Pension Lifestyling

Pension scheme trustees have to pick a default investment strategy for their members. This is supposed to be a prudent investment strategy that your average Joe can invest in without too much worries. It used to be the Balanced Managed fund up until the great financial crises. In 2008 alone, we saw the average Balanced Managed fund fall by -34.58%. There were cries of “I didn’t know my pension fund could fall by that much” and “why is there so much is equities when there’s a crash”.

The truth is, a Balanced Managed fund was never a low or medium risk portfolio. The average Balanced Managed fund has 65% in equities. The fund managers are also mandated to hold a certain level of equities and so will not go to cash when there is a stock market crash. So investors will have to take the hit, or do their own thing and move to cash themselves.

After the crash, the default investment strategy moved to lifestyling.

What is lifestyling?

Lifestyling is the switching of your pension investment funds to “less risky” funds as you near retirement. The idea behind it is the further you are out from retirement, you can afford to take more risk with your money as you won’t be drawing it down for a long time. You can weather the big ups and downs of the equity markets.

As you near retirement, you don’t want as much risk, so the equity content reduces and the bond content increases. This is a gradual, automatic process that can start from up to 25 years out. Different companies start reducing risk at different times and the end portfolios can look different too. Some having 25% in cash to protect the lump sum (you can’t protect a percentage of a fund value), others still having up to 60% in equities in you intend to invest in an ARF and others going 100% in bonds if you intend to purchase an annuity.

The problem with lifestyling

The first issue with lifestyling is they start reducing risk far too early. 25 years out is far too far to start reducing risk. Someone with a retirement age of 65 will be just 40 years of age when their fund starts to reducing risk. They are still closer to school age than they are to retirement age. Reducing risk that far out is leaving money on the table.

The term risk is misused. There is risk with all asset classes. The word they should be using is volatility. In a really bad recession, equities have fallen by -50%. They can also grow by the same amount (usually after markets hit the bottom after a recession). Bonds can also fall in value, but not by as much. 2022 for example was a really bad year for bonds with the average Irish bond fund falling by -12%. 2023 was a good year when they grew by 13%. As you can see, the bad and good years aren’t a big as those under equities. But there is lots of risk but it is not as great.

What if you were invested in bonds over the last few years? If you had €800,000 in your pension three years ago and were contributing €1,000 a month to your pension, you’d have €730,476 today. You lost almost €100,000. If it was five years ago, you’d have €814,958 today, a loss of €45,000.

Meanwhile, the equity investor would have €1,038,455 from 3 years of investment or €1,284,791 from 5 years of investment.

That is not to say you have to be all in equities. If you stuck with the much maligned Balanced Managed fund, you’d have €920,649 or €1,068,880 respectively!

Pension scheme trustees are trying to find a once size fits all approach for scheme members. This is impossible to do. What is lacking is advice to the scheme members. They are usually left to fill out forms online or do a risk profiling questionnaire that funnels them into a fund and the compliance boxes are ticked without finding out more about the member. A bit more information and education for the members will help them understand what they are exposed to and they can make informed decisions on where their money is going.

 

Steven Barrett

25 March 2024