This month the Department for Work and Pensions calculated that by 2020, 10 million people will start saving, or saving more, due to auto-enrolment. They’ll soon collectively be putting away billions each year, mostly into default funds.
So what makes a good default, and in a world where most people save into one what other fund choices should there be?
What makes a good default, and in a world where most people save into one what other fund choices should there be
For those responsible for choosing or recommending a scheme, there’s a need to find a default that’s right for workers within an appropriate risk framework. This can be challenging given the diversity among workforces, even small ones.
Our response has been to create a default strategy of nearly 50 retirement date funds. When a worker enrols, their money is invested in a retirement date fund based on the year they’re expected to retire. For example, if the year they’re expected to retire is 2055 we’ll invest the member’s retirement pot in the 2055 fund.
Each fund is a single-year target date fund, and this set up is unique in the UK. Whatever approach people select to meet the needs of the workers in question, the aim will be to find something that’s right for most of the workforce.
Around this default, how many fund choices are too few? How low can the number of alternatives go before it’s at odds with the regulatory guidance and what clients’ workers need? Or is this less about the number and more about the variety a scheme’s fund range offers?
A number of factors are important here:
The total range of different risk profiles offered across the options
Whether a scheme might be offering a number of funds that, on closer inspection, cluster around the same risk profile
Whether different faiths and beliefs are reflected in the fund choices. A range that is inclusive and reflects diversity will reduce the risk of savers wanting to opt out because they don’t feel catered for
Whether the fund options available are the legacy of existing schemes or have been tailor-made for auto enrolment savers
The majority of those responding to the international consultation that informed Nest’s investment strategy recommended keeping our fund choices clear, simple and small in number. They said this would be the best way to help members make sensible decisions, and would also be consistent with low charges.
Today, in addition to the yearly cohort of target date funds that make up our default strategy, Nest offers five alternatives covering ethical investment, sharia, higher risk, lower growth and pre-retirement.
These five choices reflect the diversity of our members’ needs without being overwhelming. Members have access to options that cover a broad risk spectrum that also reflects diversity in terms of faith and beliefs.
We think that providing a clearly defined default strategy and supporting choice framework – where all the options are well defined and meaningful – is right for auto enrolment. It not only meets the Pensions Regulator’s expectations, but also the needs of employers and their workers, many of whom are now saving for their retirement for the first time.
Mark Fawcett is chief investment officer at Nest
