It is important to understand how your retirement product works and for retirement annuities this means understanding what the underlying unit trusts invest into.
The products described in Part 5 of the Retirement Savings Series provide you with different benefits and restrictions, but you may wonder how do retirement products (i.e. pension funds provident funds and retirement annuities) actually work?
Retirement products wrap around investments, which grow over time. In a retirement annuity your returns usually come from unit trusts, where your money is combined with the money of other investors and our investment managers use the pool of money to buy underlying assets, such as equities, bonds, cash, property and offshore - depending on the unit trust’s objective.
As you move down the list the assets become more conservative, but also less likely to give you inflation-beating growth. Let’s look at each asset type in turn to explain why it matters what you are invested into:
- Equities are shares (or stocks) in a company. A company issues shares to raise money and gives you part ownership of that company in return. Over the long term equities tend to outpace other asset classes, but in the short term they can be very volatile.
- When you invest in property you buy with the intention of making a profit. In most cases unit trusts will invest in property companies that are listed on the stock exchange, which exclusively derive their income from managing and owning property.
- Bonds are like IOUs with structured terms defining interest rates and the payment schedule. An institution asks for money and promises to pay you back according to these terms.
- Cash, as an investment term, refers to short-term loans that are offered by institutions like banks, governments and some big companies at a slightly higher interest rate than your normal bank account.
If you were strictly invested in one asset type for your entire working life, especially the more conservative classes, you may lose out on growth. For certain periods of time one asset class delivers better returns than others (e.g. in the past decade, local property outperformed all other asset classes). Knowing when to move into and out of an asset class (or switching between unit trusts that invest in different asset types) is difficult. Mistiming this move can be costly if you sell when one asset class is in the shallows and buy when another is peaking.
The easy way
For most investors leaving these decisions to an investment manager, who will have more knowledge and experience with the markets, is the best solution. Balanced funds that invest in a range of assets and comply with retirement fund regulations are an easy way to manage your retirement savings. You won’t have to worry about rebalancing your assets to comply with regulations and a good investment manager can effectively diversify your risk.
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