What do you think when you hear ‘default fund’? Look it up in the dictionary and it says ‘default’ means something that exists or happens if you don’t change it intentionally by performing an action.
It’s a shame something so positive has this label. Default funds are, in my opinion, the next success story after auto-enrolment – a well-governed default is the simplest path to achieving good returns. People lead busy lives, get overwhelmed by too much choice and complexity, and if left to their own devices may make poor decisions. The beauty of the well-governed default is that it’s simple for members. They don’t need to actively do anything to benefit from the default but, behind the scenes, there’s a huge amount of dedicated activity by experts in the complex world of investments.
And with 99.7% of savers in master trusts remaining in the default (according to the Pensions Policy Institute), it’s a part of the system I believe we should be celebrating as an industry.
Risks for DIY investors
A recent report by The People’s Pension and State Street Global Advisors highlights the risks for most people of taking investment matters into their own hands rather than staying in the default. ‘Workplace Defaults: Better Member Outcomes’ models potential outcomes from the most common mistakes DIY investors make with their pension savings and compares them with a typical default fund. Over 40 years the default investor amasses a pot of nearly £430,000. The DIY investors risk missing out on as much as £247,000 by switching out of the default.
- Mistake 1 is chasing past performance – ‘Performance chasing Patricia’ buys high into a strong performing fund expecting it to continue to do well but sells when it falls, and she loses faith.
- Mistake 2 is putting all your eggs in one basket – ‘Eggs in one basket Elliot’ fails to diversify his portfolio and invests in only UK funds.
- Mistake 3 is not taking enough risk – ‘Cautious Connor’ doesn’t like taking risk so invests in a cash fund.
- And finally mistake 4 is forgetting to take account of changing circumstances – ‘Forgetful Fiona’ is initially an active investor but as time goes by, she forgets to review her investments.
Default is not a last resort
I’ve spent my working life trying to demystify pensions, and I know that savers and employers alike crave things to be as simple as possible. It’s true there may still be a lot of complicated technical detail within the inner workings of pension schemes, investment funds and regulatory input. But that’s the point with a default fund. Dedicated experts whose job day in day out is to be specialists in this stuff take the necessary action to ensure a scheme is well run and investments are managed with great scrutiny, so that members don’t have to. A default isn’t a last resort. In well-governed master trusts, they represent a solution which is in the best interests of the vast majority – a lot of thought goes into it so that members who don’t have the time or the specialist knowledge can get better outcomes.
Add to that the tight regulation and governance assigned to master trust defaults, in particular, and it’s clear they are far more than just a back-up position for those who don’t engage with investment decisions.
We should celebrate a system which offers better outcomes for most members in a simple way without them having to make any difficult decisions. In a world where we’re so often faced with an overwhelming array of choices, it’s hugely reassuring.
Read the report, Workplace Defaults: Better Member Outcomes.