By John Lawson
There are several potential solutions to this problem, depending on how much you want to be involved.
Default funds in workplace pensions
Since 2012, all employers automatically began putting employees into a pension scheme, and workplace pension funds have been required to have a default option. Most employees don’t actively choose their investments. Because they have to cover such a wide range of people, default options need to be designed as a ‘best fit’ for everyone who joins the pension scheme.
Although new joiners of workplace pension schemes are defaulted into one particular fund, in most workplace pension schemes, the employee will have choices. If the default fund does not match your risk and return ambitions, consider switching to another fund or portfolio.
With all the solutions the value of investments can go down as well as up and you could get back less than invested.
In the case of ready-made investment portfolios, once you’ve decided how much risk you want to take with your savings and investments, you leave investment experts to do the rest. They will place your savings into a portfolio of investment funds that match the risk tolerance that you are comfortable with. Ready-made portfolios of funds are available on most online investment platforms.
People who save and invest via investment platforms are typically using individual savings accounts (ISAs) for flexible saving, and self-invested personal pensions (SIPPs) as a means of saving for retirement. They might also use their SIPP as a home for consolidating their existing pension pots, or to draw income or capital in retirement.
Ready-made portfolios focus on the saver’s or investor’s ‘attitude to risk’. In simple terms, attitude to risk is how much volatility you are prepared to accept.
Generally speaking, the more risk and volatility you take, potential the better the return you will get on your investments. However, it doesn’t always work out like that –you might need to invest over a long period for it to happen. If the thought of your retirement savings falling 20% or more in one year would give you nightmares, choosing a portfolio of funds with a medium-high or high-risk outlook probably isn’t for you.
Even if you do have a high tolerance for risk, taking excessive risks as you approach retirement may be a bad idea if a fall in the value of your investments means you can’t afford to pay the bills.
On the other hand, if you have other savings you don’t have any immediate need to access, you may be able to afford to take more risk with them. So, you could adopt a different attitude towards risk and volatility for different savings pots that are earmarked for different life goals.
Investments are usually split into anywhere between three and ten grades ranging from low to high. The following table shows the types of investments that may be suitable for a person with risk tolerance in each category on a one to five scale. Similar tables are widely available, but bear in mind these may differ from each other, so regard the following as a rough guide:
Risk level low
Low risk investments usually aim to provide returns similar to those you would get from deposit and savings accounts, although there may still a risk that the value of your investment could fall.Risk level low to medium
Risk level low to medium
Investments that are expected to provide better long-term returns than savings accounts. These funds typically invest in high quality corporate and government bonds, although there is still a risk the value of your investment could fall.
Risk level medium
Investments that have the potential for better long-term returns than lower risk funds, although there’s a risk the value of your investment could fall. Generally invests in a diversified mix of assets including shares and commercial property and in lower quality corporate bonds issued by companies that have a higher risk of defaulting.
Risk level medium to high
Shares (equity) of larger and well-established companies. For example, shares of companies listed on the UK main market or other major stock markets. Fund prices may fluctuate significantly but offer the potential for good returns over the long term.
Risk level high
Higher risk sectors. For example, emerging market shares or specific themes, such as new start-up companies. These investments offer the greatest potential for long-term returns, but the highest prices fluctuations and risk of losing money.
The investment portfolios that match your choices are constantly readjusted to ensure that they stay within your chosen risk tolerance.
Selected or preferred fund ranges
Selected or preferred fund ranges are designed for savers and investors who want to pick the actual investment funds that their savings and investments go into, but who want some help in whittling down the huge choice available to a more manageable set of options.
Select or preferred fund ranges are provided via workplace pensions, where the trustees, employers’ adviser or managers of the pension scheme will typically make 20 to 40 funds visible to the scheme members.
A similar service is also offered to people who save or invest via investment shops in ISAs and SIPPs. Online investment platforms tend to use their own investment experts to present a range of funds that they think have the best chance of delivering against their goals, using detailed screening criteria.
To maintain an impartial approach, some providers that have their own in-house investment funds choose not to include these funds in the selection process.
The selected fund ranges are usually divided into their separate asset class ‘sectors’ such as UK Equity Growth, European Equity Income, UK Fixed Interest, Property, and so on. There are usually only a few funds in each sector. Across all sectors, the total number of funds usually ranges from around 40 to 150.
For some people, choosing from this limited range is much more manageable than trying to pick from 2,000 or more options. In addition, savers using this method know the funds have been screened by investment experts. However, there is no guarantee that the funds appearing in selected or preferred ranges will turn out to be the ones that best meet their goals.
These lists are constantly revised by the experts who curate them, so savers and investors using this method of picking funds need to keep up to date with the list.
The full choice
People who are confident about investments may prefer to do their own research on the whole range of 2,000 plus funds available. They might also choose to mix and match, choosing some funds on their own and some funds from the selected range.
And, in addition to funds, people taking the full choice route can also invest directly in the underlying investments such as individual company shares, government and company loans and so on.