Monthly Archives

May 2021

May 27
2
Senior man sitting at table with laptop planning finances

The advantages and disadvantages of lifestyle pension funds

By | Pensions

Within many pension schemes, default investment strategies now employ a process known as lifestyling, which claims to do the hard work of managing your pension assets for you as you get closer to retirement. However, adopting such lifestyle approach may well not be suitable for everyone.

 

What is a lifestyle pension strategy?

Lifestyle strategies are designed to effectively ‘lock in’ the investment growth built up in your retirement pot as you get closer to your designated retirement date. A lifestyle pension will start by investing a larger proportion of your retirement pot in equities, which offer the best potential for growth, with higher levels of risk. As you get older, and closer to your retirement date (typically 5-10 years before retirement), your pension will automatically start switching into lower-risk holdings, such as cash and bonds. The aim is that when you retire, and want to begin drawing your retirement benefits, you have a pot that is invested largely in a mix of cash and bonds and is less exposed to stock market volatility.

Pension providers like to talk about lifestyle strategies as offering a ‘glide path’, and there is a very good reason for doing it this way. After all, the last thing anyone just days from retirement would want to happen is to learn that stock markets have crashed, and a huge amount of their pension has suddenly been wiped out. A lifestyle pension takes away this risk because the pension has already been moving away from higher-risk assets into more low-risk investments over a number of years.

 

What are some of the advantages/disadvantages?

In theory, lifestyle pension strategies are a good idea, and certainly provide more certainty to individuals who do not wish to make investment decisions within their pension funds. That being said, lifestyle pension strategies still have a few drawbacks that anyone with a company pension would do well to be aware of.

 

Times have changed

Perhaps the biggest irony with lifestyle pensions is that they do not quite fit with the lives of today’s retirees. Retirement needs have changed considerably in the last few years. Some people are now choosing to retire later, either because they need to keep working or they don’t want to retire just yet. Others may want to reduce hours prior to retirement and begin taking pension income a little earlier.

Also, lifestyle pensions were introduced back when it was compulsory for UK retirees to purchase an annuity in exchange for a guaranteed pension income for the rest of their life. But since compulsory annuities were scrapped back in 2015, it’s no longer a requirement to have a large pot of cash ready to buy an annuity when you hit retirement age. In recent years, using income drawdown has become a more effective way of receiving an income during retirement, as this avoids locking into the low annuity rates that we have currently.

 

Lifestyle strategies may not deliver the retirement flexibility you need

Another important factor associated with lifestyle pensions is their relative rigidity. When you start your lifestyle pension, you are expected to name your retirement date. Lifestyle pensions will focus on ‘growth assets’ in your early and middle years and, based on your ‘glide path’, will phase-in less volatile investments as your retirement date approaches. However, the timing of this shift from risky to less risky assets can make a huge difference to the overall size of the pension pot.

If your pension starts switching someone out of equities on your 45th birthday, because you told your company you planned to retire at 55, you could be missing out on a decade or more of investment growth, seriously limiting the final value of your retirement pot.

 

Switching from equities to bonds may not be the best investment strategy

Although owners of lifestyle pensions have done very well in investment terms over the last decade, this has been partly due to the strong performance of bond markets. This may not necessarily be the case over the next decade. The problem with a lifestyle pension is that it will make the switch based on the retirement date, rather than the conditions within investment markets at the time. At a time when everyone in retirement wants their money to go further, giving up ten years of investment growth may not be the right decision.

 

One size does not fit all

Lifestyle pensions became the default choice for company pensions because they offered a very straightforward method of pension planning – build up a pension pot and then purchase an annuity once you retire. But once you take annuities out of the equation, and make the retirement date a moving target, the simplicity of the lifestyle approach becomes less of a solution and much more of a problem. Based on the current economic climate and modern retirement patterns, there is an even stronger case to be made for keeping pension pots invested in growth assets well into retirement, choosing instead to take income via drawdown.

 

Have a conversation about your pension

If you have a company pension invested in a lifestyle pension strategy, it might be a good idea to discuss the details with us. We can ‘look under the bonnet’ of your current pension, and can help to determine whether it is set up to support your retirement plans. You only get to retire once, and an overly cautious investment strategy can be just as dangerous as an overly risky one. So, let us help make sure your lifestyle pension is really capable of delivering the lifestyle you want.

 

If you are interested in discussing pension arrangements with one of our experienced financial planners at FAS, please get in touch here.

