Paying into your pension isn’t enough – it’s growth that counts

You contribute diligently every month, so that’s your pension sorted, right? Not necessarily. While many of us will feel comforted by our contributions, they are only part of the equation. What makes the biggest difference to the size of your pension pot in retirement is not how much you put in, but its growth. New research shows people haven’t really grasped this. GrowthNearly two-thirds of the value of a typical pension pot comes from investment growth, says Nick Charalambous of Alpha Wealth. He’s quoting new research from Standard Life.Your contributions, and any from your employer, form the vital foundation, but how successfully this money is invested plays the biggest role over the long term, says the UK-based data. READ MOREFor a typical defined contribution pension pot of £100,000 (€116,500), about two-thirds of the total value, or £65,000, comes not from the individual’s contributions but from compound investment growth, according to Standard Life.Individual contributions make up just £18,000 of the pot according to the research and employer contributions make up £13,000.Compound investment growth happens when your pension contributions are invested in a way that earns a healthy return, and then those returns generate their own earnings over time, says Charalambous. Ideally your pension contributions are snowballing – they are earning a great return, and any dividends, interest or capital growth are reinvested back into your pension pot – so there should be growth on growth. Two-thirds of a typical pension pot comes from investment growth – but three-quarters of people don’t know that, according to the research. Despite its importance, just one in four people believe that pension investment strategy is the main driver of the final value of their pension pot, according to Standard Life. Instead, pension holders over-estimate the impact of their contributions on their pot, and underestimate the value of investment growth, according to Standard Life. Maybe if we grasped the truth, we would take a more active role in managing, or at least monitoring, how our pension contributions are invested. The reality is that less than half of people in Ireland, 46 per cent, say they always or generally review their annual pension statement, according to the research from the Competition and Consumer Protection Commission (CCPC) published this month.Just over one in 10 of us has never looked at their annual pension statement. Investment strategy is the silver bullet when it comes to our pensions, so we’d better start opening those pension statements, and maybe taking a more active role in managing our money. Default scheme Are you in your pension’s default investment strategy? The majority of pension members remain in this strategy throughout their working lives, according to industry studies. Default funds make for a simpler, hands-off approach. These funds aim to deliver steady, long-term growth, without needing you to manage your investments.Our preference for them reflects our low engagement with our pensions, our limited investment confidence and a perception that the default represents a “good enough” solution, says stockbroker Davy. “It’s designed for middle ground, for people who don’t want to spend their Friday night reading fund fact sheets,” says Ralph Benson of MoneyCube.“You are not going to end up with no growth in your wealth accumulation years, and equally you will avoid major risk just before you retire,” he says.But the middle of the road can be a dangerous place to stand, says Benson.Default pension investment strategies are typically designed using a “life-styling” framework, allocating members to growth assets such as equities early in their careers, before gradually derisking into bonds and cash as retirement approaches. “Typically when you are young, your money will go into high-risk, high-growth investments. As you get older, your money will be moved to low-risk, low-growth investments,” says Benson. But there can be a downside. “I would say default options have a bias towards being conservative,” he says.“People are far more likely to shout at their pension provider if they lose money than ring them up and congratulate them if there is an outsize positive return, so their bias is towards risk-off,” says Benson. Default schemes can be quite patronising when it comes to age too, he says. The strategy is often no risk for age 60, regardless of your circumstances. Life-styling means that about 10 years before normal retirement age, your investments tend to be put on a generic, predetermined “glide path”. The trouble is, this may not align with your individual financial situation or your retirement plans. “People at that age often have much less debt, they are on better pay, maybe they have less financial responsibility,” says Benson. “In a lot of cases, they can afford to lose money in a way those younger might not be able to,” he says. Life-styling can be geared towards you drawing your pension from age 65, but many people are deciding to work later. You can end up derisking into a lot of cash years too early, at a time when cash is losing value, says Benson. The default strategy can be problematic for those intending to retire earlier too, says Charalambous.“If you are looking to retire before the normal State pension age, you should be looking to pull back sooner than the default – but it doesn’t know you want to draw down at 60,” he says.Getting a financial adviser to review whether your pension is invested in a way aligned to your individual situation could leave you far better off. Two-thirds of us say we have never spoken to a financial adviser about our pension, according to the CCPC research.Take controlOpting out of the default strategy and taking more control of how your pension contributions are invested is certainly not for everyone, but for the curious there are a few themes to consider, says Benson.