Pensions: Risks v Rewards
Most of us feel very uncomfortable when the words “risk” and “savings” are used together in the same sentence. But every pension fund — whether worth millions or billions — takes some risk with people’s contributions in order to maximise growth.
That is why financial advice will always come with warnings such as “the value of your investment may go down as well as up” or “past performance is not a reliable guide to future performance”.
There are no cast-iron guarantees when it comes to pensions, apart from the Public Sector where the cost is underwritten by the State. Private sector Defined Benefit (DB) schemes, once considered as close to a guarantee of a fixed retirement income as you could find, are now on the wane after several faced difficulty with underfunding and even insolvency.
When it comes to risk, there are numerous questions about your pension fund that you will need to discuss with a financial adviser. We have outlined a selection of the most common queries below.
Who manages my pension fund and how much do they charge?
Life insurance and investment companies are the main providers of pension plans in Ireland. They employ fund managers to grow your pension pot. Some of the best known funds include Zurich Life, Standard Life Investments and Davy Asset Management.
Most funds invest in a mix of assets. These might include shares, bonds, property and so on. A default fund is an investment option used in most DC schemes and PRSAs where a person has not chosen to get involved in how their fund is invested.
The value of your fund will be reduced by any fees and charges you have to pay. Passive management and active management have very different costs so seek expert advice to ensure you are not being overcharged.
What is a typical return on investment?
Investments go up and down in value but what’s important to understand is how your pension fund is performing over the long term. In recent years, some pension funds in Ireland have delivered returns as high as 10% but remember, investments can also fall in value. Sometimes this happens suddenly and by a large amount (for example, during the 2008 economic crash).
Your pension fund is a long-term investment, ideally for 30 years or more. This should allow enough time for it to recover growth if it falls in value. As a general rule, the longer you keep your contributions invested, the more likely it is for those contributions to grow in value.
What is meant by a “real return”?
Pension funds have to outperform inflation (ie; rises in the cost of living) for what’s called a “real return”. This means that if an investment achieves an absolute return of 8% and inflation is 4%, then its “real return” is 4%.
Please explain growth versus risk?
There is a correlation between higher risk funds and higher returns. But you have to be comfortable with that level of risk.
For example, the difference between achieving a 6% return per year with a higher risk fund and a 4% return per year in a medium risk fund across 35 years may result in a massive 50% difference in the size of your pension pot upon retirement.
How should my funds be managed?
A financial adviser is best placed to advise you on which funds offer the most growth with the least risk. You may be able to split your pension savings between low-risk, medium-risk and high-risk investment funds.
One of the main factors to consider when it comes to fund management is how near you are to retirement. A high risk approach might be fine in your 30s, when you have plenty of time to claw back losses. But if you are 10 years or less away from retirement, it makes sense to adopt a more prudent approach.
You will want to reduce your risk exposure to help protect the value of your pension fund. Someone less than two years away from retirement might, for example, opt to move their fund into cash and/or a Government bond. A financial adviser can outline your options.