Thanks to the introduction of Auto Enrolment (AE) back in 2012, most people employed are automatically enrolled into a workplace Defined Contribution (DC) pension plan.
But have you ever asked yourself, or even considered where are my monthly contributions invested. Where do my contributions actually go, after they are deducted from my salary ?
Well this blog, will provide some key information about what actually happens to your hard earned invested contributions.
What level of contributions do I normally invest ?
Thanks to the introduction of Auto enrolment back in 2018, effective in the UK at present. The minimum that any individual will invest is 8%, whereby you may contribute 4%, your employer will contribute 3%. and the government will add tax-relief of 1% (hence 8% in total). Some employer’s and companies will pay in a higher % figure, as some kind of benefit incentive to attract staff to join them. But 8% at present, is the minimum level according to current pension law.
Most individuals will be automatically enrolled into a DC pension, selected by the employer. you can choose to opt out if you wish, it isn’t compulsory to contribute to a workplace pension. But it can be seen as free money from your employer, and it could be seen as a very tax efficient way of savings towards retirement through salary sacrifice if you do make contributions. As it will lower the amount of income tax payable by you.
Ask yourself, can you afford to make minimum contributions, what are the benefits of doing so ?
The aim of the pension is to give you an income in later years when you are in retirement.
How are they deducted and passed onto my pension provider ?
Your employer will simply deduct contributions automatically on your behalf through their payroll system, just like income tax and NI is taken.
Then will then invest the funds on a set date with the respective pension provider and then allocated into every members individual pension plan.
There is nothing for an individual to do, once it is set-up its done a monthly automated basis, you can just switch off. Contributions are then automatically allocated and invested on your behalf.
But where do my contributions actually go ?
Your pension provider will offer you a range of funds and investments, normally linked to your age, risk profile or attitude to investment risk. They may be somewhat basic, such as a default fund or lifestyle fund. But when it comes to investing, the vast majority of people are uncomfortable picking their own funds as they have never done it before. So people normally pick simple funds on offer by your pension provider, as the idea of investing is outside of most people’s comfort zone. It’s something that we don’t teach so it’s alien for the majority.
Unless you have made your pension arrangements and have set up a SIPP (self-employed personal Plan), whereby you can then pick your funds, stocks, investments etc. But this will normally relate to seasoned investors who are happy making their own investment decisions.
So what is a default fund ?
A default fund, or default investment option, is the investment strategy automatically used for a pension if the member does not choose a different option. It’s designed to be a “one-size-fits-all” approach for people unsure about investment choices or who prefer a hands-off approach.
What is pension lifestyling ?
Lifestyling in pensions is a type of investment strategy where your pension savings are automatically switched to more stable, low-risk investments as you approach your retirement age. This is done to protect your pension pot from market fluctuations and potential losses in the years leading up to retirement. So are you get nearer to retirement, your funds are supposedly becoming less riskier. The last thing you need I the later years, just prior to access is for your fund values to be like a rollercoaster, suffering dips ahead of accessing.
So what types of investments do pension funds invest in ?
The common form of investments are:
- Stocks – stakes held in public listed companies
- Government bonds / GILTS
- Corporate bonds
- Commodities
These forms of investments could be held solely in UK, but mostly they will he held across numerous countries as part of a so-called global portfolio.
At present, it is believed that UK pension funds are holding around 6% of its assets in UK listed stocks and companies. Around 70% is invested overseas predominately USA based at that makes up the largest % of the total market index cap. The proportion of assets invested in the UK has been reducing in recent years, hence reason why the current Labour government is trying to takes steps to incentive workplace pensions to invest greater sums into the UK. Which can hopefully promote and provide some well needed stimulus to the UK economy.
What is a stock ?
Stocks or shares as they are known are the same thing in principle. Whereby it refers to owing a slice or portion of a listed company on the open market. Companies issue shares so investors will put money into that money in the hope of a return on their initial investment. Through investment growth and also the opportunity to receive a dividend paid from the profits as some kind of reward.
These are known as “Equity” investments, and your pension provider will invest large sums around numerous stocks to own a small portion of these must-million dollar companies.
