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How to choose the right pension funds

Updated 26 May 2021

5min read

Nick Green
Financial Journalist

Whether you have a workplace pension, personal pension, SIPP – or a combination of pension plans – it's important to understand how and where your pension fund is being invested by your pension provider, particularly as you move closer to retirement.

What is a pension fund?

Essentially, a pension fund is a long-term, tax-efficient savings plan that you can access in later life when you want to work less or retire. Pension funds are made up of a portfolio of assets in which your pension contributions are invested, such as stocks and shares, bonds, cash and commercial property.

You can receive a pension from three different sources: the state, personal pensions that you've set up yourself, and workplace pensions from employers. Depending on the type of pension you have, you may be able to choose how your pension contributions are invested to best suit your plans and circumstances.

What are the fund options for my workplace pension?

Workplace pensions come in two types:

If you have a workplace defined contribution scheme, your employer may offer you a default investment fund. This investment strategy is for people who can't or don't want to make their own pension decisions and is designed to reduce risk as the pension saver approaches retirement age.

In some instances, you may choose an investment fund yourself – this depends on the terms of the workplace pension scheme. You can do this by speaking to your pension provider or viewing your pension plan online and looking through the fund options. You may find it helpful to seek financial advice to help you decide which are most suitable.

If you're a member of a defined benefit scheme, it's your employer who takes the investment decisions and risks needed to reach the pension target that's been set. However, you may still need to make pension investment decisions at some point, for example, if you want to boost your pension savings by making additional contributions to a defined contribution scheme.

What fund options do I have with a personal pension?

If you have a personal pension, stakeholder pension or self-invested pension plan (SIPP), you'll have a say in how your money is invested.

Your pension provider will offer a range of investment funds that are designed to invest your money in different ways over the years until your retirement. Again, there's usually a default option that invests in a broad range of funds to suit a wide range of people.

You'll probably be offered a choice of funds that:

  • Specialise in specific assets – such as a fund focusing on shares in European companies
  • Invest in a mix of different assets – such as a fund investing in both global shares and government bonds

Most people choose to invest their pension in a blend of assets because spreading – or 'diversifying' ­– your investments is a good way of managing risk.

SIPPs, in particular, are flexible plans that provide access to a wide range of assets and give you more control over how your money is managed. However, this option is best suited to those who have good financial knowledge and are comfortable making their own investment decisions.

How do I choose the right pension fund for me?

Choosing a pension fund is a tricky decision, and generally isn't one to be made without first seeking independent financial advice. Your IFA will guide you on the best choice of funds to suit your particular stage of life and long term goals.

That said, there are certain broad strategies that their advice may follow. As a rule it makes sense to spread your money across different assets, sectors or geographic regions – rather than putting all your eggs into one basket. Many basic managed funds do this for you, but if you want to take a more active role, start by looking in detail at how you spread your risk across a range of investments.

You should also consider your 'investment style' and what you feel comfortable with, for example:

  • Cautious
    Your aptitude to risk is low, so you'll want to invest in lower-risk assets.
     
  • Aggressive
    You have a high tolerance to risk (meaning, you can afford to make losses - perhaps because you are many years away from retirement) and are happy to invest in higher-risk assets for potentially higher returns.
     
  • Balanced
    You'd like a balanced mix of higher and lower risk assets.

There are thousands of investment funds available to UK investors offering a wide range of options and levels of risk, including:

  • Asset type (equity, fixed interest, property or cash funds)
  • Investment in specific geographical areas (country or region-specific funds)
  • Risk-adjusted funds where assets are chosen to suit a particular risk profile or investment style (cautious, balanced or aggressive funds)
  • Combination funds which combine a number of the different sectors listed above (these include managed funds)
  • Funds that alter their risk profile as you approach a target date (lifestyle funds)

Investing in pensions funds is a complex matter, so you may find it helpful to speak to a professional financial adviser who can explain the intricacies of each option in more detail to help you make the best choice.

What's the difference between active and passive funds? Which is better?

One of the biggest debates in investment revolves around the subject of active funds versus passive funds. Some investors believe it's best to invest in an actively managed fund, where a fund manager and team of financial analysts pick the shares they think will perform best. Others believe the best option is a passively managed fund, which mirrors the ups and downs of a specific market index. Here's a summary of both:

  • Passive funds, also known as trackers, are one of the simplest ways to invest. A passive fund aims to 'track' the performance of a stock market index, such as the FTSE 100. They're known as passive funds because the fund manager isn't making any active decisions about which shares will perform best. Because they require no investment analysis, costs are much lower, which some see as a key advantage because charges eat into investment returns over time
     
  • Active funds seek to outperform an index. The fund manager will invest in companies they believe will perform better than the average to do this. Because there's a fund manager and analysts to pay for, actively managed funds have higher charges

Do I need to change pension funds?

Choosing the right pension fund is important if you want to make the most of your investment. A young person just starting their career, or someone who has a higher tolerance for risk will opt for a different portfolio of assets than someone in the last few years before retirement who'd prefer a low-risk pension fund, particularly if they want the guaranteed income of an annuity.

As a guide, if you're less than 15 years away from retirement, it's a good idea to start moving some of your pension investments from funds that invest primarily in shares to ones that invest in bonds and cash. Many personal, stakeholder and workplace defined contribution pension plans offer a 'lifestyle' fund, which automatically shifts the balance of your investments towards less risky investments as you get closer to retirement.

If your pension isn't in a lifestyle or target-date fund, you can reduce the risk yourself by switching your pension from riskier funds to ones that have a lower risk. You might be able to do this easily online on your pension provider's website, although worth consulting a financial adviser unless you're confident about selecting the suitable funds. If you decide to switch funds, check if there's a switching fee and what the charges on the new funds will be.

Can I invest in more than one fund?

Defined contribution pension schemes usually offer a range of different funds in which to invest your contributions. Your pension provider should provide detailed information about the various options available to you on a fund fact sheet. Before you invest in a fund, you should be given a Key Investor Information Document (KIID). This will explain the fund's investment objectives, charges and other information.

Can a financial adviser help me choose the right funds?

If you need help choosing a pension fund or want to review your retirement options, particularly in the decade before you plan to retire, speak to a financial adviser. Regulated financial advisers are authorised to give you advice and recommend suitable pensions products and investment options so you can look forward to a comfortable, financially secure retirement.

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About the author
Nick Green is a financial journalist writing for Unbiased.co.uk, the site that has helped over 10 million people find financial, business and legal advice. Nick has been writing professionally on money and business topics for over 15 years, and has previously written for leading accountancy firms PKF and BDO.