Pension providers should encourage young investors not just to make an active choice for their pension, but to take a little more risk.
More than three years have passed since George Osborne announced a raft of pension freedoms leaving us in charge of our own financial destinies for retirement. Now, a review by the Financial Conduct Authority, focusing on consumers who have not taken professional advice, has revealed how we’re getting to grips with our new opportunities and responsibilities.
The report makes distinctly uncomfortable reading for anyone who thought the pension freedoms regime would automatically transform people’s attitudes to their financial futures for the better. Interestingly, there’s little sign so far of profligacy – people are not taking out their money and blowing it on ‘treats’ or Lamborghinis. Instead, and perhaps with hindsight much more predictably, the report finds that too many people continue to take very little interest in the progress of their pensions until far too late in their working lives, and that this lackadaisical approach persists when they finally come to make use of their savings.
The majority of people simply start a drawdown plan with their existing provider rather than shopping around, and then in many cases make, or are ‘defaulted’ into, poor investment choices; a third of non-advised consumers have the whole pension pot sitting in cash.
The issue is fundamentally one of lack of engagement: people still see the P word as inherently scary, complex, opaque, beyond them – the province of others with years of experience. That’s an understandable perspective as far as final salary pension schemes are concerned; but those schemes will have less and less impact on retirement prospects in the future.
And the defined contribution pensions replacing them are very different beasts. Essentially, they are just long-term regular investment plans with generous tax relief. You put money into a stockmarket- based fund each month and leave it for a very, very long time. There’s little need for tinkering once it’s up and running (though that absolutely does not mean putting your pension plan in a drawer and forgetting about it for 20 years).
Cure for pension apathy
However, it’s really important to select a fund that is appropriate for the timescale involved. And it seems to me that is one of the biggest keys, over the long term, to the enduring problem of pension apathy.
Hargreaves Lansdown recently published a piece of research which reveals that those who actively choose which fund they will invest in are likely to end up very much better off than those who stay in the default pension option. It finds that the funds chosen by the investment decision-makers outperform those of the default investors by an average 4.75 per cent a year.
To put that in perspective, if you saved £50 a month for 40 years into a fund producing an annual return of 6.25 per cent, then (all else being equal) you would end up with a pot of £102,000. If you chose a fund that had an annual return of 10 per cent, your pot would be worth just shy of £280,000.
That’s a whole load of extra choice and freedom down the line, without having to make additional contributions or work extra years. All it requires is for young workers to be engaged and motivated enough from the outset of their pension journey to understand that while some parts of the stock market are inherently riskier than others, they are also inherently more rewarding over the long term – and that even small extra rewards build up over time to make an enormous difference to the final outcome.
As Nathan Long of Hargreaves observes: ‘Many people don’t think of themselves as investors, but as soon as you are put into a workplace pension, that is exactly what you become.’ Pension investors who make no active selection will see their savings go into a default fund. These are designed to be conservative, one-size-fits-all solutions, but most workplace pensions offer different choices for those willing to go to the effort of reading the paperwork.
‘People tend to choose their investments after their pot has built up a little or they have been a scheme member for several years, but you don’t have to wait; after all, it’s your money and the choices you make can massively boost your retirement prospects,’ adds Long.
I suspect there’s nothing like good performance to focus the attention: if your fund is growing meaningfully each year and you can see what that means for you way down the line, you’re more likely to remain engaged with it – and with investment more widely – and to take active interest in managing pension fund at later stages of your retirement journey.
Of course, there will be market traumas and shakeups along the way. But part of the process of engagement should be to underscore the fact that long-term regular investors are usually best off doing not very much in such situations. The beauty of monthly investing is that you’re automatically buying at the bottom of the market when shares are cheap – setting yourself up nicely for the recovery, when it happens.
So, with an eye to the latest generations now joining the workforce, I’d like to see pension providers challenging young investors not just to make an active choice for their pension, but to take a little more risk. It could make such a difference in the decades to come.