How Does Investment Performance Affect my Pension?
How Does Investment Performance Affect my Pension?
It is important to begin thinking about a pension scheme at a relatively early age. In fact, most financial advisers believe that those as young as 30 years old should already have some type of scheme in place. After all, retirement portfolios that exist for longer periods of time will naturally provide a greater sense of security when you finally approach the age of retirement. There are several different approaches to choose and each is associated with its own set of benefits. One of the most popular and reliable is an investment-backed pension plan. Sometimes referred to as a “pension account or pension scheme”, their main role is to accrue more money over time than would be possible when dealing with a retirement scheme that provides a set return or outcome. Let’s take a quick look at the basic principles behind investment-backed pension before examining how performance will ultimately determine the level of portfolio size that you can expect to enjoy in the future.
How Does a Typical Pension Fund Work?
The basic role of an investment-backed pension is to provide you with an additional return based off of underlying assets. While you might choose the types of elements within this portfolio, they are often determined by a pension planner or a wealth management specialist. However, it is important to point out that you are not necessarily taking a “punt” in regards to turning a profit. These investments are instead intended to provide you with a long-term source of growth; often measured in decades as opposed to months. This is why the associated asset classes tend to fall into the conservative category. Some examples include:
- Corporate Bonds
- Government Treasuries
- Funds (Active and Passive)
- Commercial Property
Funds are especially popular due to the fact that they are more diversified than an investment focusing upon a single share (i.e. BP, Barclays, Google or Apple). So, you will normally be able to enjoy a more predictable rate of return alongside more long-term stability.
Another popular option is known as a “lifestyle fund”. In this case, the contents of your portfolio will be shifted on occasion in order to ensure that you are involved with assets that pose less risk. This is often handled by an adviser, so it is a relatively “hands-off” strategy from the perspective of the client. While you can always choose to manage your own investments, we need to emphasise that risks can and will occur on occasion. This brings us to the main point of the article. How does the underlying performance of your portfolio impact the value of the pension?
One recent study found that only nine per cent of all pensions in the United Kingdom generated a return in 2018. At first glance, you may be tempted to save your money beneath the mattress in order to avoid such stagnant situations. However, what about other issues such as inflation? When we talk about the relationship between investment performance and pensions, we need to embrace a long-term perspective. This is partially determined by when you finally plan to retire.
Considering the fact that the majority of individuals will own a pension for decades at a time, historical data should be highlighted. The longitudinal growth of most pensions far outpaced any short-term losses. To put it simply, they typically perform well over time. This is why one-off observations and short-term volatility are normally not used to predict performance over the years.
We should likewise point out that pension portfolios will also be affected by a number of other variables which could be entirely out of your control. Examples include the state of the global economy, decisions made by central banks and socioeconomic crises. This is once again why it is better to avoid gauging performance in snapshots; it is nearly impossible to see the big picture with such an approach.
A Look at Volatility
It is impossible to mention pension performance without looking at volatility in general. There are many times when you or your employer will make regular contributions to these plans. However, a very volatile economic climate (such as a global recession) might cause you to curtail such contributions. This is often counterproductive due to the fact that contributions may provide you with tax benefits now or in the future. Such benefits will help to moderate the level of volatility that you are currently experiencing. In the simplest of terms, it is normally wise to continue contributing when saving towards a retirement plan.
Volatility can also rear its ugly head if you happen to be retiring well before the markets begin to recover from a downturn. This is very similar to choosing to sell equity positions when it is low before allowing its value to rise once again. The only difference is that you might not necessarily have a choice if you have reached the age of retirement. This is why it is a good idea to speak with your financial adviser in order to better determine how its performance has been affected as well as to discover if there are any ways to mitigate your losses.
Taking Charges into Account
The average pension fees within the United Kingdom equate to 1.47 per cent. While this might not seem like much, it can certainly add up over time. Although some believe that higher charges equate to higher returns, this is often not the case. Be sure to perform a fair amount of research in order to determine the most cost-effective plans so that you will be able to enjoy a higher return on investment (ROI) over time.
Understanding the basic principles of pension performance is critical; regardless of when you may eventually retire. As this can be somewhat complicated depending upon the scheme, it is always wise to seek the advice of a trained professional before making a final decision.
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Blog published by Mike Coady.
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