How to pick the best pension funds
The key to building up a decent pension pot is to invest it well. Here's how to do that!
Many lovemoney.com readers think saving into a pension is pointless and a waste of money.
I disagree, but I have to admit that this view is backed up by resent research from pension website, How Much Do I Need To Retire?, which revealed that more than eight out of ten (86%) pension funds are poor performers.
It's enough to put you off pensions completely. But I still believe, for many of you, saving into a pension is the best way to save for retirement, especially if you take the time to invest your pension well. If you know where to look, you can find funds which will turn your pension savings into an impressive pension pot.
If you're one of the lucky few who have a final salary pension, the investment decisions will be made for you, providing guaranteed benefits when you retire. (That said, even if you do have a final salary scheme things can still go wrong.) But the vast majority don't have this luxury or the peace of mind it brings.
Most pension savers instead have a personal pension - or a group personal pension through their employer - where your retirement income isn't guaranteed. The amount you receive when you stop working will largely depend on how well your pension funds have performed over the years. That's why it's so important to invest your pension money in the best possible place.
What is a fund?
When you set up your pension, you'll always be asked where you want your contributions invested. Normally, you'll be given a list of funds from which you can make your selections.
But what is a fund? Quite simply, it allows individual investors to pool their pension contributions together. A fund manager then invests all that money in a portfolio of shares (and/or other assets). The type of shares the manager picks will depend on the theme and aim of the fund.
The idea is the manager will use their expertise to pick shares which will out-perform the market, and ultimately boost the value of your pension.
You can pick as many funds as you like, but if you have an older-style pension, you may find the range is very limited. In fact, you might only be able to access in-house funds run by your pension provider. Newer-style pensions and self-invested personal pension schemes (SIPPs) will allow a much wider variety of what are often better performing funds.
If you have an older scheme which isn't doing well, the lack of investment choice could be a very good reason for transferring it to a new plan.
But you don't have to your choose your own funds. If you decide not to, your contributions will be put in a 'default' fund chosen by the pension provider instead. But the trouble is the default fund isn't usually the best-performing fund on offer, so your pension pot may now growth as fast as it could.
How should I invest my pension?
If you still have many years left before you retire, then despite the risks, it makes sense to invest your entire pension in the stock market. This will maximise the potential for capital growth.
But where should you invest? Remember, these days, you have the opportunity to invest in just about any market, anywhere in the world. For instance, if you fancy putting money in Latin American emerging markets, you'll find a range of funds which can do that for you. The investment world really is your oyster!
The aim of the game is to diversify. It's a big mistake to invest your entire pension in say, a single China fund. If the Chinese economy falters, your pension pot could fall in value dramatically with no other investments to offset the losses.
So it's usually wise to spread your risks, and invest in different markets and regions.
You could pick a collection of funds which give exposure to the UK, global and emerging markets as well investing in small and large companies. You can also combine different themes by going for funds which invest solely in property shares or gold, for example. But remember the more concentrated the fund is, the more risky and volatile it will be.
So a good strategy is to mix things up a bit and then pick the strongest funds in each area you choose.
That said, you should think about reducing your exposure to shares as you get closer to retirement. This minimises the risk of the stock market nose diving and destroying your pension pot just as you want to retire.
You can do this by moving your pension out of shares and into lower risk assets such as cash or bonds. Read How to protect your pension to find out how.
How do I pick the right funds?
I'll admit this will take a bit of effort because there are hundreds to choose from, but I'll explain how I go about it. I always check past performance of the funds in the area I want to invest in first. This isn't as tricky as it sounds. I use Trustnet.co.uk to compare funds and find the top-performers over different timescales. You may also want to subscribe to our sister site, The Motley Fool, which offers investment tips and advice.
As you know past performance is only part of the story. It has no bearing on what might happen in the future. So personally, I also pay a great deal of attention to the fund manager ratings.
Many fund managers are rated on how successful they are at running their fund. You can find out the ratings from the fund factsheet (every fund has one). This data should be freely available on the fund manager's website.
I would steer clear of any manager without a proven track record. There are several fund ratings agencies - such as Standard & Poors, Morningstar and Citywire - which can identify the top managers for us. Don't forget your star manager could move to another fund, so check their replacement is up to the task.
There's also a lot of free, independent fund research out there which you should take advantage of. I use Hargreaves Lansdown to help me with their analysis of over 2,000 funds from 190 leading fund management groups.
Over the past 12 months, my own pension has grown by over 19%. Of course, there's no guarantee that it will continue to do so, but for me at least, my fund-picking strategy seems to be working so far.
Help! I'm lost!
On a final note, do be careful with your investment decisions. If you don't feel confident choosing your own funds, speak to a good independent financial adviser instead. But alas, you will need to pay for their help.
Do you have any tips for picking a good pension fund? If so, feel free to share them using the comments box below!