When you thought about the repercussions from a leave vote in June’s EU membership referendum, was a possible company pensions crisis one of the things you considered?
It wasn’t on my mind, but it probably should have been, after the latest report from pension specialist LCP shows a massive increase in the overall pension funds deficit for our FTSE 100 (INDEXFTSE: UKX) companies. At the end of July 2015, the total deficit stood at £25bn, but that’s estimated to have soared to £46bn at the same stage this year, and to have reached a staggering £63bn so far in August.
The reason behind the surge is a fall in bond yields since the vote, as bond income contributes a lot to today’s company pension funds, with an extra hit coming from the Bank of England’s decision to cut interest rates from 0.5% to 0.25%.
Poor returns
Although pension fund trustees get to decide on their own investing strategies, they must consider the risks and returns of various investments, and ensure an appropriate level of diversification commensurate with the usual professional advice. What that means is they’re effectively obliged to invest in a range of shares, bonds, gilts and other things — and that’s pretty much guaranteed to provide inferior long-term returns to a shares-only portfolio.
According to the annual Barclays Equity-Gilt Study, investing in shares has beaten cash 91% of the time over rolling 10-year periods since 1899, shares have won in 99% of all rolling 18-year periods, and over 23-year periods shares have never lost! That suggests a long-term strategy is needed to keep your investments safe — but one thing pension funds do have is time.
If our pension funds are investing sub-optimally and look like being hit by these deficits, what’s the answer? Well, the first thing to do is not panic.
One thing LCP pointed out is that these same FTSE 100 companies are still paying out stacks of cash in dividends — significantly more than the deficit, it seems. So if a pension payments crunch did actually happen, holding back a year of dividends would be ample to keep pensioners’ incomes going — not that anything that drastic is likely to happen.
And the long-term superiority of shares as an investment points to the other strategy we should adopt. Just as pension fund managers won’t put all their investments into the share basket, so we shouldn’t base our old-age security on just a company pension.
Do it yourself
In addition, we should be investing some of our own cash each month to add to the pot. And if you’ve got decades to go before you’re likely to be ready to retire, the obvious choice is to put it in shares — using a SIPP, an ISA, or both depending on which taxation benefits are likely to be more valuable.
What should you actually buy? The easiest thing is to go for a low-cost index tracker fund, and then just forget about it until you’re close to that retirement party — though personally, I’d suggest a portfolio of top dividend-paying FTSE 100 shares, diversified across sectors to minimise the risk.
But the key thing is to take control yourself, because if you need a job doing well… you know the rest.
