The stock market volatility of the past few months and especially the recent spectacular falls, have worried many pension scheme members who are close to retirement, but not so close that they or their fund managers have switched their assets from equities to safer gilts and cash funds.
Aware of the growing concern of pension members, the Irish Association of Pension Fund managers has done a study of the position of pension funds and has determined that they have not been "as severely affected as might have been expected with a typical return of plus 6.8 per cent over the last 12 months".
This may be a far cry from the double-digit returns of the last few years, but put in the longer term context of pension funds generally (which last 30 or more years) should not have an overwhelmingly negative effect.
The IAPF fact sheet is worth examining, and puts the volatility of the markets into context. The average pension managed fund fell in August by minus 10.2 per cent, but for the year to date has performed at a reasonable plus 6.8 per cent. When inflation is taken into account the real return of the average fund is plus 5 per cent, over 3 per cent above the rate of inflation.
Pension expectations tend to be quite different from those of other investments. The point is to provide people with "a reasonable standard of living after retirement", ideally at two thirds the income achieved at retirement.
"To make this possible," according to the IAPF, "it is necessary that funds achieve investment returns which match or exceed the rate of inflation. In practice, pension planning exercises are based on a return objective of inflation plus a margin which, typically, is between 3.5 to 4.5 per cent". Historically, pension funds in Ireland have more than achieved these goals. As the table shows, the net or "real" returns after being adjusted for inflation over the past 20 years show that the average pension managed fund has achieved real annual returns of plus 9.7 per cent after 20 years, plus 8.3 per cent after 15 years, plus 9.9 per cent after 10 years and plus 12.8 per cent per annum after the past five years - the latter a reflection of the strong equity returns between 1993/4 and 1997.
Most employees in this State are covered by "defined benefit" pension schemes in which the employer promises to deliver a pension that reflects years of service and final salary. Those who are in "defined contribution" schemes get no such promise, since the final pension value reflects the true worth of the fund and carries a greater risk. However, that doesn't mean, says the IAPF, that anyone with a defined contribution scheme should be switching into safer cash funds.
"Second guessing stock markets over the short term is notoriously difficult. A member can be just as likely to miss a significant recovery as protect against a significant downturn," states the fact sheet. The ISEQ index has produced a 10-year return of plus 19 per cent per annum, but "an investor who missed the best four quarters would have earned just 10 per cent", it notes.
The story is different for someone in the defined contribution scheme (or who is self-employed) approaching retirement - that is, within about five years. Such people have "a lower risk tolerance and certainly cannot afford the levels of volatility experienced in recent weeks". The IAPF recommends that the 25 per cent of the pension fund that can be taken tax free "should be ideally converted to cash" while the remainder, which must be used to purchase a retirement annuity should be switched to fixed-interest investments. (There is usually no cost for one or two switches per year for a self-employed person with a personal pension plan.) And in this current volatile climate, there is no time like the present to start those switches.
