In the wrong funds? One point in your life when you should definitely check

Clients have fed back to us that one aspect they value in our service is stopping them doing stupid things! A good sounding board, a well thought through financial plan and good fund due diligence can prevent investment in all sorts of scams or high risk investments that can quickly destroy hard earned wealth. At Cavendish Ware, we’ve ensured our clients have avoided the big mis-selling scandals that taint our industry.

In this context, it’s worth flagging a potential area of risk that may catch friends and family unaware.   As you approach pension age, many workplace pensions will automatically switch you into funds that have more bonds and less equity exposure.  The idea is to reduce risk as you move to needing to draw an income from your pension assets.  But as Lance has explained in many recent communications, bonds – particularly long dated bonds – through this year, and probably still today, carry significant risk.

Most people in a workplace pension are invested in what is called the ‘default fund’.  This is a fund that employer has decided is the best fit for for the average employee.  Whilst you are usually entitled to switch to other funds, few people do and the default is often a valid option as it will be a fairly low cost fund which will broadly allow you to participate in equity markets.  But in many schemes, those default funds will automatically switch you to a ‘lower risk’ fund with a higher allocation as you approach retirement.  The idea is that you want to reduce potential falls in the value of your pot as you move closer to the time when you would buy an annuity.

There are a couple of serious problems with this.  One more strategic and one more tactical.

Strategically, the concept of retirement at a set point in life is rather old fashioned.  There are more over 50’s in work than ever before and more businesses are set up by over 50’s than any other age group.   As a few of us can attest to, life doesn’t stop at 60!  So, a default approach doesn’t necessarily meet your needs.  With pension freedoms, there is also no need to buy an annuity.  With longer life spans you may want still have a longer time horizon and a more growth oriented portfolio may still be very appropriate.

The second problem is tactical.  As we have moved rapidly from the recent period of super low interest rates, then long term bonds have dropped in value with investors suffering capital losses.  Values of bonds which have fixed rate of returns move inversely to interest rates so as rates went up so bonds went down.  What is theoretically a low risk asset – long dated Government bond – has turned out be extremely volatile.  So pension scheme members who were automatically switched into ‘lower’ risk assets have seen significant drops in the value of their pension pots.

We can’t change what has happened over the last year.  But we’d strongly recommend that if you or any friends or family are in a workplace pensions and you are over fifty years old, then check the whether your default fund is a ‘lifestyle’ fund and if it is get some advice.  And don’t forget you may have some pensions kicking around still from employment earlier in your careers. If you are not sure how to check, then please do get in touch.