 

This content is for information purposes only. It does not constitute investment advice or financial advice. 

May 20
1
Young woman at table with laptop and documents reviewing her finances

The two big benefits of starting a pension early

By | Pensions

If you have people in your life who don’t feel it’s worth putting money into a pension, you might show this article to them to help change their minds. It could prove an invaluable piece of advice in years to come.

 

Back in February, research by Royal London revealed that within the millennial age range (18-34-year-olds) two in five respondents had stopped or reduced their pension contributions following the coronavirus pandemic. A similar survey published by unbiased.co.uk also reported 24 per cent of under-35s said they had no pension savings at all. That’s a worrying trend, as it means that many young people are avoiding paying into pensions precisely at the time when making contributions can make all the difference to their eventual retirement pot.

 

Why are young people out of the pensions loop?

It had been expected that the UK government’s workplace auto-enrolment scheme would make sure that the majority of young people would start paying into a pension of sorts. But after a year when many young people’s jobs and lives have faced upheaval because of the coronavirus pandemic, it seems that a large proportion are outside of this safety net. Perhaps the rise in ‘gig economy’ jobs, as well as self-employment, is behind the lack of workplace pension take-up among the millennial age range.

Of course, pensions are always a tough sell with 18-34 year-olds anyway. Encouraging people to start up their own self-invested personal pension may seem a low priority when money is tight and they are still paying off student debts, have bills to pay, and want to spend any surplus money enjoying themselves.

But there’s no getting around the fact that the very best time to start a pension is when you are young. And there are two main reasons why: compound interest and tax reliefs.

 

Compound interest

There’s a quote that’s often attributed to Albert Einstein that “Compound interest is the eighth wonder of the world”. Now, Einstein may not have actually said this, but whoever did say it might have been onto something.

Compound interest simply means that once you start paying into your pension, you don’t just earn interest on your savings, but the interest starts earning interest too. Think about compound interest like a snowball. The longer the snowball rolls downhill, the bigger it gets. This means that even small pension contributions could have a meaningful impact over time.

 

The effect of compound interest on your pension pot

Consider two pension savers, Susan and Phil. Susan started putting money into her pension when she was just 20, investing £50 a month. Phil waited until he was 40, but began investing £100 a month.

Assuming an average annual interest rate of 4% (and assuming both keep paying in the same amount every year), by the time Phil reaches 60, his pension pot will have grown to just over £36,500. But by the time Susan reaches the same age, her pension will be worth almost £60,000. Even though both Susan and Phil will have invested the same amount over time, Susan will end up with almost twice as much, thanks to the power of compound interest. Eighth wonder indeed!

 

Taking advantage of tax relief

While compound growth is one of the biggest benefits of starting a pension as early as possible, another valuable incentive is tax relief on pension contributions. When you make a payment into a pension, the government makes an additional contribution that effectively repays your tax at the rate you usually pay. In other words, the government will actually pay money into your pension – that’s how important it is to have an income during retirement!

 

The effect of pension tax relief over time

Returning to our previous example – with Susan benefiting from a much larger pension pot than Phil – the advantages are even greater when you factor in tax relief on pension payments.

Each time Susan pays £50 into her pension, her pension pot increases by £62.50. As a basic rate taxpayer, Susan pays tax at 20%, and her pension contributions are paid into her pension as if they have never been taxed. So, after taking into account the available tax relief on Susan’s pension contributions, she is looked at a retirement pot available at age 60 of closer to £72,800.

And what about Phil? Well, for the sake of this example, let’s assume Phil pays income tax at the higher rate of 40%. This means that each of his £100 pension payments are adjusted to become £166. However, despite this, Phil’s pension pot will still end up behind Susan’s, at around £60,600.

What this example demonstrates is that a person with a relatively modest income, who only pays a small amount into their pension, and receiving half as much tax relief, can still end up with a significant retirement pot, just by starting their pension sooner. So, if you have family members who don’t think they earn enough to pay into a pension at their age, this might persuade them otherwise. You might also want to remind them that even if they can only afford small pension payments now, they can always increase the size of their contributions later, as their income increases.

The twin drivers of pension growth – compound interest and tax relief – are really too good for anyone to ignore, and they certainly make a convincing case for putting any doubts about pensions aside. According to the old Chinese proverb: “The best time to plant a tree was 20 years’ ago. The second-best time is now”. The same applies to pensions.

