Pension

[Mushroo]

I know that everyone says it’s better to invest in your pension early so that it compounds.

But can someone explain how that actually works?

I understand the logic that if I have £1000, and I earn 10% interest in the year, I’d have £1100 the next year, and get interest on that.

But, my pension is just invested by my provider and it just seems to fluctuate? There’s currently about £45k in there and the gains jump up and down depending on the markets - it doesn’t seem any gains are ‘banked’. (Eg this year it’s ranged from a -3% return to a 6% return).

So it seems as though if the markets happen to be down when I retire, it’ll be worth not a lot. I’d almost be better to just have it not invested and in an account that just pays 4% a year guaranteed where I can ‘bank’ the interest each year.

Am I missing something?

Generally (not guaranteed) over a long period stocks and shares have a higher return. As you get closer to your retirement age most pension companies will reduced your investment risk.

Growth will vary a lot but over a long period of time you can expect an annualised growth of 5%. Some years will be lower and some will be a lot higher.

The investment funds within the pension wrapper should be Accumulation funds, so when the companies the funds invest in produce a dividend, that money is invested in the fund and the fund grows.

Pensions win over ISA due to how they are taxed. Your contributions to pension get tax relief added (or you pay less tax if a salary sacrifice scheme) so more is going in to pension than if you put the same amount you put in to pension, instead to ISA.

This video may explain it better: m.youtube.com/watch?v=y-4s1wqwQ7k

You don’t - or shouldn’t! - just passively sit back and just take what you’ve got aged 65 (or whatever).
Some pension providers call it “lifestyling” - basically you aim for growth (which can include higher risk) and then as you get close to your planned retirement age, you de-risk. You could decide to move the whole lot into cash 2 years before you retire.

As @nannynick says, the tax relief on pension contributions is the huge win here. My personal pension has been hit hard (Covid, Brexit, Ukraine, Kwarteng…) but it’s still way more than I contributed - because of tax relief.

For example, an S&P500 index tracker over the past 60 years would have averaged 9.5% a year, much more than the 4% you can get in a savings account and more than property.

Thank you all - it is reassuring I’m doing the ‘right’ thing I’m just naturally so risk averse seeing it going down is hard!