More than 90% of pension scheme members are invested in the “default” fund. This is a one-size-fits-all scheme that makes investment decisions on behalf of members, pooled by their age group.
This is the investment strategy; the younger you are, the longer you have until retirement, the larger proportion of your portfolio that should be in riskier assets. As you approach retirement, the default scheme will de-risk the portfolio on your behalf, moving out of stocks and alternatives and into cash and bonds, prioritising capital preservation over growth.
For the vast majority of savers, the default is the right place to be. Many employees have little interest in markets and would prefer to outsource asset allocation to the professionals. But there are downsides to the default fund – the fact that it is a one-size-fits-all solution, means that is it unlikely to be the perfect fit for every individual.
Due to downward pressure on fees across asset management, default schemes are now made up almost entirely of passive funds. There are certain sectors which analysts argue are better served by active management and not available to members of the default scheme.
Default funds make assumptions about a member’s retirement date based solely on their age. This is necessary to run a pooled portfolio, and benefits the scheme member by leveraging assets under management to drive down costs. This assumption may be wrong and a scheme will start to sell you out of equities as young as 50.
If you plan to work until 70, this jeopardises the size of your pension pot at retirement. It could mean you have to put more money in, or accept a lesser standard of living.
Data shows that the majority of workers don’t know their retirement date until as little as three years before the event, meaning taking an investment decision a decade and a half in advance is inappropriate for some.
If you are considering coming out of the default fund you need to be engaged with the investment process and comfortable taking on greater levels of risk.