 

If you are interested in discussing pension arrangements with one of our experienced financial planners at FAS, please get in touch here.

 

This content is for information purposes only. It does not constitute investment advice or financial advice.

May 13
2
stock market background

Index funds are useful, but they shouldn’t dominate your investment portfolio

By | Investments

Ever since index tracking funds overtook active funds in popularity with UK investors more than two decades ago, there has been a continuous debate over which approach is better. But while index funds are an essential investment tool, we don’t believe they should be replacing active funds just yet.

 

What is an index fund?

As the name suggests, an index fund is an investment created with one objective in mind – to track the performance of an index. An index fund is also known as a passive investment because there are no active investment decisions to be made. For example, a FTSE 100 index tracking fund will feature the same 100 companies as are listed at any given time on the FTSE 100 index. Should the companies featured in the FTSE 100 change, so too will the companies featured in the index fund.

 

Why choose an index fund?

There are several reasons why it makes sense to invest in an index fund. Firstly, an index fund is a relatively inexpensive way for an investor to gain exposure to a particular asset class or market. Because there are no fund manager salaries to pay, the cost of owning an index fund is considerably less expensive than the management fees you would expect to pay for owning an actively managed fund.

Second, an index fund will invariably cost less in transaction charges. While an active fund manager is free to buy and sell investments as often as they think is suitable for their portfolio, an index tracking fund will only buy and sell when index constituents are reshuffled (as an example, the companies in the FTSE 100 are reviewed every quarter to determine whether they still merit a place in the index).

Finally, investing in an index fund is a good way to invest if you plan on staying invested for the long term, or if you don’t want to keep actively monitoring your investments regularly. You can simply buy shares in the index fund and hold them for as long as you choose to.

 

What are the disadvantages of index funds?

While index funds definitely have their advantages, there are some important disadvantages that investors should also be aware of.

 

Underperformance

The first is that index funds – by their very nature – will only ever deliver an underperformance. That’s because passive investments are not designed to beat the performance of the market they focus on, they can only track it. And, when you add in the cost of investing in an index fund, this means it will always fall slightly short of the market’s returns once those fees are paid. The advantage of an active manager is that their goal is to outperform the market they invest in, by making decisions – but of course, attempting to achieve greater rewards carries greater risk too.

 

Lack of protection during the bad times

If you’re invested in an index fund, your investment is heavily dependent on the fortunes of the market your fund is invested in. While stock markets have proven to be a good investment over the long term (by this we mean at least ten years), they can be much more volatile over shorter periods. Investing in an index fund means that your investment will do well when the market is doing well, but will invariably suffer when markets are facing difficult conditions.

 

Lack of choice or control over the investments you hold

An index fund is a ready-built portfolio featuring all of the constituents of a particular market or index. So, if you own a FTSE 100 index fund, this means you own a small percentage in 100 different companies. You have no control over the companies you ‘own’, and you do not get a say on whether you believe those companies are in line with your personal principles or not (tobacco companies, oil companies, or weapons manufacturers, for example). The components of any index fund are effectively out of your hands.

 

Lack of flexibility

Another point worth mentioning is that investing in an index removes the opportunity for ‘advantageous behaviour’ or what is known as “buy low, sell high”. The downside of owning an index fund is that if a stock within the index becomes overvalued, it starts to carry more weight within the index, and your fund will be forced to purchase more of it, at the higher price. So, even if you have a personal view that a particular stock is overvalued or undervalued, by investing solely through an index fund, you do not have the ability to act on that knowledge, and nor can a fund manager do so on your behalf.

Here is an interesting example of how index investments can sometimes work against investors. When Tesla was admitted into the S&P 500 index in November 2020, within a matter of weeks it had already overtaken Facebook to become the fifth-largest company in the index. Once it gained entry into the S&P 500 index, every S&P 500 Index tracker automatically had to include Tesla as a new constituent, and this ‘forced buying’ helped to propel the Tesla share price upwards.

Why is this important? Well, Tesla had been close to gaining entry to the S&P 500 previously, meaning that many active fund managers made big profits by owning Tesla shares bought in advance knowing that once it entered the S&P 500, index tracking funds would have to start buying the shares at inflated prices. In the case of a company like Tesla, active fund managers had the maneuverability to make a smart rational decision, and this left them able to make a profit at the expense of index funds and, ultimately, their investors.