“Start by asking the question ‘how would I feel if my money lost 10 per cent of its value in the space of three months?’ Could you cope with that?”“When you are in your early 40s, that’s exactly the kind of risk you want to be taking – if you lose 10 per cent in three months, it is absolutely irrelevant compared to the risk that your money doesn’t go up enough for several of the forthcoming years,” he says. Once you’ve got your head around the link between risk and your time to retirement, another factor to consider is asset allocation, says Benson.This is how you split your money among different types of investments, or asset classes. Equities, which are shares and stocks, are higher risk with potential for high long-term growth. Bonds are lower risk providing steadier income, but smaller growth. Cash is very safe and liquid, but yields the lowest return over time. Then there are alternatives such as property or infrastructure. A mix keeps your savings from taking massive hits if one market drops. Younger savers may favour more equities for growth, while people close to retirement tend to shift into safer bonds and cashAny asset used in the wrong way can be dangerous, including cash, says Benson. “A 20 year-old putting their pension into cash is making a terrible decision,” he says.When it comes to what percentage to put in the stock market, for someone until their mid-50s, that percentage could easily be as high as 80 per cent, he says.When assessing the funds you are invested in, look at things such as market volatility, whether you are over-concentrated in a certain sector or a certain country. A fund might be concentrated too much in one sector such as information technology, or a large part of the portfolio might be tied to US equities, for example, leading to geographic exposure. “You might form the view that the valuation of US assets is quite high due to the mega-cap tech companies and the AI buildout,” says Benson.That doesn’t necessarily mean exiting US stocks, but through a fund change you could tilt the balance away from the US towards Europe and companies that are paying a cash return as opposed to promising future returns from the AI buildout, says Benson. The most important factor when choosing investments is your time to pension drawdown, says Charalambous.“Bearing in mind you typically draw down 25 per cent from the fund and the balance stays in the pension pot,” he says.If you are 45 and looking to access your pension at 60, that’s 15 years away, so you should be at around risk level five, he says. “I always ask people: ‘when are you looking to slow down?’ For most of us, it’s sometime between 60 and 65, so if you are in your 40s now, it allows you to take a greater degree of risk because you know you have 20-plus years left.”Those younger, aged 30 to 40, could look at risk level six. If you are aged 50, depending on your anticipated drawdown age, you could split things between four or five. If you are in your 60s, drawing down at 65 or 66, you could drop to level four, he says.When it comes to assessing growth of an investment, people often don’t know what good looks like. How do you know if your money is doing okay?“Something growing by 4 per cent is poor because it’s barely keeping pace with inflation, there is no real growth,” says Charalambous. “An average long-term annual return of 8 to 10 per cent would typically be considered good,” he says. It can feel safest to invest in low-risk investments because less can go wrong and you might feel more comfortable, but then your pension is affected by losing out on compounding, says Charalambous.Following a default investment strategy will follow the rules but do so too conservatively, he says.It boils down to age and risk, says Benson. “If it’s producing 4 per cent and you are aged 30, then you probably need to make some changes,” he says.Charalambous says he sees too many people opting for a risk level four in their 40s.Some will have split their money by investing some at a risk level four, some at a five and some at a six.“They might think that’s a good strategy, but it makes no sense,” says Charalambous.“This is happening more and more frequently, I’m finding, but it goes against the whole premise of riding out the bumps longer term.”Not all high-risk funds are good though, he says. They need to be diversified – you don’t want your entire pension pot to rely on the success or failure of one single asset.“I like to see the words ‘global’ and ‘equity’, for example, when I look for a high-risk fund.”Talk to a financial adviser about projections too, he says – when saving and investing, you need to know your end goal and where you are at the moment to see whether there is a gap. [ ‘I’d rather see clients mortgage-free by 66 even if that means delaying pension contributions’Opens in new window ]“I feel for any individual, if you have €550,000 in a pension fund, that is enough,” says Charalambous.Add to that the State pension, which is worth about an additional €250,000.“€800,000 is the sweet spot – it puts you in a really good position and spits out an income of €30,000 a year, or €45,000 once you add the State pension of €15,000 a year,” he says. “€45,000 is typically what we are allowed to earn and not pay any tax at the higher rate,” he says. Most people can’t tell you how much income they are on track to have in retirement, whether they’re saving enough or what actions they could take to improve their future, says Benson.It’s Pensions Awareness Week – time to open your pension statement and talk to an adviser.