Managing Risk in a Private Pension Retirement Product - Gemma

The possibility that an investment may lose part or all of its value is called risk. For example, if a company fails entirely, all liquidity (the extent to which an asset can be quickly and completely converted into currency in order to be used as a means of payment – Collins Dictionary of Economics) disappears, as does the investment. The degree of risk may range from a decrease in the investment’s value to a complete loss of the investment.

There are products that we can invest in and have what is called a ‘Default Fund Mechanism’. Default Fund Mechanisms are designed to protect long-term investments and savings which are set aside for retirement particularly if such savings are started by persons aged as young as 18 years. Such protection is essential because of lack of financial literacy, limited time to monitor investments on an ongoing basis, and because of adventurous personality types driven to take risks without much thought.

A Default Fund Mechanism seeks to balance the importance of growth with the importance of ensuring that your nest egg is not exposed to risk when you retire. There are different types of Default Fund Mechanisms one of which is the Lifestyle Default Fund.

The Lifestyle Default Fund manages growth and risk through different product combination as you age or reach retirement age. As you get closer to retirement, often 5-10 years before your retirement date, the fund automatically ‘de-risks’ your investments to ensure that you avoid losses close to retirement by transferring your savings into less risky funds such as bonds and cash. Furthermore, savings will be invested in a combination of several funds rather than just in one.

Overseas research shows that nearly 3/4^ths of the people who invest for their retirement opt for the default fund. Recent research shows that for half of those who chose the default fund, the default fund is the best option among other alternative options.

The Table below provides an example of a typical life-cycle default fund private pension retirement product.

Life Cycle	Description
Age 18 to 22 + 5 to 9 Years	Generally referred to as the ‘foundation’ phase. Ideally the private pension retirement product is purchased when a person get his or her first job. This phase has a number of aims. It is a phase where your savings are placed in high growth yet high risk investments – seeking a return of 10-12% annually. High growth investment is a life-cycle default fund happens when the person is still young and there is sufficient time to recoup any losses that may occur as the downside to high growth is high risk. Another key objective during this phase is to help young persons to form their retirement saving habit formation.
23 to 27 Years of Age +30 Years	This phase focuses on accelerating growth by at least 3% more than inflation (an increase in the general level of prices in an economy that is sustained over a period of time. – Collins Dictionary of Economics). Short-term ups and downs are likely but it’s the right time to take more risks while the person is still in employment prior to retirement. Still, investment is designed to protect the savings from big market shocks. During this phase, the life-cycle default fund is designed to meet outcomes such as o Invest in more growth-seeking assets. o Aim for steady growth in real terms over the life of the fund by being well-diversified. o Target a long-term volatility average of 6% to 10% per annum.
Age 53 to 57 + Years to retirement age at 65 years.	This phase is generally known as the ‘consolidation’ phase. This phase typically begins approximately 10 years before a person’s retirement. This is the phase where a person’s are most vulnerable to risk. If a person’s savings are invested in shares should the market crash the likelihood of a large percentage of those savings being lost is very high. This is because there is not little time between a potential market crash and the date of retirement for the market to bounce back and for your savings to reach the same level enjoyed prior to such a crash. Thus, at this point the savings start to be gradually switched away from risky investments – such as shares - to safer investments – such as bonds and cash - to protect the savings from the possibility of big falls in its value. Although some profitable rises to your capital are likely to be missed, it’s the smarter move at this stage of a person’s life-cycle not to lose any money. During this phase, the life-cycle default fund is designed to meet outcomes such as: o Continue to grow the investment portfolio in real terms o Gradually reduce volatility as the fund gets closer to maturity.