Default pension investments

atypical

bigadaj wrote: »

The lifestrategy has different options though so you can tweak the risk level and bond/ equity split. From 20% equity upwards, so going for the lifestrategy option at an intermediate level, or it's equivalent, maybe a 40% bond version might appeal?

But it's sadly not available. Will have to have a look through and see if there's anything that resembles it, thanks.

jamesd

atypical wrote: »

Are the default investment choices in employer pensions generally sensible?

As defaults yes. Probably not for you.

atypical wrote: »

Perhaps the lower risk is a good thing seeing as it's my pension. I'm 23 and otherwise investing monthly in Vanguard Lifestrategy 100% Equity.

There is a conflict between investment returns and the objectives of default funds:

1. Younger people when investing for retirement should normally be invested in higher risk investments because they have the longest time horizon, so they have ample time to recover from early drops in vale.
2. Younger people are less experienced with investing and even more prone than the average person to give up when they see a routine drop in pension pot value.

What this conflict leads to is things like NEST making a deliberately poor return investment choice for new young customers to reduce the risk of opting out. Default funds have a similar sort of thing to do and tend towards the lower end of the risk scale because the general population also has quite low risk tolerance.

So that's why default funds tend to be correct choices as default funds. They are OK to prevent the majority from becoming scared and giving up and not horribly bad on investment returns.

But now we move on to you. You're not the average person and even by asking here you're indicating that you're likely to do more to learn about risk - which is really mostly volatility in this context in the early years - and investment returns.

So for you as an individual, higher volatility funds tend to have higher long term investment returns. But to even use a FTSE All Share Index tracker fund you'd need to be able to accept it dropping in value by 40-45% once or twice a decade and 20% a few times a decade.

"40% bonds, 40% equity, 15% property/real estate" looks pretty poor to me for a person of your age with a fairly high risk tolerance and even more so given the current state of the bond market. But there's a catch: I don't know your risk tolerance, which means I can't say much about what mixture would be right for you. So I'll comment a bit on the investments:

40% bonds. There's reason to believe that we're in a once in 300+ years bond price bubble that will return to normal as quantitative easing and interest rates return to more normal values. return to more normal interest rates means a reduction in the price of bonds because price is just whatever it takes to deliver the return and a higher return means the price has to drop. Which means bond buyers today can expect to see capital losses. But that can be mitigated. Short duration bonds that end in a few years will lose less than long duration. Bond funds can have a mixture and can even short bonds to profit from drops to reduce the downside risk. But you don't know what is being done in this area just from 40%. Which makes it hard to assess the actual risk of this 40% part. But it's a good deal higher than I'd be comfortable with now and for the next few years for anyone with highish risk tolerance.

40% equity. Equity markets are not the same. What is the balance of markets being used by this one? What is the balance of company sizes? It's probably very heavily overweight in the UK, which is about 8% of the world equity market value but more likely to be over half of the investments in such a fund. The US is at quite high values. Europe at quite low, UK somewhat middling and there are lots of other markets with different properties. So what's the global mixture?

15% property/real estate: I'm pleased to see this. This is an area that can increase in value as interest rates go up because that implies economic recovery and that in turn implies benefits for this asset class. It's a nice alternative to bonds.

At the moment, for those with low or high risk tolerance, I'm inclined to suggest lower bond components than this fund has. Low because of the likely QE/interest rates effect and high because of the lower investment returns. Longer turn that'll change and I'd say different things to each group based on the lower volatility of bonds, but now there's that one way bond drop risk with no real prospect of recovery from it once it happens. So now I'm more inclined to suggest higher European equity and higher commercial property, with much money switched from bonds into those areas.

It's also worth knowing that overall, mixed asset investing with rebalancing of the proportions in each asset is expected to deliver about 1% higher returns than using just one asset. 100% equities isn't mixed asset so that's leaving some potential gain untaken. The reason for this effect is that the rebalancing tends to move money from areas that are at high prices to areas that are low priced and since asset values tend to revert to the mean value, that tends to improve returns by causing buying low and selling high.

You can try similar things by trying to buy in low priced areas and when the news if filled with stories of doom and gloom about market crashes that just happened. That means there's a sale on, cheap investments available, so buy more. This can be emotionally hard to do.

But first thing to do is work out your own risk tolerance and what it'd take to cause you to be unhappy and give up. No point in using the FTSE UK index alone if you can't deal with a routine 45% drop and recognise that as sale meaning you should buy more. the typical retail investor would want to sell, not buy.

There's a lot to learn. Don't worry about that, just get started in any way and adjust what you do as you learn, without kicking yourself once you recognise things that you'd have done differently. It's a lot more productive to be learning when you have money in the gain - actual money ups and downs and living through things while paying attention has more real psychological effects and learning opportunity than just looking at charts.

If you can, start with higher risk than you think you can deal with now and write that down to remind you when the drip happens. This is because now you will have relatively little money invested, so the losses will hurt less than the same lesson later. The writing down is to remind you that it is a deliberate experiment to learn for real what your risk tolerance is and that you've deliberately experimented on yourself. Which means, experiment, but don't let it cause you to sell if you find that your risk tolerance is lower than the risk you took. And unless you are sure you can trust yourself to do this, best not to carry out the experiment.

atypical

Thanks for the lengthy reply!

jamesd wrote: »

40% equity ... So what's the global mixture?

Of the equity portion: 25% US, 20% UK, 15% emerging markets, 15% Europe, 15% Japan, 10% Asia Pacific. It's not what I would have expected.

jamesd wrote: »

But first thing to do is work out your own risk tolerance and what it'd take to cause you to be unhappy and give up.

I think I have a high risk tolerance but appreciate this is easier to say without having experienced large (paper) losses.

jamesd wrote: »

There's a lot to learn. Don't worry about that, just get started in any way and adjust what you do as you learn, without kicking yourself once you recognise things that you'd have done differently. It's a lot more productive to be learning when you have money in the gain - actual money ups and downs and living through things while paying attention has more real psychological effects and learning opportunity than just looking at charts.

I started investing in 2009 and certainly feel like I've learned a lot along the way.

I've had a look through the available funds and think this one better reflects my risk tolerance:
http://www.fundslibrary.co.uk/fundslibrary.dataretrieval/documents.aspx?user=landgdoc&type=custom_field.www_landg_co_uk.factsheet_WSWork&sedol=B4M22L6

jamesd

I think that equity mixture is a better one than a global equity tracker, in part because it's well underweight in the US and I think that's a good idea given current US market valuations.

B4M22L6 is another balanced managed fund, not doing significantly better or worse than the mixed investment 40-85% shares funds in general. Not really the sort of fund I like to see someone who is taking an interest and thinks they have a high risk tolerance using.

For the bonds, 4.56% of the fund is in long-dated bonds of over 15 years maturity, the group that would suffer most in a bond price drop. 1.61% in the 10-15 years range that would also suffer a lot and another 4.05% in the 5-10 year range. Around 10% that would suffer perhaps a 30% drop in value, so around 3% for the fund as a whole. Could be a lot worse but not wonderful. It's good to see that the factsheet mentions that the longer-dated ones are more sensitive to changes in interest rate.