FOOL'S EYE VIEW
A Bad Year For Pensions

By Stuart Watson (TMFTiger)
January 8, 2002

Great Titchfield Street, London -- 2001 was a bad year for global stock markets. So it will have been a bad year for your pension fund as well. The performance measuring firm, WM Company, has just released figures showing how well pension funds fared last year. In the next few weeks many people will receive their annual pension statements and so be able to see just how badly they, personally, were affected.

The average UK pension fund lost 10% last year, making it the worst year since 1990 and the first time two successive years of losses have been recorded since WM started monitoring returns in the mid 1970s. To my mind there are two things we need to do here. First of all, we shouldn't panic but we should try to understand why this fall happened. Secondly, we need to see if there is anything we should be doing as a result of this fall.

Why was it a bad year?

There have been many headlines about pension funds selling shares in the last few months (e.g. Boots). However, most pension funds still have the majority of their money (i.e. your money) invested in the stock market.

The 'Average' Pension Fund   Dec 2001  Dec 2000

Shares                            68%       72%

Bonds                             15%       13%

Cash/Index-Linked                 11%       10%
Property                           6%        5%

Source: WM Company

There has indeed been a small shift away from shares (although it should be noted that these are estimated figures at the moment). But the movement was pretty small and so it won't have made that much of an impact on last year's returns. In the long-term such a shift may make pension funds slightly less volatile but it also means the expected returns they will generate will be slightly lower.

The fact remains that when the stock market has a down year, there is a pretty good chance your pension fund will have one as well. In fact 2001 could have been even worse for your fund. Just under half of the average fund is invested in UK shares which did better than most other major markets last year.

Down years do happen from time to time. The trouble is that you don't know when. After almost 25 years of exceptionally good returns we were perhaps overdue for a setback. But people have been saying that for over 20 years. We can all say "if only we'd moved out of the market last January". But we conveniently gloss over the fact that if we moved out of shares whenever we thought the market looked a little expensive we'd spend 90% of time invested in cash and therefore be much poorer at the end of the day as a result. Despite two years' of falls, the long-term performance of shares still crushes both bonds and cash. To be honest a fall of 10% in a year like 2001 isn't such a bad performance.

What to do?

In most respects, you shouldn't treat 2001 any differently from other years. Occasionally you need to review your pension/retirement arrangements to see if you need to put in a little more and, if so, how much. You should do this whether the market has fallen, risen or wobbled somewhere in between. At the very least you should increase your investments by the level of inflation, even though it is only 2% at the moment. This is where compound interest calculators can be so useful, provided you don't get carried away with outlandish annual growth rates.

However, the falls of the last two years make it much more likely that you'll need to increase your contributions. As pointed out in an excellent thread on the Pensions board recently one of the main reasons many people's pension funds come up short is the fact they have not invested enough money in the first place, not that the fund itself did not perform well enough. This may be because they assumed the fund would grow more quickly than it did or simply that they never bothered to find out if they were putting enough in. If you don't know whether you are saving enough for your retirement then the chances are you probably aren't saving enough.

Remember that you don't have to rely on a pension fund for all your retirement income. ISAs are also an excellent way of investing for the long-term and getting tax benefits. If you are in a defined benefit (or 'final salary') scheme, then the amount you 'contribute' is effectively fixed by the fund's trustees. If you don't think it will be enough, then you'll need to make some provision for yourself.

More: Pension Centre | 10 Things You Must Know About Your Pension