Pensions appear to mystify many – even for those who already save into them. If you’re bewildered, I think I can help you. I’ve spent 25 years working in financial markets, asset management and behavioural science, and I’m a pension fund trustee. Here are my top tips:
1. Just do it!
Firstly, let me say that setting up a pension should not be difficult. Just do it. The earlier you start, the less money you need to put in to get a good return from it.
Most employers (all of them in the UK) will have a scheme, and often they will pay into it too, so even if you put in the minimum each month it’s worth it. There are usually tax advantages as well. Not joining (or opting out of auto-enrolment) means you are effectively throwing money away.
If you aren’t saving into a pension there may be a good reason – such as having a very low income. But that may change in the future; setting up a pension fund now and saving a small amount means the systems are in place to start saving more when your luck changes.
2. Keep it simple
Don’t be fooled by those who say pensions are bad value and you could do better by saving for old age in another way. They may be right – but do you want the hassle of monitoring your own investment fund? I joined whatever scheme my various employers had. It was quick and simple.
3. Take some risks
Whatever you do, don’t just save only cash for your retirement. That approach is unlikely to give you the return you need. Your pension provider will probably offer a choice of funds.
The simplest advice is to put your money in one that takes a stake in a diverse range of companies around the world – a global equity tracker– then forget about it for 20 to 30 years. Investing in these index funds is essentially the advice of investment guru John "Jack" Bogle.
4. Take risks early, not later
Some people are worried that they will lose money if they invest only in shares. That’s a reasonable position. So consider reducing risk as you get older or approach your retirement savings goals.
One way to do this is to split your money between equities (shares) and government bonds. Take your age and subtract it from 100: this is the amount you should have in equities; the rest should be in bonds.
So a 20 year old would have 80% in equities and 20% in bonds. A 50 year old would have 50% in equities, 50% in bonds. This is a simple life cycle approach to investing, reducing the proportion of riskier assets in the mix as time goes on and you’re closer to retirement.
The second option is to keep your fund at 60% in equities and 40% in government bonds for your whole working life. It’s easy to manage that way.
5. Keep fees low
High fees are the death of long-term investment returns, so it’s critical to choose a fund with low fees, and resist the urge to make changes that could increase them. Be brutal on this point.
This is why index (tracker) funds are often recommended. Their fees are typically much lower than active funds. Further, much evidence suggests they provide better returns over 10, 20 or 30 years. Remember, small differences each year add up to a lot over such time periods.
6. Starting small is OK – but commit to more
Putting the minimum amount into your pension may sound like a bad idea: it seems unlikely to grow to a big amount and make a difference. But if this is all you can afford, don’t worry. The important thing is to take that first step.
Pre-commit to putting more away when you get a pay rise. Make it a specific amount –if you get a two percent rise, say, you’ll put half in your pension pot.
I get annoyed when advice about pensions assumes you have a regular wage – something that is less common these days. What if you’re self-employed or working in the gig economy?
Your income might vary widely, so rather than trying to put something aside every month, make sure that every time you have a good run, you take that opportunity to reduce debt, pay down your mortgage – and top up your pension fund.
7. Reframe the challenge
I hate the way that saving – whether for a pension or anything – is often presented as something requiring discipline and denial. This sounds rather grim, and unlike with exercise, you’re unlikely to get an endorphin rush when you save while friends are flashing their latest mobile phones.
So let’s think differently about saving: economists sometimes call it “deferred consumption”, because you’ll still be spending it, just later on. It’s a nicer way to think about it.
8. Personalise your pension
Make the pot of money you are accumulating meaningful to you. My pension has a name, one that has changed over time. First I called it my “I will not be eating cat food when I stop working” fund. After the fund grew and my future dietary choices were secured, I started referring to it as “the money that will allow me to take control of work, rather than work take control of me” fund. I may never retire, but I will have the choice to work less if I wish.
It’s possible to save too much
It’s often claimed you need to be able to replace as much as 70% of your income when in employment to make saving for retirement worthwhile. But this benchmark can be nonsense.
Firstly, for most people, work costs a lot of money; commuting, travel, suitable clothes, buying lunch – they all add up. Stop working and these costs can fall sharply.
And if you’ve been able to pay off a house before stopping work, that’s another cost potentially reduced – although let’s not forget that a house still costs money in terms of maintenance and repairs.
Also, talking about a percentage of income focuses on your total pay, but if you’re saving 10% of your gross pay into your “not eating cat food” fund, you are living off 90% of your gross income. This means that the 70% retirement income replacement figure can be reduced by 10% too.
Don’t be too pessimistic – it is entirely possible to save more than you need; your wealth could outlive you. Remember, many people working in the finance industry benefit personally from getting people to save.