Workplace pensions: how NEST will invest your compulsory pension
As NEST, the Government's compulsory pension scheme, gets ready to launch, we look at how your pension will be invested.
If you’ve got a job and you’re not saving for a pension, a big change is about to hit you. The Government’s new auto-enrolment scheme is about to start and that means you may be obliged to save into a pension.
Indeed, some people will be automatically enrolled in a pension scheme as early as this October. If you don’t like the sound of this, you’ll have to make the effort to opt out. If you do nothing, you’ll be saving for a pension whether you like it or not.
It’s up to your employer to decide who will operate your workplace pension scheme, but it’s expected that many employers will go with NEST, a new Government-backed pension provider.
As there’s a good chance you’ll end up with a NEST pension, I thought it would be worth finding out more about how NEST will invest your pension nest egg.
Retirement date funds
Most NEST savers are expected to invest their pensions in retirement date funds – also known as target date funds. These are funds that are managed on the basis that you’re most likely to retire in a particular year.
So if your most likely retirement date is 2025, your pension will be invested in the 2025 retirement date fund. If your most likely retirement date is 2055, you’ll be invested in the 2055 fund.
You can read more about retirement date funds in A better way to build your pension. I’m a big fan of these funds because they mean your pension will be invested in appropriate assets for your age.
So if you’re 35, you can afford to have a fairly risky investment portfolio because you have plenty of time to recover if share prices fall. But if you’re 58, you won’t have that time, so it makes sense to invest in lower risk assets at that point.
NEST’s retirement date funds will be split into three phases. Let’s look at them in more detail:
1. Foundation phase
If you’re joining NEST in your 20s, your early contributions will mainly be invested in low-risk assets. Only about 30-40% of your cash will be invested in the stock market.
That might surprise you. It surprised me when I first heard it. In fact, I thought this approach was a big mistake. It goes against what I said earlier about investing in higher risk assets when you’re young.
That said, NEST’s chief investment officer, Mark Fawcett, has persuaded me that it’s not such a dumb idea after all.
That’s because NEST has done some extensive research into the attitudes of twentysomethings to investment risk. It turns out that many young people react extremely badly to any sign they might be losing money.
Let’s imagine that NEST invested 90% of all Foundation phase investments into stocks and shares. Let’s then imagine that the stock market had a bad year and fell by a quarter. If that happened, there’s a big danger that young savers would be very upset and opt out from auto-enrolment for many years to come.
But if twentysomethings have a lower risk portfolio, they’re more likely to carry on paying into their pension for the rest of their working lives.
NEST’s research shows that people in their 30s are less scared by one or two bad years. So at that stage, it makes sense to put people’s money into riskier assets.
2. Growth phase
This is when greater risks are taken. The greatest risk will probably be taken when you’re in your 40s, and after that there will be a gradual shift to less risky assets.
Although there’s a broad framework for how the risk levels will change, Fawcett does have some room to ‘flex’ his investment decisions if that’s appropriate. In other words, if stocks and shares look cheap, he might invest a bit more than normal in the stock market. And if they look expensive, a bit less than normal.
But whatever the market conditions, Fawcett is determined to consider a broad range of assets including property and corporate bonds. He’ll never invest more than 80% of any fund in the stock market.
3. Consolidation phase
The consolidation phase is for when you’re heading towards retirement – probably for the last ten years that you’re working. Your fund will increasingly be invested in low-risk assets such as gilts.
Although it’s expected that most people will go for the appropriate retirement date fund, there are some other options you can choose from. These include a high-risk fund, a Sharia-compliant fund and an ethical fund.
The other really important investment issue is charges. NEST will charge an annual charge of 0.3% on all your assets plus 1.8% when you first invest the money. So if you invested £1,000 this year, you’d pay a 'contribution charge' of £18, and if your total pot was worth £10,000, you’d pay a £30 annual charge. If you invested a further £1000 next year, you'd be charged a further £18 contribution charge on that fresh investment.
The annual charge is very reasonable but the contribution charge is on the high side at 1.8%. Sadly, NEST has to pay back a loan to the Government, so that’s why it has to charge so much. That contribution charge will probably be cut back at some point, but it’ll be a while.
In spite of that high contribution charge, I think that NEST’s overall investment approach looks sound. If I worked for an employer that offered a NEST pension, I’d be happy to stay enrolled. No opt-out for me.
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