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 learned 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 learned during that era, that would better prepare me 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 reiterate. Yes, I should have bought more of the fund when my pension tanked.
You will potentially earn higher returns for sinking your cash into undervalued stock (assuming you have a decent fund in the first place). 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, I wouldn’t rely solely on your pension. Some folk did (like my good colleague) and had to start over. 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.
1. I consolidated all my 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.
2. Then this pot of money (all my consolidated pension funds) were deployed into an index-linked fund (took me a while 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 managed funds).
I love firing up my Hargreaves & Lansdowne broker app and watching the fund grow:
Pension/ SIPP Update
I use the Vanguard LifeStrategy,
60/40 (60% Equities/ 40% Bonds) 80/20 (80% Equities/ 20% Bonds). As you can see below, 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 moderate growth/ less risk by selecting the 60/40 fund…or just 100% equities.
I recently switched from the 60/40 to the 80/20, as I can potentially gain greater returns on my hard earned cash.
Don’t get me wrong, the 60/40 is a brilliant performer and it’s risen a healthy 7.86% since I first started reporting my income back in Q3, 2016.
However, it wasn’t aggressive enough for me. As you need to invest more in assets that are riskier than bonds if you want to meet your investment goals without having to save an extremely large percentage of your income.
I have more time on my side (15-20 years), unlike someone in the withdrawal phase. I am a long-term buy and hold investor, hence I can afford a few downturns between now and the legal retirement age.
Again, this is part of my fast track strategy.
As a side note, no dealing charges were incurred for switching out the SIPP and it took roughly a week to do so. If I was getting technical, you don’t strictly switch it. You sell the 60/40 then purchase the 80/20. It was a clean transition with no surprises.
The Vanguard LifeStrategy 80/20 fund contains Equities such as:
Vanguard FTSE UK All Share Index Unit Trust GBP Accumulation Shares – 18.3%
Vanguard US Equity Index Fund Accumulation Shares – 19.2%
Vanguard Emerging Markets Stock Index Fund Accumulation Shares – 6.6%.
And Bonds such as:
Vanguard Global Bond Index Fund Pound Sterling Hedged Accumulation Shares – 13.9%
Vanguard UK Inflation-Linked Gilt Index Fund GBP Gross Accumulation Shares – 1.8%
Vanguard UK Investment Grade Bond Index Fund Accumulation Shares – 1.6%.
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%)
Since I switched to the LS 80/20, my pension fund/ SIPP is currently returning 5.47% on invested capital (since inception in April 2018), as you can see from the screenshot above i.e. it’s returning 5.47% annually 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 10.81% (as you can see below in Morningstar screenshot).
The Irish Pension’s 5 year annualized return is 5.40%, a little under half that of the Vanguard LifeStrategy 80/20.
“Over the last 90 years, an 80/20 split has an average annual return of 9.6%, which is roughly 6.5% after inflation” (according to the Bogleheads Forum).
Hence, this SIPP is providing much better returns and smaller management fees than my 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, not everyone agrees. 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 close colleagues 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, here are 5 advantages of investing in a SIPP:
1. You will massively reduce your corporation tax bill (if you happen to operate a Ltd company) 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 for fun. The pension is a legitimate business expense you can set off against Corporation Tax.
2. For a basic rate tax-payer, the government will provide you with 20% on top of what you stick in your pension. This is basic rate tax relief. Tmaximumium 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.
Maybe drip feed that 25% over a long time period. Otherwise, you could potentially lose out on heftier returns.
5. An Index fund (SIPP) grows like a beautiful flower. A set and forget if you like, so there are no headaches in managing it. Apart from adding cash to it every quarter or so.
To answer a question from one of my colleagues… “What are the best pensions for contractors?” It’s the Vanguard LifeStrategy for the 5 reasons stated above. Point number 1 is pertinent.
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 optimize 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 interesting and ‘shiny’.
Now I would like to hear from you.
How’s your pension fund shaping up? Or, maybe you’ve found another asset class that’s outperforming the market?
Let us know in the comments…