Pensions News Bulletin September 2015
1. Future looking companies embrace Recareerment
Liz: “I hear you’re retiring next month”
Bob: “I’m not ready to put my feet up yet. I’ll be doing 2 days a week at my local DIY superstore and 2 days back here helping out in accounts and mentoring new recruits throughout the group”
Liz: “Haven’t you had enough of the rat race by now?”
Bob: “Actually this couldn’t be better. I will now have 3 days a week off and my working days will be an hour less at each end of the day. I’m going to continue getting paid, the company are keeping my experience and using it more flexibly plus I’m costing them less. Also I’m only going to take a small part of my pension and keep most of it invested so it grows until I really need it.”
Liz: “This seems like a growing trend. My neighbour retired last year and now has a local gardening and decorating business – so he’s got something for all weathers. I don’t think he had much of a private pension. He says his business at least doubles his state pension and he’s even thinking of expanding.”
Moneyfacts, the financial information and comparison site, published survey results showing that the value of new retirement pensions are three quarters less in 2015 than in 2000 and even 8% less than just a year ago. This is due to the higher cost of annuities from lower interest rates and longevity, plus poorer stock market returns over the preceding 20 years. You can find more about the results here.
Such a survey is further validation of what has been apparent for some time. That average pension incomes relative to personal earnings will be less in the next 20 years than they were in the 1980s to 2000s. In those days there were fewer people with private pensions (company and personal) than there will be after auto enrolment roll out but the transfer of investment risk to the individual, the long term reducing job security, the household debt burdens and intergenerational family support costs, are all competing for an employee’s limited income and will together result in lower average company and personal pensions.
Yet most people will be living longer than ever, and longer than they think, and the marvellous news is that a growing number of older people are fitter and healthier than in any earlier generation and this trend will accelerate. They, or rather you and I, will want to continue being useful, feel fulfilled and also want to augment our income. Even where it’s beyond what we need we will want to earn to spend, to pass along the family, to enjoy great holidays and pursue favourite hobbies and of course to ensure we are not a burden if, or when, we can’t ‘do’ for ourselves.
Corporates can no longer make retirement mandatory and besides the loss of their most experienced people is counter commercial. The progressive and winning companies can also see retaining experience helps with recruitment and training of new employees and improves profitability. Not least by ensuring someone like Bob is doing terrific and focussed training and mentoring while allowing Liz to continue her day job instead of compromising that to provide the training as well – as traditionally expected. This is just one example of job continuance and job transference merging with job succession. There are many more ways to find advantages. It’s a win win any way you look at it. If companies don’t see the commercial benefits (which also come with co-incidental social benefits) they need to address a new growth strategy based on how both young and old want to work in the 21st Century.
So when people like Bob are asked in future, they will say “I’m taking recareerment rather than retirement next month”. Good recareering Bob.
2. Get ready with your pound cost averaging story
The stock markets, particularly the UK market has gone up and up the last few years, reaching its highest ever peak earlier this year. More recently it’s been lower and volatile, and that may continue while there are so many contrary indicators driving the sentiment of the largest market participants. When interest rates rise and quantative easing withdraws, and assuming unsettling economic news from around the world continues, we could see lower account values than previously on employees’ DC pension statements.
Depending on how your DC scheme’s statements are designed your employees may see a red figure as their pension account ‘growth’ over the year or a minus sign in front of it, or it may say loss rather than gain. However the loss is illustrated, DC members don’t like to see their account value being less than it was a year before particularly when they’ve paid an extra year of pension contributions.
I hear you say, “the website has a section on it” and you’ve told the staff about this in the various presentations or newsletters. However most pension schemes do not give this issue prominence. Many companies don’t consistently help their employees engage and understand the pension scheme details and where they do, partly because of the way they do, the stuff about pensions is not absorbed. Then when an employee becomes worried and wants to know something, they think they’ve never been told before.
But guess what, if their pension value has reduced rather than grown, emotion kicks in and there will be employees who hurt because their account value has lost money. They will think they have wasted the year’s contributions, that they should have spent the money elsewhere or that the pension fund has been badly run. Worse, those who feel like that will spread their feelings to their colleagues, family and friends.
This situation can have a lasting effect even when markets and their account value recover because employees now have a measure of the risk they bear and without support they may not understand that it can, and should be, a bearable and acceptable risk.
The support comes in the form of some engagement which prepares staff and explains the concept of pound cost averaging before employees receive their pension statement.
This message explains the most fundamental advantage behind the concept of the DC pension design. As we make monthly contributions into a fund, when that fund dips in value our contribution buys more units or shares of it than the same amount buys when the fund is higher. When the fund is higher every unit or share costs more. Therefore when the fund value rises it means the value of those units or shares has risen, and because we bought more when the fund was lower we have a greater value from that month’s contribution than we would have had if it hadn’t dipped in value.
