What is a default pension fund and should you diversify?

When you enter employment, you will be registered for your employer’s pension scheme, unless you actively object to this.

If you go along but do not accrue any further interest, your money will be placed in the ‘default’ or standard investment fund and will remain there.

Your employer’s standard pension fund is chosen to suit the average employee.

“It’s the equivalent of everyone getting a medium-sized T-shirt,” says investment expert Jason Hollands. “But of course one size doesn’t fit all.”

Yet the vast majority, around 90-95 percent, stay with their employer’s default fund whether it really suits them or not.

This is likely because employees have a lack of interest in retirement savings, don’t understand how pensions work, or are afraid to choose different funds without fully knowing what they’re doing.

This is Money checks where your money is going and whether you should be happy with the choice.

We also look at what else is possible through your pension scheme if you feel like something more adventurous.

What’s in a standard fund?

Default funds tend to play it safe because employers don’t want to be blamed for costly mistakes that jeopardize their staff’s retirement savings.

Most such funds are trackers, although some are actively managed to some extent.

Trackers passively track the performance of one or a selection of the world’s stock markets and are cheap to own.

Active fund managers choose investments to outperform the market, but often underperform despite charging much more.

‘You should simply regard the default fund as a starting point,’ says Hollands, managing director of Evelyn Partners.

An alternative choice may make sense depending on your own circumstances, such as your age, risk appetite or personal preferences.

“Younger savers, for example, who have decades left before retirement and access to retirement, should be willing to take on more risk than someone who expects to retire within a few years.”

More adventurous funds, with greater exposure to equity markets, have historically delivered much higher returns over the long term than other investments, such as corporate or government bonds, he explains.

‘A saver may also want to look at alternatives to the standard fund if, for example, he wants to invest his pension ethically or in funds that exclude fossil fuels, for example.’

Should you look at other funds within your pension scheme?

Defined contribution pensions receive payments from both employers and employees and invest the money to provide a pot of money in retirement.

Employees could get a better pension in retirement by diversifying investments within the ‘walled garden’ of other funds typically offered by schemes.

Previous research by Hargreaves Lansdown suggests that ditching the default fund and proactively choosing your own investments can dramatically increase your final retirement pot.

Hargreaves calculates that increasing investment returns by just 1% per annum could increase a pension pot by nearly £60,000 by the time an employee retires.

‘A person who earns £28,000, who starts saving 8 per cent of his salary for a pension at age 22 and retires at age 68 with a 5 per cent return on investment after costs, can expect a pension of £190,961.

“If their investments grew by 6 per cent each year, the pot could be £250,036,” it says.

How do you research the other investment funds of your pension scheme?

Tips for viewing the other funds in your plan.

1. Consider how much risk you plan to take

The key point is how long you expect to be invested until you retire, as this should help you think about the level of risk you should take, Hollands said.

“The longer you are invested, the more exposure you should have to equities compared to less volatile but lower yielding investments such as bonds.”

2. Look beyond the website of your pension scheme

A good place to start researching is This is Money’s Fund Centerbut Morningstar and Trustnet also contain a lot of detailed information about funds, who manages them and how they performed.

This is Money’s jargon buster guide to the cryptic names given to funds.

3. Diversify your investments and don’t just chase performance or what’s fashionable

Diversification is important for all investors because it helps mitigate risk and increase exposure to opportunities. So look for a fund or funds that are not too narrowly focused on one particular market, such as the UK, as you have the world as your oyster,” says Hollands.

“Be careful not to take excessive risks or be guided by whatever niche is currently in vogue, nor by short-term performance.

‘Retirement is in most cases a very long-term investment and none of us has a crystal ball to know for sure what the future will bring.

“A widespread approach to investing will be more sound than trying to pick a winning theme, such as investing heavily in specialist areas such as technology or robotics or placing big bets on spirited markets such as Chinese equities.”

Do you need to split your money between multiple funds?

One way to diversify is to divide your retirement pot into a number of funds, one of which might be the default fund – but there are a few pitfalls.

The limited range of funds offered by retirement plans means that many funds will be multi-asset or global and therefore carry a great deal of diversification.

Therefore, check the investment strategy and the holdings in case there is a lot of overlap between the holdings you decide to hold.

Hollands says whether you should split your pot depends on how much active interest you want to have in your investments, or if you just want to put your money away for the longer term.

“If you decide to make your own choices, the homework isn’t just about making your first choices,” he says. You should be prepared to monitor them closely and review them at least once a year in case circumstances have changed. For example, a fund manager has left or performance has declined.

“A ‘core’ and ‘satellite’ approach, where you choose the standard fund for the majority of your investment but supplement it with a few of your own choices, can be a sensible approach if your plan allows for that flexibility. ‘