Pension investing

Money in a pension is invested to help it grow, so it will go further. Most modern pension schemes are ‘defined contribution’ or DC pensions, where you build up a pot of money by paying contributions (and if it’s a workplace pension, your employer pays money in too). This money is invested to help it grow over your working life so you can get more income when you retire.

So you’ll probably find yourself asked to choose investments, which is where a lot of people get scared. How does investing work? Read on and we’ll help you understand.

(If you’re in a ‘defined benefit’ or ‘final salary’ pension the money’s still invested, but the trustees who look after the pension are responsible for managing this. The amount of pension you get is set out in the rules, so how the investments perform doesn’t affect how much pension you get.)

Isn’t investment risky?

Yes, but so is life. You take a risk every time you switch on a light, get in the car, or go out of doors when it looks like rain. The difference is, you understand these risks and how to manage them. So you call an electrician to check the circuits; you follow the Highway Code when you’re driving (and get the car MOT’d); you put on a raincoat and take an umbrella with you.

It’s the same with investment. Once you understand what the risks are and how to manage them, you’ve got a good start.

Different kinds of investment risk

Most people think of investment risk as the risk your money can lose value quickly – as in the investment warning ‘the value of your investments can go down as well as up, and you may not get back all the money you invested.’

But that’s not the only kind of investment risk. There’s also the risk that over time, the ‘real’ value of your money can be eaten away by inflation – especially at the moment, when inflation is higher than it has been for years.

There’s also a risk from putting too much of your money in one place, such as one type of investment or one part of the world. Just because something’s done well in the past doesn’t mean it always will in future. If you’ve put all your money in one place and it does badly, all your money is affected. This is why investment experts recommend spreading your investments around – for example, using a lot of different types of investment and investing in various parts of the world. Doing this is known as ‘diversification’. The idea is that different areas tend to do well and badly at different times, so it smooths out the risk.

So where are pensions invested?

A good way to think about investment risk is to also think about the kind of growth – or reward – you get from the investment. For example, investments that have a high risk of falling in value suddenly are usually the ones that grow the most over a long time.

Shares in companies are a good example. The FTSE 100 (which represents the top 100 companies on the London Stock Exchange) may go up and down like a yo-yo, but if you look at the trend over 10-15 years or longer, it’s up. So a good way to avoid your money being eaten by inflation is to use higher-risk investments – but only if you’ve got at least 10 years to invest in.

What about low-risk investments that don’t grow much, like cash? The reward from these investments is that they keep their face value – at least in the short term. So if you’ve got money you want to protect from sudden falls in value, such as savings you’re about to use for pension income, you might put it into low-risk investments for the reward of stable value.

How is pension investing different?

Pensions are invested over a long time – lifetimes, in fact. So successful pension investment aims to balance the different kinds of risk at different times.

While you’ve got 20-30 years to go before you retire, you’re likely to want your money to grow as much as possible, so you may be happy with higher-risk investments that are more likely to grow over the long term.

When you get close to retiring and want to lock in the value your investments have built up, you probably want to choose lower-risk investments that will protect your money from falling in value just before you’re due to start taking pension income.

How do I find out about my pension investments?

Ask your pension provider. If you’ve never asked about investment before it’s likely you’re in your provider’s default option – the one you go into if you haven’t made another choice.

All pension providers must have a default option designed to be suitable for most people. They’re usually set up to balance investment risks and rewards over your lifetime in the way we’ve described, by using ‘growth’ investments over most of your working life, then automatically moving your money to ‘protection’ investments as you get closer to retiring. You may see this called ‘lifestyling or ‘lifecycle’.

Investment, retirement age and timing

If you’re in one of these ‘lifestyling’ arrangements, it’s important to keep tabs on the age you plan to retire, and make sure it matches up with the retirement age your provider has on file for you. This is usually called something like your ‘target’ or ‘planned’ retirement age. Don’t assume it’s 60 or 65. Many providers now use your State Pension age unless you’ve told them something else, and this may not be the age you plan to retire at.

It’s important because the timing of moving your money from growth to protection investments is based on your retirement age. Leave your money in growth investments too close to the date you retire, and you risk it falling in value just when you’re about to use it for pension income. Move it too early and you could miss out on investment growth.

What about ethical investment?

There’s a whole other article in this, so here’s a summary.

Ethical investment isn’t new, but it’s developing fast and becoming mainstream. People are increasingly interested in whether their money is doing good in the world – helping to combat climate change, for example. Lots of people want to avoid investing in things like fossil fuels or weapons manufacture, and prefer to invest in things like renewable energy and sustainable transport.

There’s still a lot of debate about what exactly ethical investment is, and whether investing ethically can give lower or higher investment returns than traditional investment. We expect to see a lot of development in this area over the next few years.

Can we help you?

Baffled about pensions? Not sure what the best thing is to do? Ask us for help. We love helping people get the best out of their money.

Here are a few of the reasons you might want to give us a go.

• The personal touch. We go out of our way to understand you, your life situation, and what you want.
• We really know our stuff. We’ve got over 50 years’ experience of helping people plan and achieve the retirement they want.
• We’re completely independent and unbiased. 
• Your first consultation is on us.

We can help you plan the retirement you want, so you can get on with enjoying life without having to worry about money – now or in the future.