Auto-enrolment has made its mark on the UK. Nearly 10 years on from its launch, over 10 million people have been enrolled into a workplace pension. Every penny set aside via the system potentially benefits participants later down the line.
Nevertheless, the policy has two problems: contribution levels, and (secondly) engagement.
The first has been covered in great detail. Industry types agree that workers contributing just 8% of qualifying earnings is simply not enough to grant them the comfortable retirement they might want (and need) later on.
To the second issue, there is an awkward behavioural problem too. Much of the policy’s success can be attributed to its “opt-out”-style nudge. In plain English: unless you say you do not want to participate, you end up with a pension.
But there is a conflict: between the passivity that produces participants in the first place, and the engagement required of savers later on if they eventually retire. It is an uncomfortable truth that auto-enrolment will not on its own produce a generation of pension-rich (and happy) savers. That will require engagement and education.
At the heart of this issue is the "default" fund. What is that?
Profile Yourself
When you save into a pension, your contributions are put to work in a variety of markets.
Default funds are investment funds selected by your pension provider for you. The majority of auto-enrolment investors will be in one. A great deal of regulatory wrangling has taken place to determine what an appropriate default fund looks like for disengaged investors.
For younger investors, however, a default fund may not be optimum. Heather Owen, a financial planner at Quilter, says auto-enrolment investors should look to take on as much risk as they can. A default fund may be too cautious.
“Young pension savers should be heavily invested in equities, which we would expect to provide a better return over the long term,” she says.
“There is no hard and fast rule to exactly how much exposure someone should be aiming for as everyone’s financial circumstances and goals are different, but as the money is going to be locked up for well over 30 years there is ample time to ride out any volatility. Diversification is king when it comes to investing, and this can still be achieved within a 100% equity portfolio by ensuring there are a range of sectors and geographical regions held.”
How to Choose a Different Fund
That is the theory at least, but how do you go about choosing a different fund? There are so many choices. The first thing you need to do is understand your own risk profile. This is a rough measurement of your attitude to financial risk, but should also include an assessment of how much you can actually afford to lose.
“For most younger people, they should adopt a more aggressive risk profile as they can afford to make losses in the short term as the higher risk assets may potentially also bring higher returns in the long term,” Owen says.
“Many pension providers will have a range of ready-packaged funds that novice investors can choose from based on their risk profile. Managed by experts, these often give an investor exposure to a number of different sectors, asset types and geographical regions.
"However, some investors may want to create their own investment portfolio, by selecting and managing a collection of a number of different funds. If doing this it’s important to ensure that the portfolio is diversified.”
When you are doing this, keep an eye on how much you are being charged. For instance, seeing a charge of 2% on the fund you select may not seem like much right now, but it could amount to a significant sum over the life of your pension. If you amass a pension pot worth £500,000 through your career, 2% of that is £10,000!
The Ethical Bit
Younger investors may also be concerned to hear of another problem with default funds.
Their “one size fits all” nature often means they are not designed to address individuals’ personal qualms about investing. In short: many savers may not even know their contributions are invested in companies popularly regarded as being “sin stocks”.
Those include arms companies, tobacco firms, or perhaps oil and gas giants, or companies with connections to pornography.
PensionBee chief engagement officer Clare O’Reilly says there is often a simple enough solution to this issue of ethics, though it does require savers to be extremely switched on about their decisions.
“Although more than 90% of savers stay in their default plan, most workplace providers will also offer a responsible or ethical option, which may provide additional screens for weapons, tobacco or coal producers, depending on the provider,” she says.
“Savers can switch out of the default plan and into one that better suits their needs, simply by contacting their pension provider. However, it’s important for savers to remember to look very carefully under the hood of any ‘ethical’ options, as some may still invest in oil and tobacco despite this label.”
In short then: to do this you need to get good at asking questions, and you should know that it is OK to do so. Your provider will not be able to advise you on what you should do, but they should give you enough information to find out more about your options.
A note on safety. Though the company that provides your workplace pension will already be an approved entity, always remember to check who you are dealing with, particularly if you are selecting funds, or transferring or consolidating your pots. The Financial Conduct Authority is the UK financial services regulator, and has a register you can check to ensure companies you deal with are authorised.
