Just because a stakeholder pension is low-cost does not mean that it will make a good investment. In fact, the most important pension choice you have to make is this: how will my pension pot be invested?
Compare stakeholder pension best buys hereStakeholder pensions can be invested in a variety of different ways. For example , some use with-profits funds or trackers to create investment performance. However, the majority rely on large pooled investment funds made up of shares and/or bonds and possibly some commercial property.
Most
stakeholder plans only offer a limited range of investment funds to choose from but it is still worth thinking about which of the available options is best for you. If you don’t do this, the pension firm will just put your contributions into its ‘default’ fund. Default funds vary widely from pure equity funds, mixed funds of bonds and shares, tracker funds and with-profits funds. These funds may not perform as well, or suit your circumstances as well as other funds on offer.
More risk should mean a higher potential return Which types of investments are in your pension pot are important because they produce very different investment performances. Which asset mix is right for you partly depends on your attitude to risk, and partly on how long you are investing for. Equity-dominated investment funds will generally be more volatile in value and so are generally considered to be higher risk than, say, funds primarily invested in bonds.
However, the longer your money will be invested for, the more risk you can – and should – accept. This is because more volatile investments like shares and equity-linked investments have historically produced higher returns in the long-term than less volatile ones like bonds.
The younger you are… the more aggressive you can afford to be In general, if you have ten years or more to go before you retire then your pension should be almost entirely invested in shares or equity-linked funds. As you get closer to retirement, you will probably want to become more defensive by moving more of your money into bond funds. When you get to within about three years of retirement you should begin to move your pension pot into cash.
Many providers offer a
lifestyle option ; this is when they automatically begin to transfer your pension pot into more defensive investments like bonds as you approach retirement. Eventually, they will transfer you entirely into cash so that you do not suffer any sudden losses in value very near your retirement date.
With-profits funds : These funds also offer a mix of assets, but, as your return is calculated as an annual ‘bonus’ averaged over the long-term, it may not reflect the true gains (or losses) in your investment. With profits funds operate by smoothing the investment returns that you receive over time. In good years the investment provider will pay a reduced bonus so that, when times are bad, they can pay out a higher bonus to policyholders.
Where many with-profits funds got it wrong recently was to pay out too much in the good years and to underestimate the effects and length of the bad times. This left them unable to meet their commitments to policyholders, and led to the well-publicised problems of recent years. With profits funds are still a viable concept, but the new type of with-profits fund available through stakeholder pensions is likely to produce lower returns than the traditional with-profits plan, leaving equity funds as the natural choice for the longer term and managed/lifestyle funds as the appropriate choice for more cautious investors.
Check our
Stakeholder Pension Plan Best Buys for the best available of the different types.
