Pension investment options – an overview

If you have a pension, or are joining a pension or setting one up for yourself, you might be asked to decide how your money will be invested during the years until your retirement. The aim of investing money in a pension is to help grow the money into a larger amount and, aside from any contributions, will be the second biggest factor in determining how much you will have available to use when you retire. Find out about the investment options and what to consider when building up money in a pension.

Do you need to make investment choices?

Whether you need to make an investment choice is likely to depend on the type of pension you’re in and whether you’ve joined a pension set up by your employer, or one you’ve set up yourself.

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Defined benefit schemes

If you’re a member of a defined benefit scheme (often called final salary or career average schemes) in your workplace, you’re not responsible for the investment decisions. 

The scheme’s trustees decide how to invest, to be able to provide the retirement income that’s been promised. 

But you might still need to make pension investment decisions at some point, for example, if you decide to boost your pension savings by making extra contributions to a defined contribution scheme. These are often called Additional Voluntary Contributions (AVCs). 

Defined contribution schemes

In a defined contribution pension, you build up a pension pot which 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 either 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.

Workplace pensions

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.

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 and change to a different fund or spread your money across a number of funds throughout the time you’re building up your pension pot.

Pensions you set up yourself

If you set up a pension yourself, you’ll usually need to make a choice upfront about how to invest the money.

Pension providers will usually offer a range of investments and offer some level of support to help you choose.
However, this can vary depending on the type of pension and the provider you choose.

Some providers will offer a smaller selection and have options for those who want more straight-forward options, while other providers will offer a much larger range and might offer extra tools to help more confident investors narrow down their selections.

Providers have to 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.

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.    

What are the main investment options?

Most defined contribution pension plans offer a range of investment funds that are designed to invest your money in different ways over the years until your retirement.

You can usually choose to invest in one fund or spread your money over a number of funds.

All the details – such as the choice of the specific investment types that the fund invests in – are handled by the fund’s investment experts.

Investment types include company shares, property and bonds. These might be in the UK or overseas.

Lifestyle and target date funds

Many pension plans offer a ‘lifestyle’ or ‘target date’ fund. This usually means that more of your pot is invested in riskier investments (such as company shares) when you’re younger, and as you near retirement the balance of your investments shifts towards less risky assets (such as bonds and cash).

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

Key things to consider when choosing your investments

Choosing your own investments

There are many things to keep in mind when thinking about investments for your pension, including:

  • the length of investment
  • inflation
  • risk
  • spreading your money between different types of investments
  • fees and charges
  • reviewing your investments.

Investing for the long-term

Pensions are long-term investments.

You can’t usually touch the money in your pension pot until the age of 55 at the earliest, and you might not need the money until much later when you stop working.

This means you can invest the money differently from money that you know you’ll need in the short term, for example to pay a bill next month.

It also means that when investments fall in value (as they do from time to time) it’s worth remembering that, although not guaranteed, values do tend to go up over time.

If you have several years before you’re planning to draw your pension, there could still be time for your pot to recover from falls in the stock market that occur in the short to medium-term.

Inflation

For the money in your pension pot to grow so that it’s worth more to you in the future, your money needs to grow by more than 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. Due to low interest rates, if you invest your pension pot in cash, you might even find that the interest it’s earning is less than the rate of inflation meaning the real value of your pot goes down.

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

Most default funds are designed to do this for you.  

Risk

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 have an effect on determining 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 that 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.

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Spreading your money

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. 

Fees and charges

All funds have charges, often called an annual management charge or an overall charge figure.

This is often expressed as a percentage and automatically taken out of your pot by the provider.

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. Although 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. 

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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 take into account the type of investment fund, the objective of the fund and its performance.

A good fund manager might justify the 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. 

Review your investment choices regularly

You might not have to make any changes, but it’s important to check your investment choices regularly to make sure you’re still comfortable with the level of risk and that charges haven’t gone up.

Checking your funds at least once a year is recommended.

The information on your annual statement is a good place to start. This will tell you how the value of your pension pot has changed in the past year. Most annual statements also provide information on the charges.

This is even more important as you get closer to retirement.

At this point, you’ll want to make sure your investments are in line with what you intend to do. For example:

  • if you want to use your pension pot to buy a guaranteed retirement income (known as an annuity), you might want to move to lower-risk investments to help protect the fund you’ve built up from any shocks in stock market performance
  • if you want to use your pension pot for a flexible retirement income (also known as pension drawdown), you might not want to be in investments that are reducing in risk as inflation could begin affecting the purchasing power of your investments.

It's worth looking at investments that meet your ongoing needs.

Where to get more help

  • Ask your provider for information about the funds they offer and ask if they can provide any guidance.
  • Consider getting regulated financial advice on how to invest your pot. Due to the costs involved, this is more likely to be suitable when you’ve built up your pot.
  • If you’re aged 50 or over, you can have a free and impartial Pension Wise appointment. It will explain the different ways you can take money from your pension pot, which might be relevant when deciding how to invest the pot. 
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MoneyHelper is the new, easy way to get clear, free,
impartial help for all your money and pension choices.
Whatever your circumstances or plans, move forward with MoneyHelper.

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Looking for us? Now, we’re MoneyHelper

MoneyHelper is the new, easy way to get clear, free,
impartial help for all your money and pension choices.
Whatever your circumstances or plans, move forward with MoneyHelper.

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