The five biggest pension mistakes

Each one of these mistakes could reduce your retirement income by thousands of pounds.

The headline of today's piece tells you what to expect, so let me get stuck in:

1. A bad start

Many people don't take up their best retirement option to begin with, and get off on the wrong foot.

It might be that you don't trust pensions. But a good company scheme, for example, might match your own contributions, immediately doubling your investment. This reduces your chances of leaving the scheme with less money than you started to practically zero.

Other people will rush headlong into a pension when perhaps a share ISA, or a combination of the two, would work better. Yet others would do better to pay down high-interest debts more quickly before getting stuck in to retirement saving.

So consider your options before you start or, if you've begun, do some research to see if you're doing it right. All the information you need is out there, and, for personalised suggestions, get a variety of opinions and debate from knowledgeable users in busy discussion boards and other social media, such as lovemoney.com's Q&A.

2. Getting distracted by next week

It's the fault of insurers, advisors, fund managers, and even us journalists. They (ok, we) make retirement savers focus on events that might happen tomorrow afternoon, even though saving for retirement is a decades-long journey, and the impact of events we all get a little pre-occupied with will be long forgotten by the time we get to the end of our trip to retirement.

This short-term focus causes us to make rapid decisions, to move investments around as fast as the financial headlines are written, and to try to forecast the temporary blips or booms that might occur tomorrow, rather than focus on the bigger long-term risks, such as inflation. Moving our money around rapidly due to short-term factors, buying and selling in panic and greed, all of these things cost us money, which the financial industry is very happy to take from us.

Focus on the short-term leads to the recommendation that “risk averse” people focus on “cautious” or “safer” investments, which normally means bonds. You might be directed to put some of your pension funds into such investments.

However, that is a short-term view focusing on short-term safety, which is irrelevant to pension savers with their long-term goals. With an investment horizon spanning decades, shares are unquestionably safer and lower risk, since they are far, far more likely to keep up with inflation in the long run.

The best thing retirement savers can do, in my view, is invest 100% in shares, and ignore short-term frenzy or, better yet, pile more money in when everyone else is saying the world is ending. It's been said often before, but again it isn't true, and it won't be next time either.

3. Too much trust in the status quo

When we're offered a pension by our employers or even by a single insurer, we typically have a list of investment funds to choose from, but Barings Asset Management says that just 20% of us actually choose the fund or funds we invest in.

The problem is, the default fund is not necessarily the best one. That one typically comes with a reassuringly normal name like “balanced-managed fund”, but with no explanation of how well the fund manager has performed over a sensible period of time, meaning ten years or more. It probably won't even tell you the manager's name.

Investment funds are not like furniture, food or fine wine. It is one of the few things you buy that is usually worse the more expensive it is. The best thing you can do is look for the cheapest funds that invest in shares. To do this, look for the “total expense ratio”, which ideally will be less than 1% and fantastic if it is 0.5% or less. Index trackers tend to be the cheapest, and that's why they outperform most other funds over the long term.

4. Not investing enough

It's wishful thinking to just put a bit of money aside and hope that one day it'll be enough. Little amounts over long periods make a big difference, but if you don't do a few calculations, for all you know that might just mean you have enough to pay your energy bills instead of wearing five jumpers.

What you want to know is if whether you're on track to have the retirement you want, and how much you should contribute to get there. To do that, check out this guide.

5. Floating along

If you drift along and casually, at the finish, let the insurer who runs your pension sell you its bog-standard annuity you're going to be much poorer (an annuity is a guaranteed monthly retirement income for life, which you get in exchange for giving up your pension savings).

Keep revisiting your pension, once a year, to ensure you're on track, which you can do by going through the steps I lay out here. Plus, before retiring, boost the income you get by 20% to 40% by shopping around for your annuity, since you can buy it from dozens of insurers, not just your own, and on much better terms, especially if you have health problems. If you've saved hard, that'll mean thousands extra in income each year.

When you retire, you may also have other options to annuities, and these alternatives are becoming more attractive, so do some research before simply buying. Check out How to combat falling annuity rates.

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