Pension investment options – an overview

The aim of investing money in a pension is to help grow the money into a larger amount. After any contributions, this will have the biggest impact on how much you will have available when you retire. Find out about the investment options and what to consider when building up money in a pension.

In a defined contribution pension, you build up a pension pot that will pay you a retirement income based on how much you and/or your employer contribute and how much this grows.

Your money will usually be invested in one fund or a number of funds. A fund is a way to invest money.

Depending on what type of fund it is, your money could be invested in property, shares in companies, bonds, or a mixture of different types of investments.

When you join a workplace pension your money will usually be automatically invested in a fund for you.

This is sometimes called the ‘default’ fund and will have been chosen by the pension scheme to meet the investment needs of most of the members.

If you’re happy with this fund, you don’t need to do anything more. Often this will be a ‘lifestyle’ or ‘target date’ fund. There’s more information on these types of fund below.

Most workplace pensions will also give you the option of choosing a different fund if you prefer. So it’s worth looking at these in case they’re better suited to you.

For example, there might be funds that offer higher growth but these might be riskier, meaning your pension pot could rise and fall in value more often.

Or there might be an ethical or socially responsible fund that appeals to you.

Some pensions also offer Sharia-compliant funds which invest in accordance with Islamic law, for example avoiding companies involved in gambling or alcohol. If one of these types of funds is of interest, check if your employer’s pension provider offers them. If not, ask your employer if they will make pension contributions to a different pension which does include these options. 

Even if you decide to stay in the fund chosen for you by the pension scheme for now, you can usually change your mind later. You can then change to a different fund or spread your money across a number of funds throughout the time you’re building up your pension pot.

Providers must provide certain information to help you decide. For example:

•  information on how the fund is invested
•  what returns the fund has made in the past
•  what the charges are
• what risk is involved with the fund.

The widest choice of funds is normally offered by self-invested personal pensions (SIPPs).

If you have a stakeholder pension, there will be a standard investment option that you can choose. This will often be a be a ‘lifestyle’ or ‘target date’ fund. There’s more information on this below.

Many pension plans offer a ‘lifestyle’ or ‘target date’ fund, which takes your expected retirement date into account. This usually means two things.

First, when you’re younger your pot is invested in riskier investments, such as company shares. These are more likely to grow over longer time periods, but their value can fluctuate more, particularly in the short-term. 

Second, as you get closer to retirement, your investments will shift gradually and automatically to more stable assets, such as bonds and cash deposits. But keep in mind, even more stable investments can go up and down in value. 

Bonds tend to move in line with annuity prices, so if you’re planning to buy an annuity with part of your pension pot, they can work as a way of protecting against changes in annuity prices. If you aren’t planning to buy an annuity, you may need to choose a different way of investing your pot.   

If you’re in a lifestyle or target date fund and your retirement plans change, your investment might no longer be suitable, and you may wish to review your investment choices. 

Many default funds are set up on this basis. This shift is handled by the fund’s investment managers. 

For the money in your pension pot to grow so that it’s worth more to you in the future than it is now, it needs to outpace inflation.

If it doesn’t, the spending power of your money will go down. Even when inflation appears low, over the long-term those small increases can add up to a lot. This means your money today will buy a lot less in future years. Low interest rates mean that if you invest your pension pot in cash, you might even find that it’s earning less than inflation. This causes the real value of your pot to fall.

Inflation is particularly important to take into account for pensions as they can run for such long periods of time. This means you need to consider investment types that aim to produce better returns than inflation.

Most default funds are designed to do this for you.  

It might be natural to think that as your pension pot is important, you want to keep it safe and don’t want to take any risk with it by investing in anything that can rise and fall too much in value.

But if you want your investments to grow, that’s difficult to achieve if you only choose lower-risk investments, such as cash or bonds.

Company shares have historically performed better than cash or bonds over the longer term, but be aware that there are no guarantees they’ll always do that. 
While all funds are designed to grow over the medium to long-term, the investment types that a particular fund invests in will affect the fund’s risk profile. This basically means whether the investments in the fund will be low, medium or high risk. 

Funds that invest in higher-risk investment types have the potential to produce higher investment returns over the longer term.

But they might lose value due to the volatility of the investment market. This means they could be severely affected by market downturns and other factors.

Lower-risk funds might be less volatile, but over the longer term could produce lower returns than higher-risk funds.

To protect yourself against a particular investment falling in value, you can spread your money between different types of investments – for example, company shares, property and bonds. This is known as diversification.

The performance of different investment types will vary over time. As each investment type has different characteristics, market conditions and world events will affect them differently.

The main advantage of diversification is that if one type of investment falls in value, other types might not fall – and could even go up.

Holding a diverse range of investment types in line with your goals and risk tolerance will help minimise the bad performance of a single investment type on your overall investments. And it will help take advantage of opportunities across the market.

Many default funds are invested in a range of investment types to give you this diversification without you having to do anything. Your provider will be able to tell you how their funds are invested. 

All funds have charges. A common one is the annual management charge.

It is often shown as a percentage that your provider automatically takes out of your pot.

The charges cover the provider’s costs in investing your money.

In many workplace pensions, the fund charges also cover the costs of administering your pension pot. Sometimes this is charged separately, particularly in pensions you set up yourself. So make sure you check all the charges when comparing the charges between different providers. 

Check how much the different funds on offer charge. This is because, while the performance of your investments can vary over time, you’ll have to pay charges regardless of how well your investments do. Over time, fund charges can make a huge difference to the amount you get at the end.

As a reference, if you’re in a workplace pension and you’ve opted to remain in the investment chosen for you by the pension (‘the default’), the maximum annual management charge is 0.75% per year. Some charges are much lower than this and some are much higher.

When looking at investments, you need to consider the type of investment fund, the aim of the fund and its performance.

A good fund manager might justify higher charges. For example, they could offer the potential to achieve better performance or have set the fund to smooth the ups and downs.

If you’re looking at past performance, always remember that past performance shouldn’t be relied on to predict future fund performance.