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 3/4ths 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.