Contributions to a defined contribution scheme are
invested. What you get out depends on the rates of return on
the investments made.
Most schemes provide a choice of funds to invest in.
Typically the choice might be:
- Global equity fund
- UK equity fund
- Gilts fund
- Cash fund
- Property
A UK equity fund invests in shares in UK companies, and a global
equity fund invests in shares both in companies in the UK and
overseas.
Gilts (or gilt edged stock) are issued by the Government, who
pay fixed interest on them, for a fixed period. Gilts are generally
considered to be the safest investments. However, as they are
traded on the stock market where their price will go up and down,
depending on what traders think will happen to future interest
rates, their value may go up and down.
Cash funds invest in bank and building society deposits.
Other investment types include property, corporate bonds (issued
by companies to raise money, with fixed interest payments and a set
date for repayment) and overseas gilts and bonds.
Different fund types will have different levels of risk, and
this should be spelled out in the scheme booklets.
Some companies categorise their funds as Secure, Stable,
Balanced or Opportunity. Others categorise funds by risk, for
example, Low risk, Low to medium risk, Medium risk, Medium to high
risk and High risk.
As a general statement the greater the risk taken, the higher
the level of return expected. So equities or shares are
expected, in the long term, to give better returns than gilts, but
there is a greater risk of the investment going down in value.
A popular approach to managing risk is to choose a Lifestyle
option.
This invests in mainly shares to begin with, but switches to
lower risk index linked or fixed interest gilts, or cash closer to
retirement. A good Lifestyle fund should allow members to
select their target retirement date.
Stakeholder schemes have to have a ‘default’ option, which will
be the fund or funds used if the member does not make any other
choice. A ‘default option’ normally has a Lifestyle
approach.