Getting the right pension fund
As the October tax deadline approaches, thoughts will rightly be turning to pensions. But market volatility means investors must very carefully weigh up their options, writes Justin O'Gorman
Published 14/10/2010 | 05:00
THERE will be numerous newspaper articles written over the next few weeks expounding the virtues of investing in a pension prior to the October 31 tax deadline.
Most of these will rightly focus on the important tax savings that can be made by the self-employed and those with non-PAYE income by making a contribution to a pension.
However, there is another issue that people are concerned with -- where to invest pension money in the present volatile investment market?
Traditionally, when people speak about pension investments they think of equities or shares, as in the vast majority of cases that was where the money ended up.
As pensions are seen as long-term investments, equities were seen as an appropriate investment because of their long-term performance.
However, during the market crash of 2008/2009, a lot of investors suffered significant losses on their equity portfolios and while markets have recovered from the lows of March 2009, there is still ongoing volatility.
So, how does an individual maximise the tax relief available before October 31 without losing that benefit in an investment that falls in value?
Whereas in the past a pension contract might have offered a reduced level of choice, the existing contracts from the various life offices have a much wider range of investment options that should suit every investor's risk appetite.
Here are some of the options.
There are still a couple of pension providers with access to deposit accounts with set rates of interest over specific terms.
The investor receives a guarantee on the rate of interest the account will pay, while also benefiting from the tax relief on the pension contribution.
It is important to know, however, that the government guarantee that applies to individual deposit holders does not apply to these deposit accounts.
Prior to the introduction of specific deposit accounts, all the life offices offered access to cash funds.
These typically invested in short-term cash instruments with a variety of banks to try to maximise the return. Theoretically, a cash fund cannot lose capital value because of the fact that it is invested in cash.
However, if the management feels what the life office is charging is greater than the return the cash fund is achieving then there will be a negative return on the fund.
Eighteen months ago most people may have been aware of bonds, but paid very little interest to them.
Now we listen intently to what rate of interest is applying to Irish government bonds as if we are all bond dealers.
A bond is a loan instrument issued by a sovereign state or corporate entity.
It has a specific maturity date on which the holder of the bond will receive the initial investment amount back in full.
The issuer of the bond also agrees to pay a rate of interest known as the coupon on a yearly basis.
Sovereign bonds are normally considered as safe as cash, as the debt is backed by a government, notwithstanding the concerns over Greek and Irish debt.
Corporate bonds are not as secure; the debt has to be repaid by the company issuing it.
If the company goes out of business, the bond holder could end up losing the investment.
Bonds are normally considered safer than equities, but riskier than cash.
In recent months a significant number of absolute return funds have been launched by various life offices.
While there may be some differences between the make-up of the funds, they have one common feature -- they aim to make a positive return in all market conditions.
Unlike traditional managed funds, which benchmark themselves against other funds or stock market indices, an absolute return fund will benchmark itself against cash.
By benchmarking against cash, these funds should be less volatile than traditional managed funds.
These funds are not an alternative to existing investment strategies but a complement. An investor may use them as their core investment or as part of an overall portfolio.
What investors will need to be aware of with these funds is that, in a strong bull market, traditional investments should outperform an absolute return fund.
However, in a volatile market an absolute return fund should protect the investor's capital from the extremes of market performance.
Before making any investment decision an investor should seek independent financial advice so as to determine which investment option is best suited to them and their circumstances.
Ideally, the investor should also pay for this advice to ensure it is completely impartial.
- Justin O'Gorman is a senior financial adviser with MyAdviser.ie.