What is a SIPP?
A self-invested personal pension (SIPP) is a type of pension available to UK residents that grants the pension holder greater freedom when investing. An investor can choose and manage their own investments within a SIPP, and still get the tax benefits available to other types of pensions.
Why open a SIPP?
Many people are in the position where they have worked for a few employers during their working life and have built up several pension pots of varying sizes. Consolidating them into a single pot makes sense for several reasons: many of those pots won’t be being managed to achieve the best returns, for example, while a larger pot can work harder for you due to the impact of compounding.
Most importantly, a SIPP gives you a pension pot you control. You can manage it as you wish, ensuring you target returns based on your expectations for life after work.
Read more about three reasons to transfer your pension to a SIPP
Once you’ve decided to open a SIPP and chosen your provider, you must then complete the transfer documents, which your new platform will send on to your existing pension provider or providers to close the account(s).
The majority of individuals are in workplace pension schemes, whereby the employer makes a monthly contribution into a default fund. In a process that is likely to take around one month the units in that fund will be sold, and the cash proceeds sent over to the new provider.
Once this is complete you are in position to make some investments, but how should you start?
Tips for investing in your SIPP
You may have heard the advice ‘only invest in what you know’. This is sound advice, but regrettably it is often misinterpreted by investment novices. It doesn’t mean that if you do your weekly shop with Ocado, for example, and have a good experience, you should buy some shares for your SIPP.
Investing in what you know means understanding how the company makes money, and critically understanding what’s on its balance sheet. For example, everyone knows that UK housebuilders buy up land and build property, but investors a decade ago were buying into businesses with huge piles of debt on their balance sheets. This is known as being heavily geared. A decade on from the financial crisis and the UK’s main listed housebuilders are much leaner, debt-free businesses. The business models may be the same, but the relative riskiness of the companies are poles apart.
So, if you’re choosing a portfolio of stocks for your SIPP, make sure you do your research.
You’ll then need to consider things like diversification. How much of your portfolio do you want in stocks, and how much in, say, bonds, or commodities, or exposed to property?
Read more about how to master investment portfolio diversification
Keep your costs low
This is more sage advice. The lower your costs, the more you keep for yourself, though saving every last pound will make a negligible difference. There will always be some fees to pay — the trick is to avoid the hidden costs. The good news is that the industry as a whole is being forced by regulators to become more transparent about fees, although there’s some way still to go. The advent of online investing platforms and passive investing is also helping reduce costs.
Investing in a SIPP is for the long-term
Investing for the long term is important, as time gives your investments the opportunity to grow. Nevertheless, a bad investment is still a bad investment, whether held over a week or a decade. Concentrating your investments into a few individual stocks and some high-growth ‘themes and dreams’ may possibly prove to be lucrative strategy, but it carries a high probability of going horribly wrong. The bulk of your SIPP should be invested sensibly; a retirement fund is not the place to take too many high stakes risks.
You should consider having the bulk of your investments in an approach that aims to outperform inflation and reduces individual company risk, yet continues to benefit from asset class growth. If equities and bonds didn’t make better long-term returns than cash nobody would own them. Therefore as long as global growth continues, investors should be rewarded for getting exposure to these riskier asset classes.
A portfolio of exchange traded funds (ETFs), such as IG Smart Portfolios, can deliver diversified asset allocations and low costs in one effective product, while still giving you the flexibility to make investments in your best share ideas. If you’re interested in individual ETFs, our Top 50 ETFs guide should help your decision-making process.
When do you plan to retire?
Your retirement date and your overall financial position both have a large bearing on how you should position your investments. All things being equal, the closer you are to retirement the less risk you should take on.
UK pensioners used to be obliged to purchase an annuity on retirement, but now they have the choice of investing in more or less wherever they wish which will likely include holding a substantial portion in equities.
Read more about the pension conundrum: buy an annuity or use drawdown?
Investors with more than ten years to retirement should consider having at least 70% of their investments in equities, tapering down that exposure over time if they wish to buy an annuity with a guaranteed income.
Above all, try and stay calm when stock markets fall. Making short-term losses is part and parcel of investing. As long as your portfolio has enough global diversification, you should be comfortably set to ride out the storm.