What’s the one thing you could do today to increase your wealth in retirement? If you’re a member of an occupational pension scheme, there’s a good chance the answer is simple: move your savings out of its default investment fund.
If, like most occupational pension-plan members, your scheme is a defined-contribution, rather than a defined-benefit scheme that pays guaranteed pensions, your pension in later life will depend on how well your money is invested. That comes down to the returns that managers achieve and the charges they deduct. On both counts default investment funds tend to score badly.
Switching out of the default fund should pay off
Recent research from financial adviser Hargreaves Lansdown suggests that the ten most popular funds with savers who have moved away from the default options in their pension scheme are performing far better. Over the past five years, savers in these funds have earned 5% more than those in default products.
Such outperformance can have a huge impact. A saver currently earning £28,000 who starts saving 8% of pay at age 22 and retires at 68 could expect to have a pension fund worth £191,000 if they earn an average return of 5% a year. An average return of 6% would produce £250,000.
Of course, there’s no guarantee that a different fund will outperform your default option. Bear in mind, however, that employers tend to be conservative about default investment options.
If you’re many years away from retirement, you can invest in higher-risk alternatives in the hope of achieving higher returns; there is plenty of time to recover from any setbacks.
As for charges, default pension funds aren’t normally allowed to charge an annual fee of more than 0.75% a year. But many stay close to or at this cap and there are far cheaper alternatives available. The cheapest index tracker funds cost less than 0.1% a year.
Again, charges make a huge difference. A saver putting £100 a month into a pension for 40 years and earning an annual return of 5% would end up with a fund worth £145,000 if they paid charges of only 0.1% a year. A 0.75% fee reduces this to £124,000.
If default funds cost more and perform less well, why do nine in ten occupational pension-scheme members stick with them? Doing so is the easy option – it requires no action. But the danger of not seizing the initiative and exploring better alternatives for your savings is that you’ll pay heavily for your apathy later in life.