If you want to retire earlier, or create a bigger income for yourself in retirement, then new data uncovered by Hargreaves Lansdown, would suggest you need to take a much more active interest in your pension, particularly the fund you invest into.
Because if you do, you are going to enjoy greater returns, resulting in larger fund sizes, which will allow you to fast forward your retirement - that is to say having a passive source of income which allows you to continue to work, if that is what you choose.
Hargreaves found in a sample size of 58,000 workplace pensions, those who took an active interest in the selection of their fund choice, beat those who simply opted for their employer’s default plan, by a margin of 4.75% per annum over a five-year period.
And the delta doesn’t have to be as wide as 4.75% to make a difference, even a 2% differential can make a significant impact. Let me show you how much that impact could be.
If an individual earned an average income of €70,000 between the ages of 30 and 68, and they invested 8% of their salary into a pension, and their employer matched this contribution, they would accumulate a pension fund at retirement worth c. €794,031 assuming an annual return of 3%.
However, if they managed to get a return of 5% per year, the value of their pension fund would breach the €1 million mark and amount to an impressive €1,272,567.
What this means is, if you earned a 5% return, you would have the same size fund at age 60 than your colleague would at age 68, if they earned 3%.
The value of your fund would fly by theirs if you continued to work, or you could stop working, if the amount was enough for you, whereas they would have to work eight more years, just to catch up with you.
The reason there can be such a difference is because default and target date funds are not designed to beat the broad market at all times. Due to their broad diversification, they are designed to produce steady gains with low fees and minimal volatility over time, and their performance will vary based on different target retirement dates.
The advantage of using default/target retirement date funds is that they make it easy to spread the amount you invest each month among stocks and bonds and rebalance the amount invested in each, as conditions change and as you get closer to retirement. They were designed in the first place, to help people who are inexperienced when it comes to investing, and ordinarily would find it challenging to select funds themselves. The default fund takes an element of guesswork out of the equation for the inexperienced individual.
Although, there are considerable benefits to default and target date funds, not everyone likes them either. Some advisers don’t like the one size fits all, cookie-cutter type approach to choosing how your pension fund should be allocated. Not everyone has the same risk tolerance, cash-flow needs or time horizon requirements, so they shouldn’t all have the same asset mix.
Because of this and because of the Hargreaves findings, I believe you need to be more conscious and more engaged with the fund you are investing into each month. If you don’t, you are effectively outsourcing the responsibility of how your fund will perform and what income you will be receive, to someone else; that could go well for you, or not so well.
What I have seen happen with people who join pension schemes, is that from the outset, they don’t pay that much attention to the choices offered to them, and for the purpose of just getting the paperwork out of the way, they choose the default option and promise to review it when they have more time.
There is nothing wrong in choosing a default option and if you have one, there’s nothing to be concerned about, they are fine, but the Hargreaves findings are compelling.
To begin taking action, you should first assess and review what fund you are currently investing into.
Next, I would spend five minutes completing a risk questionnaire and look at the results of it.
What risk rating are you and is it aligned to what fund you are currently saving into. If there is a difference between the two, I would suggest you need to make some changes. After you complete that, that’s a job well done. Your next step is discovering if the percentage of your salary you are contributing each month is enough. To find out if it is or isn’t, you need to know how much you will need when you are older and not earning an income.
The good news, is that I will bring a resource to you in the coming weeks which will identify all those numbers you need to know about with very little time, input and effort – watch this space.
Liam Croke is MD of Harmonics Financial Ltd,
based in Plassey. He can be contacted at firstname.lastname@example.org or www.harmonics.ie