Pension Investment Choice

The equivalent of having a bank savings account in your pension. Safe, but returns are unlikely to be that attractive over many years. It's where you should be invested in the few years before taking your pension to ensure a financial crash doesn't hit your pension pot.

These are IOUs from the Government. In return for buying a gilt the Government promises to pay you a fixed rate of interest for a fixed period, before returning your money. They're as safe as the Government, but be aware that you can lose (or make) money if you buy or sell between the initial issue and final redemption.

A gilt is issued at £100 paying £5, i.e. 5%, annual interest for 20 years. After 5 years interest rates have increased to 10%, which makes the gilt's £5 interest unattractive. It's price on the second-hand market might fall to £50 so that the £5 interest is equal to 10%, attracting buyers once again. Buyers now have the added incentive that if they hold the gilt another 15 years until redemption it'll be worth £100.

Investment grade corporate bonds

Very similar to gilts, but the IOUs are issued by large, financially stable companies. However, because they're not viewed as being as safe as gilts, they must pay higher rates of interest to attract buyers.

High yield corporate bonds

Unlike investment grade bonds, these are issued by companies whose credit worthiness is less certain. As a result they have to pay higher rates of interest to attract buyers. High yield corporate bonds also tend to be affected by stock market movements more than investment grade. Falling markets usually increase worries over the ability of weaker companies to pay the interest (and eventually return the initial investment) on their bonds.

Commercial property

Commercial property pension funds typically invest in retail parks, offices and factories. Unlike residential property, companies who rent commercial property normally agree to very long rental periods, 10 - 25 years is common. This should provide a stable long term income, although the prospect for rising property prices is lower than residential.

Residential property

Not practical to hold in your pension, but included here to help you gauge the relative risks of the other investment types.

Developed stock markets

Refers to buying shares in companies based in developed economies such as the UK, US and Europe. Your investment buys shares in a company, so your investment returns depends on that company's fortunes. Your returns can come from either a rise in the company's share price (because it's doing well and others want to buy its shares) and/or a share in the company's profits that it can choose to pay out each year, known as a dividend.

Of course, risk (and possible returns) can vary very widely between companies. A large well-established company with predictable earnings is likely to be safer (but less exciting) than a small technology company just starting out. The technology company could make a fortune or might just fall by the wayside.

Emerging stock markets

Similar to buying shares in developed stock markets, but the underlying economies (e.g. China, India, Russia and Brazil) are still developing, making them potentially more exciting but also riskier. If things go well your investment could soar, but temporary or permanent setbacks could see the value of your shares plummet.

Also bear in mind that these economies tend to be dominated by a handful of industries, so if one dominant sector sector struggles the whole country (hence other companies) could suffer.

A commodity is something that is standardised worldwide and has a universal global price. There are 'hard' commodities such as gold, metals, oil and gas as well as 'soft' commodities such as rice, meat and sugar.

Given commodities are generally not available in unlimited supply, the long term prospects look favourable if worldwide demand continues to grow.

However, be warned, prices can fluctuate quickly and wildly, so probably a good idea to steer clear if you're approaching retirement.

These funds usually (but not always, so check!) invest in two or more investment types. You'll often find them called cautious, balanced and adventurous (or something along those lines), which should indicate towards which end of the above investment diagram the fund is biased. They can offer a simple low-hassle approach to investing, but check how widely the fund invests (e.g. is it restricted to just UK shares and gilts, or is it a comprehensive mix of global shares, bonds and property) and the fund manager's track record.

'Tracker' funds aim to track one or more stock market indices, e.g. the FTSE 100. The attraction is that they tend to beat the majority of actively managed funds in mainstream markets and charges should be low. The potential downside is that stock market indices tend to be dominated by a handful or large companies and sectors, so your investment may not be as diverse as you think.

The 10 biggest companies listed on the UK stock market usually account for around half of the FTSE 100 Index and 40% of the FTSE All Share. This is because these indices are 'weighted', meaning the larger the company the greater the influence it has on the overall index.

These actively managed funds normally invest in one specific investment type, allowing you to focus on a particular area, e.g. European stock markets, gilts or commercial property. If you're happy to take a more active role in managing your pension investments then consider combining several of these funds. As always, try to establish how risky each fund is and check the manager has a decent track record.

Just because a manager has performed well in the past it doesn't mean they will in future. However, if they've consistently performed well it suggests they're probably more skilful than a manager who's consistently performed badly.

The key is to look at year by year performance (called 'discrete' performance), not a simple three or five year figure. You should then compare this to a suitable index to see if, and by how much, the manager beat it.

There's loads of fund ratings available on the web, but the most useful are those provided by research companies and advisers who interview fund managers face to face as part of a process to decide whether they're actually any good.

It's not failsafe and, as some research companies charge fund groups to interview managers and rate funds, you need to draw your own conclusions on how impartial they might be. However, comparing a few of these should at least give you a feel for what the 'experts' think.

As the name suggests, funds of funds are investment funds that in turn invest in a range of other funds. Fund of funds managers need to be good at picking successful funds if they're in turn to succeed.

It doesn't hurt to look at what funds successful fund of funds managers invest in. They don't always get it right, but they'll be putting considerably more effort and resource into their investment selection than a typical private investor could.