Early Retirement Strategy #2 – Optimise Your Company Pension

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I’m still surprised by the amount of people I talk to who don’t realise that their company pension is invested in the stock market.

And that’s if they’re even enrolled in their company pension in the first place!

It’s crazy that we aren’t educated about how to save for retirement, pension plans and the stock market when you consider the fact that the entire global economy is affected by its movements and vice-versa.

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Investing and understanding the stock market used to be the reserve of the rich and powerful. The graphs and ticker symbols are confusing, the hectic images of wall street traders in the news and the sheer cost of executing trades was enough to put anyone off.

So, I can understand that people don’t want to investigate their pensions and find out where their hard earned cash is being invested. I didn’t for more than 4 years!

That was until I found the ChooseFI Podcast and the Financial Education Youtube Channel, which taught me almost everything I know about the stock market, investing and how to find good deals.

I’ll talk more about retail investing, how and where I invest and my investment strategy in a another post. For the sake of continuity and helping those who haven’t considered any of these strategy’s, I want to first talk about your company pension plan and how to maximise your returns.

Get this all squared away before you consider moving on to building a stock market portfolio.

First and foremost, enrol!

If you’re not already enrolled in your company pension scheme, stop reading this right now and go and enrol!

Speak to your HR department and ask for the forms and whatever you need to get on their scheme ASAP!

If you want to retire at all, ever, you need to be enrolled in your employers pension scheme. Unless you’ve got a huge inheritance of multiple hundreds of thousands of pounds?

Didn’t think so. Enrol!

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If you didn’t already know, employers in the UK are mandated to match your contributions to a certain amount. The legal minimum is 3% for your employer but most employers contribute more than this to provide incentive to work for their company.

THIS IS FREE MONEY.

If your contribution is 4% and that means you’re putting in £125 per month, your employer matches that and gives you £125 too! That’s a 100% gain immediately! Not to mention the tax relief due to the fact it’s taken from your pay before tax and deductions.

Also, company’s normally receive national insurance tax relief and will often contribute this too, which is an extra little top up.

The key message here is to get on your plan, now!

The next thing you need to do is max out the matched contribution.

If your company matches up to 4%, put 4% in. If they match 8%, then I’m extremely jealous, but put 8% in!

As I mentioned above, this is literally free money, in addition to your pay that will help you grow a nice, tidy stash in retirement.

Now, how to manage your pensions investments…

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At this point in time, your company pension’s investment strategy is probably not optimised.

This isn’t your fault and it’s not your employers fault either. It’s down to a set of defaults that are applied to everyone who gets enrolled into the company pension scheme.

Your employer likely has a third party provider who receive your contribution and your employers contribution, and then invest this in a particular set of stock market funds depending on the risk level you selected when you set it up.

For most people though, their risk level is defaulted to 3 out of 5. These risk scores have corresponding funds which are set up by the provider and, in fairness, they’re normally quite well distributed, low cost, passively managed funds.

A passively managed fund, for those who don’t know, is a fund that tracks a particular index. An example of an index is the FTSE100 or the S&P500. When a fund tracks one of these indexes, it basically splits your investment between every company in that fund. So, you own a tiny piece of every company in that list.

Therefore, if one of those funds in your pension investments tracks the S&P500, you own a small piece of Microsoft, Apple, Amazon, Facebook and 496 other companies.

Pretty cool, right?!

These are much less risky than picking those stocks individually, because if any one of those 500 companies goes bust, or their value drops dramatically, they simply fall off the list and are replaced by the next most valuable company in the US.

Because passively managed funds don’t require a well educated, well salaried investment banker to execute trades and research stocks, their fee’s are usually many times lower than actively managed funds.

This means they take less of your cash in fee’s when you invest, which leaves more to be invested and compound over time! See my previous post to understand the power of compound interest.

But surely these passive funds don’t perform as well?

Surely, if someone can actively buy and sell individual stocks, they can time the market, buy low and sell high and maximise my returns? No. >99% of actively managed funds and individual stock market investors fail to outperform the market.

This doesn’t mean it’s impossible. It just takes a bit of work and research to find those stocks that are undervalued that have the potential to grow dramatically in value.

So, what I recommend for the vast majority of people is to make sure your pension is invested in low cost, broad-based index funds. These give you the ability to set and forget you investing. Meaning your money will flow into these funds each month automatically via your salary sacrifice and grow better than most actively managed funds without you having to do anything.

Which funds, or set of funds to pick is up to you! It depends on what’s available through your provider.

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But it’s really not hard to find out, or to switch if you so choose. Most of these providers will have an online portal for you to log in and see your pot of cash and will have an online chat or ‘contact us’ option so you can simply ask what’s available to you.

Failing that, these providers have to give all employees enrolled in their scheme access to free pension advice with a trained adviser for up to one hour per year. This may vary with provider.

Take full advantage of this and ask any and all questions about what funds are available to you on your plan and how to switch and distribute your current pot and future distributions between different funds if you like the look of more than one. What you need to say, is:

I want my money invested in low-cost, broad-based index funds with maximum exposure to the stock market. What funds are available to me, and how do I switch?”

You’ll often find funds available to you, yielding many more percentage points per year than the one you’re currently invested in. If not, and your plan is the one you like the look of most based on your appetite for risk and preferred split between equities (stocks) and bonds (loans – e.g. government or corporate), then that’s great!

At least you now know and can sit back, and watch your money compound year after year! I prefer to have 100% exposure to the stock market at this point in my journey.

Bonds are good for a safe bet. But you’re looking at returns of 1-3% versus 7-12% per year with the stock market. As I approach retirement, I’ll switch portions equivalent to my yearly expenses into bonds every couple of years so I’m less at risk of short term drops in the market.

That’s everything for now on company pensions.

Let me know in the comments below if you have any questions relating to this topic, or want to share your strategy and what your employer contributions are.

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Next up in this series – Minimising lifestyle expansion to maximise your savings rate.

See here for How to invest in the stock market

See here for Stocks vs ETF’s

See here for My full year investment portfolio breakdown

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Published by Finance&Lifestyle

A Dad from the UK documenting his journey to financial freedom. Sharing my lifestyle and finance hacks so more people can find financial independence, retire early and take back control of their future.

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