Why pension savers should still trust the stock market

Stock market returns over the last decade have been diabolical, but here's why pension savers should still invest in shares.

A new report by independent policy adviser, Dr Ros Altmann for insurer, MetLife claims: "The whole UK pension system has been a giant bet on the stock market."  This is a gamble which has failed to pay off for thousands of people retiring now, who have seen the value of their pension funds collapse.

There's no question stock market performance has been truly diabolical. Shares have been the worst performing asset class since 1997. And, over the last decade, they have generated a return of just 1.2% a year*.  

Should you steer clear of shares?

There has been a long-held belief that, over the long-term, shares will always outperform the return from cash savings. For example, according to the Barclays Capital Equity Gilt Study 2009, over an 18-year period, the probability of shares outperforming cash is 99%!

Historical data also shows that returns from shares have not always been as poor as they are now. In the decade from 1978 to 1988, the UK stock market returned 12.4% a year. While from 1988 to 1998, shares posted annual growth of 11.1%.

But this is of little comfort to you if you're now nursing a battered and bruised pension fund, and wondering how on earth it's going to see you through your retirement.

Altmann's report challenges the 'blind faith' we have had in the stock market. And, although I completely sympathise with those who don't trust shares, I disagree with Altmann. I believe investing in the stock market is still a suitable strategy to save for your retirement. And here's why:

Stock market recovery

I don't deny for a second that market returns have been dire. But I believe once this financial crisis is over, shares prices will eventually recover. In fact, many people see a depressed market as the ideal buying opportunity. If you buy low and sell high, you will always make a profit. But, of course, that's far more easily said than done.

Don't forget, pensions should always be thought of as long-term investments. If you're a young(ish) pension saver, you could still have 20, 30 or even 40 years remaining until you retire. This should be enough time to iron out the peaks and troughs of the market, and provide a reasonable return.

If you're saving regularly, your pension contributions will buy more shares when prices are low. These shares are then poised to take off in value when an upturn in the market occurs.

Diversify

Remember, the UK stock market is not the only place to invest. And shares are not the only asset you can hold in your pension. You could, for example, invest in fixed interest investments such as corporate bonds (company debt) or gilts (UK government debt), as well as commercial property, cash and so on.

If you have an adventurous attitude to risk, you may even choose to invest in individual shares or futures and options, which is possible under SIPP (self-invested personal pension) rules.

Above all, I would recommend that your pension is diversified. In this way, the poor performance of some assets should be offset by the stronger performance of others. But you don't need to be a seasoned investor to achieve that.

My own SIPP is an example of this. I don't expect to retire for over 30 years (alas!) so for now, my pension is 100% invested in the stock market, because I expect a reasonable level of capital growth over this period.

As I approach retirement, I plan to move my pension fund into safer assets to protect it from a sudden stock market collapse.

But for now, I invest in a range of investment funds run by fund managers which have been 'approved' by my pension company, Hargreaves Lansdown. Around half of my fund is invested in the UK stock market while the remainder is invested globally in China and various emerging markets. I also invest in some undervalued companies, which are expected to perform well in years to come.

But, let me assure you I'm no investment expert. I rely on the research carried out by analysts at Hargreaves Lansdown who are far more experienced than I am.

It's still early days - my pension has been running for less than a year - but to date it's returned 7.6%. I may have been lucky, but so far I'm happy. I'll keep a close eye on performance - and the degree of success achieved by the fund managers I have chosen - as time goes on.

It's really important that you monitor the value of your pension fund periodically - I would say at least once a year. This is the only way to avoid a disappointing fund value at retirement. If you're not comfortable doing that yourself, get help from a good independent financial adviser.

Lifestyling

As I mentioned earlier, in the run up to my retirement, I intend to gradually move portions of my pension fund out of higher risk investment funds, and into safer assets such as bonds or cash. This process is known as 'lifestyling'.

Unfortunately, it's too late to help pension savers who are already on the verge of retiring, but if there's a decade or so left until you do, lifestyling is a strategy worth considering.

So, how does lifestyling work? Here's an example:

Let's say 10% of your pension fund is automatically switched from shares to cash each year for ten years prior to retirement. So, in the final year, there is no stock market exposure whatsoever, with 100% of your fund held in near risk-free cash. This protects your pension fund from a stock market crash, which would depress the value just as you want to draw an income.

You don't have to use lifestyling. You could simply move your fund into cash when you're happy with the value, and you don't want to take any further gamble on the stock market.

On a final note, I won't deny that investing in shares can be risky, but I still think there's plenty of scope for decent returns. Good luck!

Find out more about lifestyling by reading How to protect your pension.

*FTSE All Share Index fact sheet - 2009.

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