 

Overview

The debate over whether active or passive funds offer the best value for investors will no doubt rumble on. But investors do not need to see it is a decision to adopt either one approach or the other. A better way is to consider them both as valuable tools that deserve their place within a well-built investment portfolio. We believe that holding a blend of both actively managed funds as well as a carefully chosen selection of index tracking funds, is the best way to build a well-balanced, cost-effective, and risk-managed investment portfolio.

 

If you are interested in discussing your investment portfolio with one of the experienced financial planners here at FAS, please get in touch here.

 

This content is for information purposes only. It does not constitute investment advice or financial advice.

May 06
0
Inflation sign in front of financial report

Should savers be worried that the inflation ‘tiger’ can’t be tamed?

By | Savings

Although inflation has been a relatively benign threat in recent years, it’s become an increasing concern in 2021. But how worried should savers be, and what can they do to make sure inflation doesn’t seriously erode the value of their assets?

 

Fears of higher inflation have been dominating investment markets throughout this year. Back in February, the Bank of England’s chief economist Andy Haldane caused a stir when he compared inflation to a “sleeping tiger” that may prove “more difficult to tame” than he, or his fellow central bankers around the world, would like.

 

What is inflation?

In a nutshell, inflation is the rate at which the price of goods and services increases over time. It is the reason why a single can of Coca-Cola cost 45p in 2007, but today will set you back 90p. Inflation is one of the key measures of financial prosperity because it determines what consumers can afford to spend their money on.

Inflation is usually expressed as a percentage increase (or decrease) in prices over time. The Bank of England has set itself a target of keeping UK inflation at around the 2% level. So, for example, if the cost of a litre of petrol increases by 2% a year, then motorists will need to spend 2% more at the pump than they did last year.

 

Why is inflation particularly bad for savers?

Inflation can be good news for holders of assets, particularly homeowners and the owners of some shares, especially if the value of their assets rises faster than the general level of inflation. However, inflation is usually bad news for anyone with a fixed income or those that rely on savings interest.

People with large cash amounts, as well as bond holders, could suffer most. Cash loses value very quickly when inflation starts to pick up, and investors start selling bonds – which pay a fixed rate of return – because inflation eats into the real value of that income. Higher inflation also increases the prospect of the Bank of England raising interest rates to push inflation back down.

Of course, the main reason why those on fixed incomes worry about inflation is that it erodes the purchasing power of money. If inflation is rising, it means the money in your pocket doesn’t go as far. For savers, if the money in their savings account isn’t rising at least in line with inflation, then the value of what they can purchase with that money is declining over time, and they run the risk of seeing their standard of living fall.

 

Why is inflation a concern now?

Over the past 12 months or so, inflation in the UK has been fairly subdued. That’s because the demand for goods and services has been low, thanks to the pandemic. However, while inflation has remained below the Bank of England’s 2% target since 2019, the Bank itself expects an inflation surge this year, as the economy recovers from its COVID-19 slump, and more demand pushes up the prices of goods and services.

And fears over rising inflation are not just confined to the UK. Across the globe, over the last year, enormous economic stimulus packages have been implemented by governments to help prop up their economies as countries experienced widespread lockdowns. If higher inflation is on its way, then it looks likely to be a worldwide problem.

 

Should you be on your guard for inflation?

Opinion is divided on whether inflation is going to become a serious problem for savers and retirees in the next few months. But it’s not a bad idea to plan for higher inflation and make changes to your finances just in case.

For example, now would be a good time to think about whether you have any savings held in savings accounts earning a tiny rate of interest, and whether you would be better off investing that money in ways that allow it to earn a higher return.

Retirees often hold more of their pension and other investments in cash or fixed-income assets. If this applies to you, it might be worth considering purchasing more equity investments that historically tend to perform well when inflation is rising. Finally, we can also undertake a review of your retirement plan to make sure it remains on track, as well as taking higher inflation into account when determining how much income you will need to give you the retirement that you want.

 

Riding out the inflation storm

With the threat of higher inflation looming, those reliant on savings income or fixed incomes should consider taking a long-term view while making some slight short-term adjustments. The important thing to remember is that there are several things you can do to limit the potential impact of inflation on your savings or your pension fund. With a few structural changes, we can help you to position your finances to benefit from inflation, instead of falling victim to it.

 

If you are interested in discussing your investment portfolio, cash savings, or pension with one of the experienced financial planners at FAS, please get in touch here.

 

This content is for information purposes only. It does not constitute investment advice or financial advice.