Very excited by developments in @agewageuk scoring that are helping us understand the risks each saver experiences relative to all relevant risks members can take, more in weeks to come!
— Henry Tapper (@henryhtapper) July 2, 2020
It is narcissistic to blog about your own tweet but I’m going to anyway!
As regular readers know, I am interested in the value I and millions like me have got for the money we’ve had paid into our pensions. I choose my words carefully, few of us save directly , most of us do it through payroll.
And because this money is paid through payroll it is part of our pay – the amount sitting in our pension pots is a combination of the money we paid in , the money the tax-person paid in and the amount it has grown since being paid in. This is our savings experience, it is unique to us and we know very little about it.
We don’t get receipts for the money we , our employers and the tax-person pay in, nor do get a statement telling us how much our pot has grown. Instead we get statements from time to time telling us how much is in our pot.
Not only do we not know how fast our money has grown but we don’t know much about where our money has been invested. We know very little indeed about what – apart from our house – is likely to be our biggest asset
But it doesn’t have to be like that. A simple analysis of your contributions received and the current value of your pot results in your unique rate of return. We call it your internal rate of return with “internal” meaning – inside you!
It’s also easy enough to work out what your internal rate of return would be if you were invested in the average workplace pension. AgeWage helped Morningstar create Britain’s first every pension index. It tracks the daily increase in price of a unit in a fund going back to 1980. By reinvesting your contributions into this index we can find out what you would have got – had you been the average person.
What is hard, what we’ve spent a year on, is how to express the return you have experienced (your IRR) with the return you would have got in the UK pension index (what we call the universal benchmark).
Recently we have been doing a lot of research involving millions of simulations to discover how most fairly to express one return against each other. The word “fairly” applies because we want the score to tell you not just the experienced return you have experienced but the experienced risk you have taken.
To investment analysts we could explain the process we follow like this.
The AgeWage score takes the IRR achieved by a member. The IRR embeds the risks actually experienced by the fund into which contributions were made. In other words, it is the member’s risk-experienced performance.
In order to produce the score, we compare this IRR with the distribution of other IRRs
which might have been experienced by the member. These comparator IRRs consider all of the risk which crystalised during the period, including those experienced by the member.
The score does not consider risks which might have occurred but did not.
Destinations are important, but so is the journey!
During the course of your saving career, you will experience a few bumps in the road, you probably felt one in February, there will be more to come.
The way your pension fund deals with these bumps over time is your experience of risk. The longer we can measure your journey, the better we can look at the way your pension fund absorbs these bumps (experiences risks) and this is the point.
Your experience is relative to the risk you faced, not all the risks you could have faced. If you had prepared for every risk, your rate of progress would be so slow you might never have got to where you wanted to be – or could have got.
So what does past performance tell you about our future?
Well it tells us how much value we’ve got for our money and (with a benchmark) tells us how we’ve done against others. Assuming we’re travelling the same road in future, it tells us whether we’re in the right kind of vehicle or at least asks us to think more closely about how we want to travel in future.
This is important as there are huge differences between the outcomes of one pension fund against another and simply spraying your pension money across lots of little pot is unlikely to be a good idea. By consolidating pensions you are likely to pay less fees and have a more manageable way of paying yourself an income in later life.
Understanding the experience you have had from your various pension pots is a starting point in working out how to bring your pots together.
As we consider our futures, we cannot ignore the past, history is an important subject.