Pension Funds & Performance

As a pension investor there are a number of risks you need to consider when making your investment decision:

Risk to Capital Value

This is the risk most familiar to investors and the one on which most investors focus – the risk that the value of their investment will fall. This risk is of particular importance to investors with a short time horizon – e.g. one or two years – as they are most likely to be affected by a fall in capital values. For longer-term investors, the risk to the value of their capital is reduced as investment returns in the long run are more likely to be positive. For long term investors other risks become significantly more important, especially inflation risk.

Inflation Risk

This is perhaps the most important risk facing medium to long-term investors but one that is often overlooked in favour of the more obvious Capital Value risk, outlined above. The inflation risk relates to purchasing power. If your investments are earning a return of, say, 2% p.a. but prices are rising at 5% p.a., you are actually losing purchasing power at the rate of approximately 3% p.a. – even though the value of your fund is rising, prices are rising even faster so with every year that goes by, your money is able to buy you less and less.

Annuity Rate Risk

This risk is somewhat specific to pension investors. When you come to retire, a substantial portion of your accumulated fund may be used to purchase a pension. The amount of pension you can purchase depends on annuity rates at the time you retire and these can be somewhat volatile. The main factor leading to this volatility is long-term interest rates – if long-term interest rates fall, the cost of purchasing a pension can increase and vice versa. If the cost of purchasing a pension increases immediately before retirement, you may not be able to afford as much of a pension as you had hoped. Note that this risk is typically not relevant to money which will be invested in ARFs or taken as tax-free cash at retirement.

Risk Trade-offs

Unfortunately there is no one investment that protects you from all these risks – it’s a question of finding the right balance, depending on your investment needs.
For more information on risk and the different levels of risk faced by investors, you can log on to the Financial Regulator’s website - www.itsyourmoney.ie

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Pension Fund and Performance