Imagine running out of your pension fund halfway through retirement. Or, thinking you were ready to retire, only for some crisis to wipe out over half your portfolio (as well as your hopes and dreams). But it happened…
Let’s go back to 2007 (when I didn’t know any better). I decided then to open a pension fund for my Ltd Company. There were already pension pots from previous workplaces (which were all over the shop).
I had lined up a financial advisor and was happy to get my act together and plan for the future.
However, the timing couldn’t have been worse. Who could have foreseen the worst financial crisis in history? The pension fund tanked around a year later. The banking crisis bit hard and I lost a little over half of my pension.
Around the same time, I always remember a colleague of mine stomping around the office. He had a face like thunder. I learnt later, he was just about to retire but the banking crisis had taken away his main source of income. It was back to the drawing board for him.
Some key pointers were learnt during that era, that would better prepare myself and others for the financial turmoil from any other crisis, such as Brexit (although, a slightly different kettle of fish).
Key Pension Fund Takeaways
1. Don’t Panic
The most critical piece of advice during a financial crisis.
Don’t sell i.e. don’t panic.
A natural reaction is to dump your stock during a market meltdown and follow the crowd.
I remember phoning up my advisor in shock and asking for advice. In fact, I was ready to sell but he told me to hang tight and ride it out. It sounded really counter-intuitive at the time, but he was right. I made the mistake to panic, but fortunately, I held my ground and didn’t sell.
The pension fund eventually climbed it’s way back years later and has currently made 32% on the original capital invested.
2. Buy More
This is another counter-intuitive piece of advice during a falling stock market.
And it was one of the costlier mistakes I made…by not purchasing more when my pension halved in two.
Lets reitierate. Yes, I should have bought more of the fund when my pension tanked.
You will earn higher returns for sinking your cash into fallen stock/ undervalued stock (as long as the fund has a long track record and performance and not too volatile). That’s why I love bear markets or recessions. I know I’m buying cheap and I’m going to be in it for the long term.
3. Pick Wisely
The reasons my Irish pension tanked so much, was mainly due to the 2 bullet points below:
- My fund was primarily held in equities. When I think about it now, I should have also used bonds to hedge against market risk. International bonds offer diversification and risk management benefits.
- Equities all held in one country. At the time, I had limited international exposure. It was a recipe for disaster.
The last thing I will say is, don’t rely solely on your pension. Some folk did (like my good colleague) and had to start again. Have some other asset classes in place and spread the risk.
Also, there can be severe tax implications by only having your pension as your main source of income.
There are so many options these days, however, I don’t blame you for being overwhelmed.
I recommend consolidating all your former workplace pensions into a SIPP (Self Invested Personal Pension). This takes away any admin headaches i.e. you only have to manage one fund, as opposed to a small handful of pensions. I use the word ‘manage’ lightly, as a quality SIPP uses automatic rebalancing. It’s passive investing at it’s best.
Then what I’m about to tell you is the best bit of advice you’ll ever here.
Stick your money (all your consolidated pension funds) into an index-linked fund (took me years to figure this out). Index-linked has outperformed all other funds over the last century and you pay minimum management fees (as opposed to other actively manged funds).
I love firing up my Hargreaves & Lansdowne broker app and watching the fund grow.
I use the Vanguard Life Strategy, 60/40 (60% Equities/ 40% Bonds). As you can see, it is fairly diversified i.e. it holds international bonds and has holdings in various countries.
This is a globally diversified set of equities, coupled with corporate bonds and gilts. You could opt for more growth/ higher risk by selecting the 80/20 fund…or just 100% equities.
The fund contains the likes of FTSE UK All Share 15.0%, US Equity 13.7% and Emerging Markets 4.6% from the equity side.
And the likes of Global 19.2%, UK Gilts 5.9% and UK Corp. Bonds 3.6% from the bonds side.
The vanguard fund charge is 0.22%. If not buying through Vanguard direct, you’ll incur another small fee from your broker. All in all, fairly cheap to run. (The Irish Pension’s fund charge is 0.62%)
This is currently returning 32.59% on invested capital, as you can see from the screenshot above i.e. it’s returning 32.59% annualy on all the previous workplace pensions and other invested capital taken from my Ltd company. The annualized return (over the long term i.e. 5 years) is 7.46%. (The Irish Pension’s annualized return is 5.40%)
Hence, this SIPP is providing much better returns and smaller management fees than the Irish Pension (and my previous workplace pensions).
5 Reasons Why You Should Include a Pension in Your Portfolio
Of course you should have a pension…I hear you. However, the number of contractors I know who have avoided this asset class is quite surprising. Why? The pension is seen as this unsexy investment vehicle. It’s regarded as delayed gratification in this fast paced, technology dependent culture.
What I discovered is, my contractor friends have opted to neglect this pot of gold for other shiny things. Each to their own I say, and folk are free to invest how they like. However, I would like to point out the number of advantages below:
1. You will massively reduce your corporation tax bill at the end of the accounting year. A bulging business account is not good, with regards to inland revenue purposes. They’ll just tax you like a bastard. The pension is a legitimate business expenses you can set off against Corporation Tax.
2. For a basic rate tax payer, the government will provide you 20% on top of what you stick in your pension. This is basic rate tax relief. The maxium you can deposit in your SIPP is 32K, hence the UK government will match this with 8K.
3. Pick your pension fund (SIPP) wisely and it can provide you with a very generous annual return.
4. With regards to drawdown, you can withdraw the first 25% tax free and the rest is taxed as income.
5. An Index fund (SIPP) grows like a beautiful flower. A set and forget if you like, so there’s no headaches in managing it. Apart from adding cash to it every quarter or so.
A pension/ SIPP will diversify your portfolio, thus spreading the risk. Think of it as a seedling, that will one day grow into a beautiful oak tree, through the power of compounding. With little management from yourself.
You can optimise the annual return of your pension fund by picking a fund with a historically good return and low total expense ratio (management fee).
Apart from the pension fund gains, our friends at the inland revenue will also give you a complimentary 20% on top of your annual allowance. So, if you stick 20K per annum into your pension, they’ll match it with 4K.
It’s a win win.
Well, what are you waiting for? Pension funds just got sexy…
Now I would like to hear from you.
How’s your pension fund shaping up? Or, maybe you’ve found an asset class that’s outperforming the market?
Let us know in the comments…