid losing track of your pension pots.
• Consolidate pension pots: If you have multiple pension pots from different employers, consider consolidating them to make it easier to manage your investments and track their performance. This can also help uncover any forgotten or unclaimed savings.

Frequently asked questions