Most UK employees saving into traditional defined contribution (DC) pension schemes do not make investment choices; instead, they choose to leave their money in the hands of trustees. From my experience, across the UK, around 80% to 90% of workplace pensions are in default funds, but other self-select choices are available.
A pension is a long-term investment, and trustees design default options to reflect the retirement time horizon of the workforce. When constructing default retirement pots, trustees seek advice from investment experts to assess a suitable level of risk.
A well-designed default should be diversified, monitored regularly, and adjusted as investment conditions change.
Given the careful consideration behind default funds, why would members choose self-select options instead? It is usually for one of three reasons.
First: the quest to achieve better returns. Members who are highly confident in their own investment skills may decide that they want more control.
Having observed how the individual investors behave in volatile markets, this is a high-risk approach that very few people get right consistently.
Second: people, fundamentally, have different attitudes towards risk and time horizons. Some members might opt for shorter investment periods, at the expense of growth potential and purchasing power, during retirement due to inflation.
Other members seek more risk than the default, believing that specific investment markets, such as emerging markets, offer the best prospects for returns. In the long term, this might be the best option, but volatility should be considered.
Third: every member’s financial circumstance is unique. One challenge for today’s DC trustee is that we can only see the investment pot held by each member in our pension scheme.
The rest of the member’s financial life, including other pots, savings, property, inheritance or some early retirement plans, is hidden.
Members may have very good reasons for selecting the investments they have, but obtaining good financial advice is important, so that risk and time horizons can be taken into consideration.
Dianne Day is client director at Independent Trustee Services
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