The UK's leading pension companies are sleepwalking their way into a PPI-style mis-selling nightmare with their insistence on pushing unsuspecting investors into 'lifestyle' funds.
Lifestyle, or ‘lifestyling’ funds, automatically begin to change the asset mix of the investor's fund either 10 or 15 years out from their retirement date.
The principle around this is to aim to reduce volatile equity exposure and increase exposure to ‘lower risk’ bonds and cash, with the understanding that this will sacrifice some growth for increased stability of the funds just before the investor starts taking their pension.
In theory, this sounds sensible, but in today’s market conditions it risks pushing unsuspecting investors into years of low-growth poverty. The problems have been caused by two main factors - a change in pension policy and market conditions.
Before 2014, the options with your pension were very limited. You worked up until your retirement and were then effectively forced to buy an annuity. The lifestyling strategy worked very well for this as when you were leading up to your retirement date, and you had more confidence in knowing what the value of the funds would be to purchase your annuity.
However, pension freedoms, introduced in 2014, completely changed this. Now people can access their pension anyway they want. They can take lump sums or income at any point once they are over 55 and their actual retirement date is not important. This is where the issue arises.
Lifestyling sees pension companies slowly move investors' money to low-growth, ‘lower risk’ assets, completely oblivious to the actual investor's goals and planned retirement date. It is only if the investor is eagle-eyed enough to spot this, or pays an IFA to do it for them, that they can change this.
If they don’t, those assets will just sit there and potentially lose value versus inflation over a protracted time period, especially if today's cost of living crisis proves intransigent.
Since 2008, and even more so over the past few years, central banks globally have conducted a financial experiment in moving interest rates to virtually zero. Never before have interest rates been this low. The reason rates have been kept so low is to try to keep the cost of debt down and stimulate the economy, but again the unintended consequences impact pension investors.
As we know the world now is facing severe inflationary pressures and interest rates have started to go back up. This has the knock-on effect of almost ensuring that the value of bonds will fall. Put simply, as interest rates go up, bonds go down. And if we’re lifting interest rates from 0, then there are only one way bonds can go – down.
This is important in relation to lifestyling because investors' money, due to this strategy, is automatically being moved into “safe” assets such as bonds and cash. In many cases, these will make up nearly 70% of the investor's portfolio. Yet this investment strategy will be almost guaranteed to lose money as interest rates rise, and have effectively zero chance of keeping up with inflation. Safe has never been less safe.
Yet pension companies continue to push investors into these funds as their default option. The UK Government-backed NEST pension scheme, which now has £21.9bn of investor assets from 10.4 million investors, even admits that over 90% of people never change from the default fund they are invested in. That’s 10.4 million people – just from one pension company – who have a very real chance that their pension will not keep up with the cost of living.
Adam Walkom, founder of Permanent Wealth Partners, a financial planning firm based in London, says:
“The road to hell is paved with good intentions and the good intentions of pension companies and Government could turn into another mis-selling scandal as people's pension pots significantly underperform over a long time period. Deleveraging by switching to bonds and cash in today's climate is actually adding risk, as it shatters any prospect of real returns. Cash and bonds are certainly not king. Unfortunately, as most people just ignore their pensions, these people will be hit the hardest by this. People who can afford financial advice or who have a detailed understanding of finance can see the risks and change things, but my fear is for the majority of people who don’t have either. Once people start seeing the size of their pension pots not keep up with their costs, this has the potential to turn into a major misselling scandal."