The auto-enrolment phenomenon has created a new generation of pension savers. But the next decision these savers need to make is how best to invest that money for their future.
At the beginning of April, the minimum auto-enrolment contribution rose from 2% to 5%, with 3% from the employee and 2% from the employer. This means millions of workers are now saving for their retirement like never before.
But while the default pension fund your company’s pension provider uses is likely to be a well-balanced, low-risk option – typically made up of mixed assets such as bonds, cash and equities – they often leave little to the imagination when it comes to growth.
For example, my workplace pension provider Aviva’s default fund is its Aviva Diversified Assets I. This has grown 11.8% in the past three years. While this is inflation beating, it could be seen as an indifferent showing in the face of the potent recent bull market. Even just investing a pension fund in a global equity index tracking fund such as Vanguard LifeStrategy 100% Eq* would have netted a 26.35% three-year return.
So where your pension is invested makes a big difference to the value of your portfolio.
Let’s take an average UK salary of £28,000, for instance. With the new auto-enrolment rules, this means you would contribute £70 a month and your employer £47. According to a handy pension calculator from wealth manager Brewin Dolphin, a ‘very low-risk’ portfolio would expect to achieve around 3.8% annually. The average expected pot after 30 years for this would be £54,000, while a better-than-average performance would see this rise to £71,000.
Now, take a ‘high-risk strategy’ with an expected annual return of 8%. For the same investment, you could expect an average-performing pot to be worth £98,000 after 30 years, according to Brewin Dolphin, while a top-performing pot would potentially be worth £233,000. This difference is simply extraordinary.
If that doesn’t make the case for switching out of your pension’s default fund, I’m not sure what will. The evidence is clear that those who are proactive now should reap future rewards.
Despite that, according to research by Investec Click & Invest, over a quarter (27%) of people say they would not put their money into investments because they are worried about risk. Meanwhile, more than half (55%) view the investment industry as inherently “risky”. But the risk of a poor-quality retirement far outweighs these concerns.
I have taken my workplace pension out of the default Aviva fund and spread my monthly savings between a cheap tracker – BlackRock 50:50 Global Equity Index Tracker – and a managed fund, Artemis Global Growth. By holding both I feel I have diversified enough to limit overall risk, while still enjoying a high-growth strategy. As I’m young, I also feel I can take this equity risk and believe I don’t yet need to diversify across different asset classes. It’s worth noting that these funds were not my first choice, but the best that Aviva offered.
Another potent vehicle for saving is an Investment Isa. Just 8% of Brits say they’d put their money into one, despite the clear benefits of better rates of return over Cash Isas, tax-free growth and the magic of compounding (Albert Einstein’s eighth wonder of the world).
According to F&C Investment Trust, millennials save an average of £3,146.27 a year. If you put this month by month into an Investment Isa in funds such as Scottish Mortgage Trust* or Witan Investment Trust*, both with a global asset base, you would likely yield a big return over time. Scottish Mortgage Trust has grown an amazing 213.96% in five years, while Witan has grown 97.62%, and F&C Investment Trust 103.17%.**
Of course, investing should only ever be for the long term. If you need short-term money, cash is the best option as it’s not impacted by short-term stock market fluctuations. It’s also protected by the Financial Services Compensation Scheme.
Find out more about good investment funds and strategies by visiting the Moneywise First 50 Funds for beginner investors hub. *Denotes a Moneywise First 50 Fund for beginner investors. **Figures correct as of 1 May 2018.