The media makes a big deal of treating the ups and downs of the stock market like a sports match. The presenters are all smiles and happy when they talk about ‘how well’ the stock market has done but gloomy when it’s had a ‘bad’ day. Yet if you compare it to anything else we buy we don’t want it to be more and more expensive every day.
It is of course true that when we want to sell something we want to get the highest price and so it is with investments at the point we want to take a pension or cash out. But before then, in the growth stage, the most powerful generator of what makes contributing to a DC pension worthwhile is the investment returns from each monthly contribution over many years. Without good investment growth, which is accelerated at times by cheaper units, we may as well save into a bank account which has no investment risk at all.
3. Lifestyle Funds or Target Date Funds – what’s the difference?
Most DC pension schemes have a default fund so employees don’t need to make an investment choice. This is the law for auto enrolment and stakeholder schemes and so it has become the usual practice for all DC schemes. Another requirement is that a reducing investment risk must be managed by the default fund as retirement approaches. This means reducing investment in more volatile assets, particularly equities, and increasing investment in less volatile assets, such as bonds and cash-like instruments. The movement from higher to lower risk investments is frequently referred to as the ‘glide path’ or ‘flight path’.
To reduce costs to the pension scheme member the default fund is usually invested on a passive basis, meaning it invests in accordance with the movement of an index such as the FTSE 100 and must track it as closely as possible. The lower fee therefore comes from the fact that there is no fund management team calling the shots, doing the research, modelling possibilities and making changes to the fund that they believe could produce higher returns. The passive fund – or index fund as it’s also called – is a data management exercise much of which should be automated. Passive does not mean the fund doesn’t do much trading. In fact it may do a lot of trading if that’s necessary to track, i.e. keep close similarity with, its index or benchmark.
Both a lifestyle fund and a target date fund invest in a range of assets from high to low volatility and both move investors over time to lower risk assets. So what is the difference between them?
A lifestyle fund, sometimes called a lifecycle fund, is a single fund or blend of funds (when it’s then called a strategy by purists), that determines what an individual’s mix of investments are dependent on the number of years to expected retirement date.
Imagine a spreadsheet where the columns from left to right represent the most years to retirement, to the least – in fact to 0 years denoting the year of drawing the pension or cashing out. Then each of these columns determine the mix of investment assets for each person for the number of years they are from column 0. An automated mechanism then adjusts each individual’s holdings according to the reading in the specific column of that spreadsheet or database as they age / get closer to point zero, by moving from left to right through the columns. (Worry if it’s actually being done by a person using a spreadsheet!)
The asset allocation strategy for the entire structure is set and everyone invested is in the same strategy, albeit at different points. Because of this there is usually a choice of three different lifestyle funds in a scheme such as cautious, moderate, and adventurous. The main difference is how early or late in the programme the ‘glide path’ kicks in, whereby the equities begin to be reduced and the bonds and cash-like elements begin to increase. Of course faced with a choice of three different risk rated options most people would go for the middle choice. That is also the choice most pension schemes choose for the default fund, so members have to actively pick one of the others if they believe the middle way is not for them.
Lifestyling really only works properly if it’s the only fund a member invests in, otherwise the asset allocation strategy is compromised because the member has other holdings which change the risk profile that the lifestyle policy was aiming for.
A target dated fund offering is made up of very many funds usually named in accordance with the expected year of retirement for each individual. For example there will be a 2025 fund for someone who will be 65 in that year where their scheme or notional retirement age is also 65. He or she will be in that 2025 fund now in 2015 and was in the 2025 fund when they joined the scheme in 2006. There will be a fund for every year that someone in the pension scheme could attain 65 e.g. a 2026 fund, a 2027 fund and so on. The assets in each will vary slightly from one fund to the immediately neighbouring funds, but each fund variant is adjusted each year in line with an asset allocation strategy offered by the fund manager or designed by the investment consultant.
The asset allocation strategies and the mix of assets used can vary markedly from one manager’s series of target date funds to another’s.
Of course the point at which someone will actually retire is uncertain until it happens, so there is flexibility in the operational arrangement and some fund managers may offer wider scope funds such as the ‘2025 to 2029 fund’ and so on.
Since freedom and choice flexibilities were introduced providers should have a ‘beyond retirement date’ strategy. So in the lifestyle fund example from counting down years to 0 ( e.g. columns for -30, -29 …… -1, 0 ) there should be an investment strategy (more columns to the right of 0) that rise from 0 (notional retirement date) to +1year, +2years etc.
Similarly for target dated funds providers have created new investment mixes to suit the potential choices that freedom and choice now offer.
Thank you for reading. Please contact me if you would like to discuss any of the subjects mentioned in the newsletter.