If you are in a final salary scheme then the income you receive in retirement will be based on the length of time you have worked for your employer as well as your salary.

If you are in your employer's money purchase scheme or a personal pension scheme such as a stakeholder scheme, the pension provider will hold your pension payments in a fund or funds.   The investment performance of the fund(s) will determine how much money you may have available when you are ready to retire.

Unfortunately no one can know how much your fund will be worth when you retire or how much income you will receive each month. However, it is generally accepted that investing your money rather than simply saving it in a bank is a more effective way of planning for your retirement.  A pension scheme enables you to invest in a range of funds which gives your money the best chance of growing to give you a decent fund for your retirement. However, the value of investments can go down as well as up and you are not guaranteed to get back the amount you invested.

In order to understand how to make the best choices about where to invest your pension payments you need to understand more about funds.

Funds allow investors to pool their money together, to take advantage of buying in bulk, spreading the money across lots of different investments and gaining the services of an expert who you would not normally have access to. All funds have different investment objectives and levels of risk. 

The fund that your money goes into is normally your choice, although your adviser will make recommendations for you if you are unsure of what to do. There are lots of different types of fund and literally hundreds of options to choose from. The variations in fund are usually in the way they are managed, the assets they invest in and the level of risk they take relative to the amount of reward they aim to achieve.

Most funds are managed on a risk basis, from cautious up to aggressive. A cautious fund aims to gain steady growth over a long period of time with little risk to you losing money. An aggressive fund aims to achieve higher growth but this increases the risk of losing money.

The assets that the fund invests in are also an important factor in the returns you are likely to receive. An aggressive fund may invest in companies that have just issued shares and so have the potential to do very well and make a lot of money, but they also have a risk of failure. A cautious fund may invest in Government bonds which provide a guaranteed growth rate. This growth rate will be smaller than you can make on the stock market but there is less risk to your money.

Many pension providers will offer a lifestyling option. This means that when you are a long way from retirement you may select higher risk investments to build up your pension fund while you still have the time to recover from any losses. As you move towards retirement your pension fund will be moved to more cautious investments to reduce the risk of a fall in value. 

You don’t need to have all of your pension money in one type of fund.  If you want to take some risk to try and gain a higher return you could start with a proportion held in a higher risk fund and the rest in cautious funds.

All pensions have a facility that lets you change where your money is invested, although if you want to change this on a regular basis you may get charged as it creates some administration work for the provider.

The value of investments can go down as well as up and you are not guaranteed to get back the amount you put in.

Funds are usually made up of one, or a combination, of the following:

• Cash
• Equities (known as stocks and shares)
• Fixed interest (known as corporate bonds and gilts)
• Property

Cash

This is essentially money held in bank deposit accounts. Money can be held in a variety of different accounts and is easily accessible. Once interest has been added, it cannot be taken away and the value of your investment will not fall.  This is the safest investment choice, if you don't like taking risks, but also potentially the least profitable.

Equities

Equities is another term for stocks and shares. If you were to think of a company as a cake, shares are simply slices (ok, more realistically bites or even crumbs) of that cake. When you buy shares, you’re buying pieces of a company, which you’ll own along with the other shareholders.

Equities are the most risky of the four asset classes. There are lots of things that can affect their value, some of which is down to the performance of the company and some can be related to economic and political events.

It’s the combination of all these events, many of which cannot be predicted or controlled that can make the price go up and down and therefore makes them a riskier investment. 

Equities or shares are traded on the stockmarket. The money you receive from shares is paid in the form of dividends.

Fixed Interest securities

Let’s face it, at some point we all need some extra money – whether it’s to buy a house or car, make home improvements or just to pay off existing debts. Companies and the government are no different – except when they get a loan it’s called a corporate bond or in the case of the government, a gilt. Like any loan, there is a fixed loan period and a fixed rate of interest. Because of this they can also be known as ‘fixed interest securities’.

As with any loan there’s a risk you won’t get your money back. To help you choose corporate bonds, they are graded. Those most likely to pay back will be highly graded, however they will offer lower interest rates. Similarly those who are less likely to pay will be lower graded, but will offer a higher interest rate to attract investors.

Gilts are not graded as realistically the government is going to pay your money back. There is still a risk but these are considered more secure.

