Three years after the landmark pensions freedom reforms, the overhaul is widely seen as a success: large numbers of savers have taken advantage of new rules making it much simpler for them to draw an income directly from their savings in retirement, rather than having to buy an annuity. This is a more flexible arrangement and means savers can continue to invest their pension funds, hopefully securing further growth.
However, there is a black cloud on the horizon. The big advantage of an annuity is the guaranteed income it pays for life; by contrast, savers who decide to continue managing their pension funds in retirement, drawing down income and investing for growth, can’t be sure they won’t run out of money, particularly if financial markets disappoint. But while managing a retirement fund is therefore a crucially important and potentially difficult job, a study published this month by Zurich reveals that many savers are very inexperienced; one in three have never managed their own investments and almost half get no independent financial advice.
How do savers resolve this difficulty? Well, independent financial advice is definitely a good idea, but if you’re determined to take the lead in managing your pension fund, look for collective investment products that are well-suited to your needs. In particular, investment companies can work very well for savers managing a pension fund.
How investment companies can help provide income
The first reason to consider investment companies in retirement is that they generate income in a very dependable way. If you’re relying on your savings to generate a regular pension income, the uncertainties of financial markets can be unnerving. Investment companies, however, provide a means to smooth out these uncertainties.
This is because, unlike other collective funds, investment companies are allowed to build up reserve accounts. They hold back some income in better years in order to fund pay-outs in leaner times; for many funds, this facility has underpinned their ability to go on increasing dividends no matter what is happening in the broader market environment. Some funds now have a record of paying higher dividends every year for decades.
Moreover, investment companies recognise the growing demand for income. Many are able to make income distributions from capital or are seeking permission from shareholders for the right to do so. This has a downside – there will be less capital for the future – but can be a useful feature if income is your absolute priority.
Finally, many investment companies offer convenience when it comes to income payments, offering dividend payments on a quarterly or even monthly basis. More funds are moving to such payments, recognising the demand from pension savers for more regular distributions.
How investment companies can help secure capital
Of course, income in retirement is only one half of the equation. Savers also need to think hard about how to preserve – and even grow – their capital over the long term. Otherwise there won’t be a pot of savings to draw an income from in the future.
On pure capital performance, investment companies have a strong record. Long-term studies of comparable investment companies and other types of fund routinely find that the former tend to outperform. There are several explanations for this, but one important element is that investment companies have the ability to take on gearing. Borrowing money to add to your portfolio gives returns an additional boost when financial markets are rising, though works in the opposite way during down periods.
As for capital preservation, the breadth of the investment companies sector provides a means with which to diversify your pool of savings – across stock markets, certainly, but also into other types of asset that can provide protection, including property, debt and infrastructure. Investment companies find it more straightforward to invest in these asset classes because of their structures.
Alternatively, several investment companies aim to provide a one-stop-shop for investors looking to spread their bets, investing in a broad range of assets within the same fund.
This is not to suggest that investment companies are right for all savers in retirement, or that they should be the only type of fund in your pension pot. However, the sector does represent an excellent fit for the priorities of most savers who choose not to purchase an annuity – access to dependable income and long-term capital preservation and growth.