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Title: Maximizing Your Retirement Plan: The Case for Active Investment Choices
Introduction
Regular readers of our content will know that we favor using a retirement plan to house long-term savings/investments. When compared to investing after-tax money, investing in your pension can more than DOUBLE the amount you get to invest (due to the tax relief and employers that match contributions) and can also DOUBLE the return you enjoy as such funds are exempt from both income and capital gains tax.
The Current Landscape
Whether you already take advantage of these funds, or may do so in the future, I want to suggest that you get more involved with choosing the investments made within. More than 90% of pension fund contributions in Ireland are made to “Managed/Multi Asset Investment Funds”, which tend to be the default investment options. Such funds will, broadly speaking, have 60% of the investment in Equities (the Stock Markets), with the balance split between Cash, Bonds (Government Loans, sometimes known as Gilts) & Property. The investment mix of these funds is a “one-size fits all” and, in my opinion, fits nobody perfectly.
The Problem with a One-Size Fits All Approach
When you are young and still decades away from retiring, too little of your savings are exposed to the best performing asset class (Equities), and when you are but a few years away from accessing, too much is exposed. The sellers of these products justify the allocation based on risk profiling, where they ask the investor to complete generic risk questionnaires, with most people adjudged to be “medium risk” takers by this blunt instrument. While an allocation to 100% Equities can, rightly, be considered “riskier” than the default, this really means that such an allocation is more volatile. Values ebb and flow by greater percentages, but once you have the time to recover, short term falls in value should be tolerated, because long term, the rewards are potentially massive.
A Compelling Example
Time for an example, and before writing this piece I looked at the last ten years’ performance of five of Ireland’s most popular “Managed/Multi Assets” pension funds (Aviva, Zurich, New Ireland, Irish Life & Standard Life). The average annual growth delivered by these funds was 4.94%. Comparing this to the MSCI World Index (which tracks the performance of the world’s markets as a whole), its annual return over the same term was 11.6%. So, if you had invested €250 per month into the average Managed/Multi Asset Fund, its value after ten years would have been €38,855, a profit of €8,855. Investing the same amount into the MSCI Index, would have delivered a value of €56,720, a profit of €26,720 (that’s 200% + more).
The Lessons Learned
There is no doubt that in the above example, the investor would have experienced considerably more periods of loss in the MSCI investment than in the alternate, but the markets recovered those losses and more in the time frame used. Over longer time frames, the additional wealth being generated would be even greater.
There are two lessons we hope to impart here:
- That short-term losses in an Equity Portfolio are irrelevant as long as you have the time to ride out inevitable downturns.
- That compound interest is your friend when it comes to wealth creation and that, as you can see, an increase in annual return of 134% delivers valuations some 200% greater when time is added to the mix.
Conclusion
Not all retirement funds will have an MSCI World Index fund option (some will), but all will have some form of International Equity Fund option and when you have ten years or more to go before retirement, I urge you to seriously consider using those funds as opposed to the defaults. If market history repeats itself, and to assume otherwise you would have to assume complete catastrophe, then you will accumulate far more wealth.