Most people invest their savings in funds managed by professional and highly experienced investment managers. But with thousands of funds available, choosing the right ones can seem daunting.
There are several potential solutions to this problem, depending on how much you want to be involved and how much risk you want to take. This article outlines the options you’ll have.
You could use the default funds in your workplace pension
Since 2012, the law has required all employers to automatically enrol employees into a workplace pension scheme. Every scheme must offer a default investment option.
What is a default fund?
It’s a way of investing for your retirement where you don’t have to choose your investments. The default option does the work for you, placing your money in suitable funds depending on how close you are to retirement. It places your money in funds that aim to grow your pension savings in the earlier stages of your retirement journey. Your investment moves into less risky funds as you get closer to retirement.
Most employees go into the default option precisely because it makes investing their pension money easy. It’s designed as a ‘best fit’ for everyone who joins the pension scheme. This is because they must cover a wide range of people – different ages, different retirement goals, different ideas on how they want to take their pension.
Although new joiners of workplace pension schemes go into one particular default fund, in most workplace pension schemes, you do have choices. If the default fund doesn’t match how much risk you’re prepared to take for a potential reward, you might want to think about moving your money to another fund.
Regardless of the type of investment solution, the value of investments can go down as well as up and you could get back less than invested.
You could pick a ready-made portfolio
With ready-made investment portfolios, you decide how much risk you want to take with your savings and investments, then leave the investment experts to do the rest. Once they know the level of risk you’re comfortable with, they place your savings in a portfolio of investment funds matching your risk tolerance. Ready-made portfolios of funds are available on most online investment platforms.
Ready-made portfolios focus on your attitude to risk – in other words, how much volatility you’re prepared to accept.
Generally speaking, the more risk you take, the better the potential return you will get from your investments. However, it doesn’t always work out like that – you might need to invest over a long period of time to build up your returns, which might mean you retire later than planned. If the thought of losing 25% f your retirement savings in one year gives you nightmares, choosing a portfolio of medium to high risk funds or higher risk funds probably isn’t for you.
Even if you do have a high tolerance for risk, taking too much risk as you approach retirement could cause problems later on. You could end up in a situation where a fall in the value of your investments means you can’t afford to pay the bills during your retirement – and nobody wants that.
On the other hand, if you have other savings you don’t need to access immediately, you may be able to take more risk. So, you could adopt a different attitude towards risk and volatility to achieve what you want, depending on the saving pots you’ve earmarked for different life goals.
Investments are usually split into grades, ranging from low to high. Below, you can see the types of investments that may be suitable for someone happy to take the type of risk described in these five examples:
- Risk level low – Low risk investments usually aim to give returns similar to those you would typically get from deposit and savings accounts. There may still be a risk that the value of your investment could fall.
- Risk level low to medium – These investments are expected to provide better long-term returns than savings accounts. These funds typically invest in high quality corporate and government bonds. There is still a risk the value of your investment could fall.
- Risk level medium – These investments have the potential for better long-term returns than lower risk funds, but there’s always a risk the value of your investment could fall. This generally invests in a spread of assets, including shares, commercial property, and corporate bonds issued by companies with a low credit rating and a higher risk of being unable to repay the money they’ve borrowed
- Risk level medium to high – Funds in this category usually invest in shares (also known as 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 go up and down significantly but offer the potential for good returns over the long term.
- Risk level high – Funds in this category usually invest in higher risk sectors such as funds investing in companies based in emerging markets or specific themes, such as new start-up companies. These investments offer the greatest potential for long-term returns. However, they also have the highest price fluctuations and a bigger risk of losing money. The investment managers monitor the investment portfolios matching your choices and constantly readjust them to make sure they stay within your chosen risk tolerance.
You could use selected or preferred fund ranges
You can choose the investment funds your pension money goes into yourself. With a selected or preferred fund range, experts whittle down the huge fund range available to a more manageable set of options.
Your workplace pension may offer a selected or preferred fund range – usually between 20 and 40 funds – chosen by your trustees, your employer’s adviser or the managers of the pension scheme.
The fund ranges selected usually cover the key asset classes:
- Equities – both UK and international
- Fixed income, including government bonds and corporate bonds
- Money market investments or cash
For many people, choosing from this limited range is much more manageable than trying to pick from 2,000 or more options. In addition, you know investment experts have chosen these funds. However, there is no guarantee the funds in selected or preferred fund ranges will turn out to be the ones that best meet your goals.
These lists are constantly reviewed by the experts who create them, so if you’re using this method of picking funds, you need to keep up to date with the list.
The full choice
If you’re confident about investments, you may prefer to do your own research on the whole range of 2,000 plus funds available. You can also mix and match, choosing some funds on your own and some from the selected range.
And, in addition to funds, you can also choose to invest directly in underlying investments such as individual company shares, government and company bonds and so on.
The choice is yours…
You can be as hands-on or as hands-off with your pension investments as you want to be. But whether you choose the default option or pick your own funds, the most important thing is to keep an eye on your pension and how it’s doing.
After all, the money in our pension will help you have the retirement you want, so it makes sense to check on it regularly.