Money Section, The Sunday Times: 11.06.2017
Don’t kill the golden goose by reacting to every market wobble — wait and give your nest egg a chance to hatch, writes Linda Daly
Equity markets have performed strongly for nine years but they are starting to look expensive — and some analysts predict a wobble.
The S&P 500, the US stock market index, continues to thrive. The bull market has lasted 100 months and is expected to continue. The last time it had such a run was in the 1990s, when it lasted a full decade.
On the other hand, the Aon Hewitt Managed Fund Index, which tracks the performance of traditional Irish pension managed funds, fell by 0.1% in May after returning 3.4% so far this year. At the same time, the FTSE All World Index decreased by 1% in euro terms as the European currency strengthened against the US dollar and sterling.
Those looking to start a pension could be deterred by overpriced equities and the fear that as soon as they invest, the market will come crashing down. With the prospect of investment returns falling, should you put off paying into a pension?
Have an age-appropriate strategy
Denis Lyons, investment consultant at Aon Hewitt, said that while market valuations were high “they are not so high as to be dangerous”. However, Lyons said whether you start an equity-based pension now should depend on how long you expect to be investing.
“If a person is going to be investing for quite a long period and is a younger person, there shouldn’t be a barrier to investing at the present time. For someone who is older and has a shorter time horizon, they have to be careful about going into the riskier investments,” said Lyons.
Rebekah Brady, head of investments and research at Acuvest, said anyone in their twenties or thirties starting off their pension should forget about markets. Her message is simple: get the ball rolling and start saving.
“It might be a different story if you are in your late fifties or early sixties and have just received a lump of cash from an exchanged-traded fund, defined benefit pension scheme or an inheritance. If you plan on investing it for a few years, right now equities are not cheap.”
Brady added that while equities were expensive now, they could become a lot more costly before turning downwards.
“It has happened numerous times historically. Going down the road of trying to call equity markets is a dangerous business. You could end up with a massive opportunity cost of having sat on the sidelines. At the minute it is costing people to hold cash,” said Brady.
Lyons said that older pension holders — those who have 10 years or less to retirement — should start to de-risk their equity holdings. Older pension holders who come into a lump sum should look to invest in lower-risk asset classes, he said.
Don’t try to beat the market
Trying to “beat” the stock market could be a fool’s errand. Many professional investors find it impossible, which means the ordinary punter does not have much of a chance, according to Jerry Moriarty, chief executive of the Irish Association of Pension Funds. “One of the dangers is that you will make the wrong decision at the wrong time. If you’re constantly reacting to the markets, you will lose money.”
Steven Barrett, managing director of Bluewater Financial Planning, agreed. “You might get lucky once or twice, but you won’t be able to do it on a regular basis,” he said.
Pension holders tend to invest solidly each month and drip-feed into the stock market, which means there is no bad time to start investing, according to Moriarty. “All investment advice and literature would say that the younger you are and the longer the investment period, the more ability you have to take on risk.”
Play the long game
The annual Barclays equity gilt study, which analyses long-term market returns, shows that equities have outperformed cash and gilts for most of the past 100 years. There was just one “lost decade”, the 10 years to 2010, where cash and gilts outperformed equities.
“If you are below 40, you will be investing your money for the next 30 or 40 years. People need to worry less about what’s happening this year, next year or the year after and get into a long-term mindset,” said Brady.
Fiona Daly, managing director of Rubicon Investment Consulting, warned new pension holders against panicking if the markets fell soon after they started their pensions. “People with 15 to 20 years to retirement should be investing mostly in equities. Short-term fluctuations don’t really matter. You may have overpaid your first couple of contributions but you will be buying in at the bottom [of the market] after that. You get more bang for your buck when you buy at the bottom and when the markets recover, you will get the benefit of that bounce.”
The cost of delaying your pension
There is a cost to delaying a pension, regardless of how equities perform. Brady said the biggest cost of delaying was the loss of compounding. The longer you delay starting a pension, the less time contributions have to compound. “The €100 you put in when you’re 25 is worth multiples of the €100 you put in when you’re 45. Starting early is key,” she said.
Twenty-five year olds who put €100 a month towards their pension can expect a personal pension of €2,237 a year from the age of 68. Those who start their pension at 40 and put in the same amount, can expect a pension of just €1,351 a year.
Pension investing is also highly tax- efficient, though the amount of tax relief on pension contributions will depend on age. If you are 30-39, for example, you receive up to 20% tax relief on your net income. If you are a sports star who retires young, you receive tax relief on 30% of your earnings.
“If you are paying tax at a higher rate, you get 40% tax relief,” said Barrett. “That means that if you’re putting in €100, €40 of that €100 is paid for by the government. Then the fund grows without income tax on dividends.”
Check your employer contributions
Employers receive tax relief on con- tributions they make to a pension, so many bigger firms will offer some contribution. Contributions paid by em- ployers will not be treated as benefit in kind, and can be paid on top of the contribution limits for an employee’s own contributions.
The Pensions Authority gives the example of “Louise” who pays tax at 40% and puts €200 a month into an occupational scheme, matched by her employer. While €400 is going into Louise’s pension, the net cost to her is just €120.
Daly added that for high-rate taxpayers, every €1 of salary put into a pension is almost matched by the government. “Immediately, the day you pay that contribution, you have a near 100% return. Equity markets have to fall a lot to erase that — almost 50% before you’re back to where you started.”
From a return-on-investment perspective, it is better than you are ever going to get in the best year of equity returns. For Daly, the advice is simple: “Start paying as soon as you can, pay as much as you can afford, and make sure you’re in the right investment strategy.”
This article was published in The Sunday Times (Ireland Edition) on the 11th of June, 2017 and features expert insight from Acuvest’s Head of Investments and Research, Rebekah Brady. Linda Daly is the author of this article.