Shares are simply a portion of the company ownership and total value. The price will fluctuate on a daily basis according to short term market sentiment. Hopefully by holding these types of assets over numerous years over the long term, they will grow in value and so will your holding within your pension plan.
In the UK, larger companies will form part of an index such as the FTSE 100. In the USA they will form part of an index such as the S&P 500, according to their total market value.
What is a bond ?
Bonds are basically loans given by customers or depositors to a certain company. In exchange for receiving fixed level of interest on the initial investment. The amount will then be repaid in full on an agreed date in future. They can also be known as fixed-term investments.
The level of interest paid is normally determined at the outset, at an agreed rate of return. They aim to provide moderate rate of investment return in return for a certain level of security.
They can be seen as safer and a more secure asset class. In the form of corporate or government issue. Government issued bonds will also be known as GILTS, and they will be issued by the UK government to raise funds.
With regard to corporate bonds, these will normally pay a higher rate to attract investors towards buying them. They will then be rated accordingly to their credit worthiness of the issuing company. Whereas government bonds will pay a lower rate of return as they are considered less riskier and more stable.
A pension provider will invest in gilts and bonds to provide security, and enable to have a more secure, stable and less riskier portfolio. Unlike company shares and stocks which can appear more volatile on a daily basis.
What are commodities ?
They are global resources which can be used in everyday life. They can appear to be very volitive in the short term, as the price is usually controlled by supply and demand. So what sorts of assets fit into this type of asset class:
- precious metals – gold, silver, platinum, palladium etc.
- natural resources – Brent crude oil, natural gas, coal, power.
- Agricultural or food – coffee, grains and wheat, soya, cocoa.
There price can also be affected by external factors, such as droughts, weather extremes, floods etc. Which could have a dramatic effect of short term supply and their price. But thankfully these types of assets will normally only form a small part of any pension fund portfolio.
What about ethical investing !
Does your pension provider offers funds and products that align with your investing beliefs. Are you investing in companies, corporate organisations or sectors that you are trying to avoid, such as tobacco, oil & gas, fossil fuels etc.
Are you passionate about sustainable investing, renewables, and more environmentally friendly companies. So does your investment options available meet your objectives and values.
What about diversification !
A pension product or personal plan is considered one of the most tax-efficient investment products currently available in the UK at present. Whereby it is known as a collective pool of assets, held by all of the members. It will try and eliminate some of the investment risk due to the size or scale of the respective fund. Along with the fact that a number of individuals will all be investing within a specific fund.
By investing in a simple workplace DC pension fund, you don’t have to do any research, investment analysis, or switch funds on a regular basis. You can just switch off and automate your investments as contributions are invested each month on your behalf. By doing this method, your provider will invest across a number of different assets based on your risk profile and selected investment strategy.
So you don’t have all your investment eggs in any one basket of assets. So if a certain type of investment underperforms in any given scenario. It will hopefully be a short term issue and won’t have a detrimental effect on your portfolio valuation.
As we all know know you will have good years of over performance and some years on underperformance. But remember pensions, should be seen as along time investment. If may well be that you are start contributing in your early 20’s but you are unable to access until the minimal UK pension age (MPA) age 55. Although this will increase to age 57 in April 2028.
One final thing of note:
Learn to get actively involved in your pension pot, what are the fees and charges, investment opportunities available to you. How are you selected funds performing, do they make money each year or are they constantly losing money. If your pot is relatively small is it being eaten away by fees and charges.
So when you log into your account, or look at your annual statement, try and learn to understand what the figures mean. Most people suffer from inertia, the statement gets files away and you may say that’s only applicable many years down the road.
The saying states ” that nobody should more about your investments that you”, so get actively involved in them. You may not look at the price or valuation each day, but review your funds and plans on an annual basis. or when your personal or financial circumstances change.
If you have numerous pots or dormant accounts,
- could it be an idea to consolidate and review your funds and allocations to simply admin
- Are you paying numerous sets of fees across several providers.
- Has your attitude to investment risk changed in recent years.
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