Inthis blogwe looked at your three pension fund options and inthis onewe gave a warning about the risk of option 1 and 2. So for those of you selecting option 3, yoiu have more work to do as you have to self-select your pension funds. In this blog we are going to try to make this easier.
The best approach when self-selecting funds is to pick funds that you can leave to grow for decades without having to constantly monitor and tweak them. There is plenty of research in the market that shows that tinkering with your portfolio is about the worst thing you can do.
When deciding on how to invest your pension fund, a good start is to take a look at what you are investing into. The three biggest investments available via your pension fund options are company shares, company bonds and government bonds.
When you buy a share in a company you are buying a share in the profits of that company. You will receive an income every year which is called a dividend, this is the part of the company’s profits that is given to shareholders. The price of the share may go up and down (which will affect your pension fund value) but as long as the company keeps making profits and sharing these with you then your pension fund should grow in the long-term. In the past, shares have always given the best long-term growth of these three options.
When you buy a company bond you are making a loan to a company to help them to invest and grow. You are not buying into the profits of the company but you will benefit again from income but this time from the interest that the company is willing to pay you to borrow your money. The value of your bond can still go up and down as other buyers will change their mind about whether that income is worth more or less to buy but in most years the rise and fall in price should not be as extreme as shares.
When you buy a government bond you are making a loan to a world government to help them pay for services to their people. You are again lending money and will receive income as interest on your loan. If you lend to a large and stable government the interest rate will be lower than lending to a company because there is less risk of that government going bust than a company going bust. This also means that in most years the price of these bonds will rise and fall the least of these three investments. There are, of course, less stable countries that you can lend to that will both give you a higher interest rate and a wilder ride on the price.
Your Standard Life pension cannot be invested in a share in a single company or in a loan to a single company/country. Instead it can be invested in a fund which will invest in thousands of these individual investments. This reduces some risk as it is less likely that thousands of companies will go bust, than a single company will go bust. There are 9,200 companies in the main MSCI All Countries World Index.
World stockmarkets are dominated by the US market which makes up roughly 54% of the total by the size of the companies that are listed there. This is obvious if you think about the giant American firms such as Apple, Microsoft and Google. It sometimes surprises people to hear that Japan is the second largest stockmarket at 10% of the total but when you think of Toyota and Sony it soon becomes clear why. The UK stockmarket is still the largest of the European markets at 4% of the total and then rest is made up by European, Asian and Developing Countries. In the long-term US shares have returned circa 9% per year. One of the worst years in this time period though, would have seen the value fall 23%.
World bondmarkets are larger by total size than world stockmarkets and unlike stockmarkets are dominated by government bonds rather than company bonds. Of these governments, the US and Japanese governments are still the largest by size, as with shares. In the long-term US government bonds have returned circa 5% per annum. Bonds typically return less and also fall less, one of the worst periods for bonds was the first half of 2022 where the fall was 10%.
To decide whether to invest in shares or bonds you need to think about the degree of risk that you are happy to take. As we see above the returns are less from bonds but the falls are also less. If you feel that a 23% loss of your pension fund might lead to you panicking and moving to bonds then it might not be wise to just invest in the Standard Life funds that are just invested in shares. Shares can be a little like Orange Squash, you can drink it neat but you might end up bouncing up and down on the spot. Bonds are a little like the water that you mix in to take the edge off. No one likes really weak Squash though. Once you have decided whether to invest your pension in shares or bonds you can select from the available funds in the Standard Life MasterTrust range.
