Investments – choice is important but knowledge is crucial

You could give someone a state of the art set of motor mechanics tools but without years of training and experience they would not know how to work on a repairing a sophisticated motor car. This analogy holds true when faced with making decisions about how to invest in a pension fund. The range of funds available is huge, and without the tools, i.e. knowledge, experience and time, it is a daunting task and poor decisions could prove financially disastrous.

Achieving above average investment performance is important; particularly for members of defined contribution (DC) schemes. To put this in perspective, outperforming the market by just 1% per annum would more than offset the value of management charges incurred on a typical DC plan.

At a slight tangent, the Personal Accounts Delivery Authority (PADA) is currently undertaking a consultation process on charges for personal accounts. Tim Jones, Chief Executive of PADA, when commenting on maximum charges said “Anything above 0.5%pc and you start to wonder why bother doing it in the first place”, an extraordinary statement. It will be interesting to see if PADA has such exacting requirements when it considers investment funds and performance expectations for personal accounts.

Who’s taking the decisions?

In a market, where employers are favouring DC schemes, it is members who bear the risks and rewards for the investment returns achieved on their retirement accounts.

Larger companies, who choose trust based schemes, will usually appoint specialist investment consultants to guide the trustees on a suitable investment strategy. The trustees and employer may take a paternalistic attitude by screening out higher risk and volatile funds. The trustees may determine how contributions are invested, or allow members to choose from a limited range.

Increasingly, medium and smaller companies are turning to contract based schemes, because the governance duties (set by the Pensions Regulator) are undertaken by the pension provider. The services of specialist advisers are less likely to be used and consequently members could be more exposed to choosing unsuitable funds.

Role of providers

Most pension providers now offer in excess of 100 investment funds and include a SIPP facility on their group personal pension plans. Such choice is only suitable for employees who are receptive to education, able to use e-tools and have the financial knowledge and time to manage their retirement savings. This relatively small group may have other assets which alongside unsecured pensions, can be converted to income in retirement.

Providers must help the informed investor determine the level of risk they are prepared to take and explain the risks associated with each fund. Risk profiler tools play an important role in determining the initial risk strategy and then to manage it through to retirement.

Employees who prefer to delegate

Most employees have no experience of investing in stock markets and would tend to choose deposit accounts. Financial knowledge amongst people in the UK is low and the government is committed to initiatives to raise awareness.

Providers must recognise that generally employees would prefer to delegate decisions where stock market funds are involved. If forced to make decisions on issues where they have no knowledge, employees procrastinate and many do not join the scheme, rather than risk losing money.

The development of default funds has filled an important gap. It is a solution which suits most workers; they simply join the scheme and leave the specialists to manage their money.