Defined contribution schemes

The importance of investment advice for defined contribution schemes

While trustees of defined benefit (DB) schemes are increasing their focus on investments, many trustees of defined contribution (DC) schemes believe that their responsibility is limited to offering a range of funds so that each individual member can make his or her own investment decisions. While ‘choice’ can be a positive attribute, in most cases it would be hard to argue that choice without guidance is in the interests of the beneficiaries.

Most people, including typical pension fund members, do not have the expertise needed to make informed investment decisions.  This was recognised by the introduction of the Financial Services Act 1986, which offers far greater protection to consumers of investment products than buyers of typical consumer goods. 

For most people, their pension is their second most important asset after their house, so it is vital that pensions are invested in suitable assets.  This is unlikely to happen if the choice of investments is left entirely to each individual member, although it would be impractical and prohibitively expensive to provide individual investment advice for each member.

The most obvious solution is to offer default investment options.  Given the significance of the investment strategy to the financial well-being of the members in retirement, the choice of default strategy or strategies is of paramount importance. Where default options are offered, they tend to be very popular. 

If the investment strategy of a DB scheme ‘fails’ (however that is defined), the sponsoring company can often make good any shortfall and can do this over several years.  If the investment strategy of an individual’s DC pension ‘fails’, then the member is likely to face hardship in retirement.

This highlights the need for trustees of DC schemes to give greater, rather than less, attention to investment strategies than those of DB schemes.  This attention should focus mainly on developing a suitable default strategy.  Alternative options can be offered to those members who wish to make their own more active investment decisions.

Products for defined contribution schemes

Advice on setting up investments of defined contribution DC schemes is available to you on our website.  We do not charge you for this generic advice.

We can review practical issues relevant to your scheme, including a review of your fund manager.