Such strange times we’re living in. Unnerving, perplexing, horrifying, boring, surprising. More dependent than ever before on digital media, we’re bombarded with information, misinformation, disinformation. We read sad stories and inspiring stories. Every news bulletin and current affairs programme is about Covid-19 and its effects (as is every post on LinkedIn).
An incalculable future is arriving. As it does, many people, understandably, have been worrying about the value of their pensions as they sit at home. Markets around the globe started to plummet a week or so before the end of February. Typically, employees in a workplace pension will have seen the value of their investments dropping for about a month, before showing signs of settling at a lower level and then regaining some lost ground. Indices are still, however, bouncing around abnormally — often rising or falling by several percent a day.
Large fluctuations in value are particularly alarming for people near retirement, of course. So, amid all this uncertainty, it’s reassuring to see that the process of lifestyling is doing exactly what it’s designed to do.
Over 90% of employees invest in the default fund in their workplace pension. In modern schemes, lifestyling occurs as retirement approaches.
Chronologically, your pension operates like this: accumulation (growth) — consolidation (lifestyling) — decumulation (taking income).
For most of your working life you invest for growth at a balanced level of risk. This means investing mainly in equities (stocks and shares), with some pension providers also using property and commodities to achieve growth. To reduce risk and volatility, between 15% and 40% of your savings, depending on the provider, is held in fixed-interest securities: corporate bonds and government bonds (gilts).
Lifestyling is designed to consolidate the gains you have made by gradually and automatically lowering the risk level of your investments. There is less focus on growth, more on stability. Less of your money is invested in equities, more in bonds. Lifestyling can take as many as fifteen years or as few as three: it varies greatly according to which provider supplies your pension.
Protecting your savings
For the purposes of this blog, I’ve chosen Aegon’s pre- and post-lifestyling default strategy to illustrate how effectively lifestyling is working. This is not an ad for Aegon, although I wouldn’t deny being a fan of their platform, Aegon Retirement Choices (ARC). Among other things I like the simplicity and transparency of their default strategy.
Aegon’s workplace default fund is called the Aegon Workplace Default Fund. During its growth phase it’s called the Growth Tracker. Lifestyling kicks in six years before retirement; and then, six years later, at the point of retirement, scheme members are wholly invested in the Interim Retirement Fund, poised to go into flexi-access drawdown. The performance of both funds is easy for me to monitor on industry-standard software Financial Express Analytics.
Here’s a graph showing how the Growth Tracker (red line, B) and Interim Retirement Fund (green, A) have performed since 21/02/20, when the precipitous global downturn started, to last Friday as I write, 17/04/20. To indicate how a mix of pure equities has fared, I have also included the FTSE 100 (purple, C), the most famous equity index in the UK, comprising the 100 companies listed on the London Stock Exchange with the highest market capitalisation.
- The Interim Retirement Fund has lower volatility than the Growth Tracker, so the line is less jagged, and it has consistently fallen in value about a third as much.
- The Growth Tracker, consisting of about 75% equities and 25% bonds and gilts, is less volatile than, and has fallen less than, the FTSE 100. Few people are comfortable investing wholly in equities for growth.
People in lifestyling have been protected from the worst of the recent shocks. The value of their pension will depend on how far into lifestyling they are. If it has just started, they will be near the red line. If it is reaching its end, they will be near the green line.
- I have every reason to believe that other providers’ default growth and consolidation phases follow a similar performance pattern to Aegon’s. That’s what they’re for. Again, I’m aiming for simplicity here, and Aegon’s approach and terminology make that easier.
- The graph is a snapshot of what’s happened over the last two months. To take a broader view: despite their recent losses, during the four and a bit years since their inception to 17/04/20, the Growth Tracker and Interim Retirement Funds show gains of 35.7% and 24% respectively.
- I’ve no idea what the markets will do tomorrow, next week, next year. I believe they’ll recover over time but I don’t doubt there will be further sudden reversals to contend with.
- Watching the value of your savings declining isn’t a pleasant experience, but as my eloquent colleague James Biggs explains in a three-minute video here, if you’re contributing to a pension, a short-term downward trend is, in the longer term, actually beneficial because of pound-cost averaging. Monthly contributions buy more investment units when prices are lower. More bang for your buck.
- Don’t panic! Remember that your pension is a very long-term investment. Making hasty decisions to try to counteract short-term disturbances is rarely wise. It may be tempting to disinvest from equities when their value goes down sharply, to seek relative safety in bonds or cash. If you do so, however, you’re effectively crystallising your loss. You won’t be in a position to gain from increasing equity values when they inevitably occur. Better, as a rule, to hold your nerve and ride it out.
Rigorous and regular governance is the core of our pensions proposition at Employee Benefits Collective (EBC). It is essential that employees are members of a pension scheme with a robust modern default fund that incorporates lifestyling to save for their future. Alongside governance we offer financial education sessions and 1:1 guidance. To find out more, please send me a direct message.