Ignore your pension fund and expect to be poorer in old age

Safety is expensive. We are constantly being urged to put more into our pension schemes, but there is much less analysis of where the money goes, and of the price that the pension investors have quietly paid for being shovelled into bonds and government securities.

The FT looked at three types of fund: 80 per cent equities, 50 per cent equities, or all in bonds and cash. Since 2020, £100,000 has turned into £130,000, £110,000 and £90,000 respectively. In other words, holding shares has paid off, despite the poor performance of the UK stock market. The holders of bonds and cash are actually worse off than if they had asked their pension provider to put the money under the mattress.

It’s easy to pick holes. Three years is not long in pension time; the period straddles the crazy days of almost-free money, and your equity portfolio might look a bit sorry if you had not held at least one of the Soaraway Seven US tech stocks that have dominated the world’s markets in the last decade.

However, the results do show the folly of buying bonds regardless of price. When the UK government could borrow for less than 1 per cent for 20 years, as it could for most of 2020, no sane investor would want to be on the other side of that trade, especially with his pension money. By and large, he or she wasn’t. The most likely party on the other side, paying these mad prices, was the UK government itself, via the Bank of England, as part of the great experiment in Quantitative Easing. As the prices of those bonds has plummeted the bill has fallen on the taxpayer.

Quite why any student of British financial history would want to lend to HMG for 20 years at 1 per cent is another strange aspect of Covid lockdown. Yet the managers of your bond fund felt obliged to buy, perhaps through some mumbo-jumbo about “liability matching”, to offset the almost unimaginable possibility that UK government bond yields would fall even further, and stay there.

As we now know, they didn’t. That 20-year bond now yields a fraction under 5 per cent, and all long-dated bonds have delivered large capital losses to their holders. At today’s yield, there is a reasonable case for buying them, although inflation is eating away at the capital faster than the 5 per cent return, and we are promised a tsunami of new debt to cover the government’s chronic deficit.

Shares, on the other hand, are victims of people’s inability to tell the difference between risk and volatility. “Shares plunge” is an irresistible headline, but on a long-run chart of the FTSE100 index, even the post-hurricane collapse of 1987, or the banking crisis of 2008 are barely perceptible. The collapse in returns from government securities since 2020, on the other hand, has been brutal.

Yet the convention persists that as retirement approaches, your fund will progressively be switched from dangerous shares to safe bonds. As the FT demonstrated, application of this standard-issue “de-risking” has been expensive for today’s retirees. The moral here is the usual one: ignore what is happening to your fund, and expect to be poorer in old age.

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