You'll need to pick the right funds if you want to build up a sizeable pension pot. Here we explain what a fund is and how to pick the best funds for your pension.
What is a fund?
When you start your pension, you'll always be asked in which fund you'd like your pension contributions to be invested.
Normally, you'll be given a list of funds to choose from.
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 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 that will out-perform the market, and ultimately boost the value of your pension. Of course, this doesn't always happen.
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 all or most of your pension in the stock market.
This will maximise the potential for capital growth over the long-term.
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 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. This is known as diversification.
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.
How do I pick the right funds for my pension?
Always check past performance of the funds in the area you want to invest in first. This isn't as tricky as it sounds.
We use Trustnet.co.uk to compare funds and find the top-performers over different timescales.
As you know, past performance is only part of the story. It has no bearing on what might happen in the future. So take a look too at 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.
We 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.
If you need help with your pension fund
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.
This article is updated regularly
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