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How can you achieve the perfect pension?
The perfect pension depends on getting the right mix of assets, starting saving early and making sure you're making the most out of your money.
by Michelle McGagh on Nov 15, 2012 at 10:08
The perfect pension for most of us is one that lets us live like a millionaire in our old age. But failing that we’d settle for a decent standard of living, and one man has come up with some rules to achieve a better pension.
The average pension pot is just £25,874 at retirement, or worked out as an income just £28 per week for a man aged 65, and falling each year thanks to inflation.
It’s a sorry state of affairs, and certainly not a decent standard of living, which is why Rod Thomas, chief executive of Axis Property Investment, wants you to ‘take back control of your pension and improve its performance’.
Thomas has written a book called ‘The pensions disaster and how to plan for a secure retirement’, in which he details ‘how to build the perfect pension’.
What should the perfect pension deliver?
Thomas has identified four things that a pension should do:
- Preserve your capital: many investors have seen the value of their contributions fall and ‘we want to avoid that at all costs’, Thomas said. This means your money is worth less than it was after being invested.
- Perform well: you need to achieve higher annual returns from income and growth investments to build up your pot. Income investments include gilts, bonds and savings accounts while growth is gained from stocks and shares.
- Protect you from inflation: as living costs increase your money becomes worth less in real terms so investments need to beat inflation.
- Let you pass money on: passing something on to your family in your old age or in the event of your death is a big deal to many people, although not essential to your immediate living standards as the other three points are.
How do I achieve this?
Most people want their pension to do at least three of these things, but achieving it is far tougher and requires dedication to saving early in life and saving regularly. It also involves making sure you get the right mix of investments.
Thomas said the structure of the pension is important, and a self-invested personal pension (Sipp) can provide the most flexibility for those who want to have a go at investing their pension pot themselves. As the name suggests, the saver invests their money rather than an insurance company investing the money, as happens with a personal pension.
Pensions are invested for the long term, which is why it is much easier to get the balance of investment growth and risk-taking right if you start saving early.
‘We should consider risk at each stage of the development of our pension. If you are at the first stage – building your capital – and you have more than 20 years until you retire, then you can afford to take a bigger risk than if you have already retired and are now reliant on a monthly income,’ Thomas said.
‘Perversely if you have left your pension provision until later in life and you have a short time to go to retirement – say, less than 15 years – you are going to need an aggressive growth strategy to build an acceptable pension pot in time. While in theory you should be taking less risks than ever, you may face the situation where the only option to successfully build the pension you need is to accept a higher level of risk in return for a potentially higher return.’
Investing in assets that are volatile should ideally be for people with time on their side, this could be anything from stocks and shares to funds that are more risky such as emerging markets.
Investors should aim to increase both the capital and income in their pension, which means investing in a mix of assets. For example, savings accounts pay income in the form of interest but the value of your capital doesn’t grow, it slowly erodes away over time.
Capital growth can be found by investing in funds and stocks and shares, as there is the potential to see your investment increase – there is even the possibility of a small income in the form of dividends paid out by companies.
To get income growth, investors need to look at bonds and gilts, which are effectively loans to companies or the government respectively, which promise to pay you back with interest (or an income) at a set point in the future.
Thomas argued that property can provide both capital and income growth – the value of a property could increase over time (capital growth) and rent from a property (income) can also go up. However, as we have seen, property does not always go up in value.
Overall, Thomas advocated a low-risk investment approach to pensions because very few people can time the market perfectly – buying at the bottom and selling at the top.
‘When your retirement is at stake, I’m not a believer in taking risks with your money,’ he said.
However, before you start tackling your pension investments Thomas said a pension review is essential to understand how the pension is performing and how much is being charged.
It will also help you understand exactly when you will be able to retire and what you can expect to live on in retirement, and whether there is a shortfall between what you want to have and what you can expect to have.
‘A lucky few will have no shortfall. If that’s you, the pressure is off. You may not have the most efficient and productive investments, but doing better will be a matter of choice, not necessity,’ he said.
‘If, on the other hand, you have identified a shortfall, it’s time to decide what to do about it.’
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