Liberating as it might feel, populating a self-invested personal pension (Sipp) can come with all manner of pitfalls. From the most experienced investors to novices, those starting up a Sipp should be mindful of several issues that commonly crop up – from individuals misjudging their own risk appetite to having too many holdings or too little diversification.
This is an issue the Financial Conduct Authority (FCA) touched on last year when it warned that individuals using non-workplace pensions were struggling to make the best decisions. “They may end up with investments that are not appropriately diversified and with too much or too little risk,” the regulator said.
The FCA has therefore floated the idea of diversified default investment options for those who lack the experience or time to choose the right investments. While Investors’ Chronicle readers are likely to have a much more engaged approach, it’s worth envisaging how a starter Sipp might look and reiterating some good practices for those who have recently opened one. These basic considerations can help avert future conundrums.
Remember your core
While investors will come to Sipps with different goals and at different times, part of the appeal lies in the level of freedom available. A younger investor can use their Sipp to back promising themes and sectors unlikely to appear prominently in a workplace pension, while more experienced hands transferring money into the wrapper may relish the opportunity to take a more contrarian approach.
This is hard to argue against, especially for those with time to stay in the market. Edward Allen, investment director at Tyndall Investment Management, notes: “A pension is a wonderful place to be contrarian. You do have the patience to sit things out.” He argues that investors could put money into areas that look volatile or beaten up but promising in the long term – from smaller companies to emerging markets.
Following this suggestion alone can, of course, lead to problems. An issue that often appears in our Portfolio Clinic feature concerns investors who have kept putting money into different opportunities, only to end up with a huge number of holdings that they cannot effectively monitor.
Two approaches can help here. First, it makes sense to have a diversified ‘core’ of your portfolio, made up of a few holdings or even just one that can give you broad market exposure.
Depending on your goals and preferences this core can take various forms, from using a generalist, diversified global active fund such as the F&C Investment Trust (FCIT) to pairing a couple of global funds with differing styles, or instead using passives, which give a good spread of exposure. Think multi-asset funds with equity and bond exposure to match different allocation preferences, or a combination of trackers in different asset classes. Many of the multi-asset funds do come with bond exposure, something that has been painful in recent months. As we mention in our asset allocation feature, there is an argument for using a spread of different alternative assets as a source of diversification rather than relying on bonds alone.
Allen notes that it might be helpful to have “50 to 70 per cent [of a portfolio] you don’t have to worry about”. The rest of the portfolio can be allocated to so-called satellite holdings, targeting areas not captured by the core. This might include more niche holdings, from individual shares to more esoteric funds, and riskier or more tactical positions. Your core allocation may rise over time if you become less interested in the day-to-day portfolio management.
Conversely, those at the early stage of investing may put everything or most of their assets in a core to keep life simple, before expanding once the portfolio is larger. As Charles Stanley chief analyst Rob Morgan notes: “If you are starting out, don’t overcomplicate. The most important thing is putting your money to work in the market. Invest regularly so you don’t notice and use simple products if unsure – cheap global index trackers, or multi asset funds – a convenient ‘one-stop shop’ that covers the important investment areas for you.”
The size of your holdings is also important to monitor as and when you start to include more investments in a portfolio, and having discipline here can be one way of preventing your number of holdings from rising too aggressively. If opinions differ, Allen uses position sizes of between 3 and 5 per cent of a portfolio when it comes to alternative investments, with the rationale that such positions can still influence portfolio returns if things go well, but not too much if they turn out badly.
Finally, there is the importance of rebalancing, usually every six or 12 months, which can be done by directing new money to the lagging areas of a portfolio. This brings you back to the previous asset allocation, and prevents the portfolio from drifting too far from its original composition.