Sensible investing for your future – it’s easier than you think

July 24, 2024

You’re a young person and you’ve made the sensible decision to make regular contributions into a pension – excellent! (Perhaps you were persuaded by my previous article, even better!)

So, what’s next?

Now you need to decide what to invest your pension contributions into. Sound daunting? Don’t worry – we’ve got you covered.

I don’t know a thing about investments

When looking at saving money over the long term, such as into a pension, deciding what to invest in might sound like a headache. How do you know if you are investing at the right time? What happens if the stock market falls?

The first stop for anyone looking for investment advice should always be an independent financial adviser. However, speaking very generally (and this is not in any way to be taken as advice), for those with 20 plus years to go before retirement, investing in higher risk investment funds in the early days tends to make sense because higher risk usually brings higher return. Plus, for the longer-term pension saver, rises and falls over time haven’t historically mattered as the positives mostly outweigh the negatives.

When you get closer to retirement, you might wish to change your portfolio gradually to move your funds from higher risk to medium and then lower as you get closer to retirement. This essentially secures your savings in the event of an unexpected stock market crash occurring months before your retirement.

A simple and effective strategy

While the concept of starting with higher risk investments and gradually lowering the risk as you approach retirement may seem a simple strategy, life is busy (perhaps involving a career, marriage, house purchase, children, home improvements and no end of other things you haven’t considered yet!) So, keeping an eye on your pension, and making these investment switches as you go, might not be a burden you wish to carry.

If only there was a way your pension investments could be switched automatically, without you needing to remember?

Well, the good news is many pension providers offer a ‘life styling’ (or similarly named) approach whereby this is exactly the case!

Lifestyle strategy

Using our Isle of Man Group Personal Pension (Rewards) as an example, we offer the option to invest in our ‘Lifestyle Strategy’ funds. Put simply, this means if retirement is more than 50 years away, all your pension contributions will be invested in a fund with a higher risk/higher return rating (essentially a high portion of stocks and shares). However, once you reach 15 years from retirement your pension fund will gradually switch into lower risk/cash investments (the allocation of which will depend on your selected lifestyle strategy).

This means pension scheme members who don’t consider themselves sophisticated investors, can relax and know that their retirement investment strategy is a sensible one. (That said, should you choose to become an investment professional in the meantime, you can always change your mind – and your investments – at any time!)

Why saving regularly is a smart decision – ‘Pound Cost Averaging’

I will leave you with a final thought about one of the benefits of saving on a regular basis and how it can reduce risk. The below sums up why you should contribute little and often, and start early.

Pound Cost Averaging reduces the impact of volatility of an investment portfolio. Put simply, by investing a fixed amount regularly, regardless of the asset's price, the investor will receive more shares when prices are low and fewer shares when prices are high. This approach can potentially lower the average cost per share over time compared to making a single, large investment.

For example:

Ed saves £50 per month for six months, as follows:

Month 1: Share price: £5, Shares bought: £50 / £5.00 = 10 shares
Month 2: Share price: £4, Shares bought: £50 / £4.00 = 12.5 shares
Month 3: Share price: £5, Shares bought: £50 / £5.00 = 10 shares
Month 4: Share price: £6, Shares bought: £50 / £6.00 = 8.33 shares
Month 5: Share price: £5.50 Shares bought: £50 / £5.50 = 9.09 shares
Month 6: Share price: £4.50 Shares bought: £50 / £4.50 = 11.11 shares

At the end of six months, he has invested a total of £300 and bought a total of 61.03 shares. The average price per share he paid was: £300 / 61.03 shares ≈ £4.91 per share.

However, if he had invested the full £300 at the beginning, he would have paid £5 per share.

We can see how investing little and often has removed the risk of investment price changes. On top of this, it is much easier to part with £50 a month rather than save £300 to invest! Apply this over 40+ years, and you have made easy and simple strides to a comfortable retirement.