Like shares, corporate bonds and gilts can be bought and sold. But the good news is that bonds are considered to be less risky than shares as their prices don’t fluctuate as much. Also, if a company does go under, bondholders are amongst the first in line to get their money back (although this is not guaranteed).

Commercial Property

We all know what property is. For most of us it’s the biggest and most important purchase we’ll make in our lives. And whether or not you view it as such, your home is an investment.

You may have more than one, as a second home, or a buy-to-let, if so then you’re probably aware of the benefits of this form of investing already. But that’s not the only way to invest. You can also invest in commercial property such as shops, offices and retail parks.

Although Property may not be the right investment for you, it is often seen as an attractive medium to long term investment. It offers a medium level of risk, with less volatile returns than equities. The value of property as an investment comes mainly from the income raised in commercial rents. Commerical property also tends to increase in value over time. However, it is important to remember that the value of property is down to the valuer's opinion, rather than fact.

Because buying and selling properties is time-consuming, property, as an asset class, is less "liquid" than equities and gilts. This may result in encashing problems at certain times.  However, at times when equities, for example, perform badly, property can provide stability. It is important to note, however, that past performance is not a guide to the future and that the value of your investment may go down as well as up and is not guaranteed.

Risk is a part of investing, just as it’s a part of life. You can’t isolate yourself or your cash from it completely. Trying to assess risk when you’re new to investing or not familiar with what it is can be a difficult skill to master, but it’s the key to getting the most from your money.

So what actually is risk? Well when it comes to investments – it’s basically the reality that you could lose some or all of your money depending on the fund or funds you invest in. But don’t let that put you off. There are lots of different funds out there, each with different risk ratings. So if you’re more cautious with your money and don’t want to risk it then you can choose a lower risk fund to invest in.

But with risk also comes reward. So whilst the riskiest fund could see dramatic falls in value, lower risk funds will mean your money will be safer but you’re not likely to get great returns from them. The key to a successful investment plan is usually to have a mix of both.

To invest comfortably, you need to understand your ‘risk profile’ – the amount of risk you’re prepared to take, ranging from ‘none at all’ to ‘all or nothing’.

To help you choose investments that suit the level of risk you’re prepared to take, they are given a risk rating. There’s no standard way of classifying risk, it’s decided by the company or adviser selling the product. But as a guide it will be based on how likely you are to get your money back.

At Norwich Union, we classify risk into five levels and profiles, these are:

1. Low – “I’m not prepared to take any risk with my capital and realise that this may not safeguard my investments against inflation”.
2. Low to medium – “My aim is to achieve greater returns over the longer term than with interest paying accounts. I’m therefore prepared to accept the risk of possibly losing some of my money and to see some fluctuation in the value of my investment”.
3. Medium – “My aim is to achieve better returns over the longer term than are available on more cautious investments. I’m prepared to accept day-to-day fluctuations in the value of my investments and the risk of a possible loss arising at any stage”.
4. Medium to high - “My aim is to achieve better returns over the longer term than are available on medium risk investments. I am prepared to accept wide day-to-day fluctuations in the value of my investments and the risk of a possible loss arising at any stage”.
5. High - “My aim is to maximise my returns over the longer term. I am prepared to accept significant day-to-day fluctuations in the value of my investments and the risk of a possible loss arising at any stage”.

Choosing which funds to invest in can be confusing if you’re not sure what you’re doing. But by taking some time to familiarise yourself with the funds on offer from your pensions provider and identifying what level of risk you’re prepared to take, you should be able to make your own decisions. If you’re still unsure you can always speak to your employer scheme representative or a financial adviser.

As a guide though, putting all your investments in to high risk funds gives you the potential for very good returns. However high risk funds also carry the highest chance of losing money.

Low risk investments are comparatively safe and unlikely to go up and down excessively. But you could pay for this security in other ways, with only modest growth over the long to medium term.

Like all things in life, it’s about getting a good balance. You can split your pensions between funds, which means that you can spread your money in a way that suits you.

However as a guide Norwich Union would suggest the following:

10 years or more to retirement

Because you have longer to invest your money, this means that you have more time to ride out the highs and lows of the stock market. Therefore you can afford to invest in high, medium/high or medium risk funds. These are more risky funds, but offer a greater chance of increasing the value of your pension fund.

If you’re a more cautious investor then you may prefer to invest in the potentially lower but more stable returns from a low risk fund, but remember these funds are unlikely to significantly improve your pension fund.

Between 6-10 years

As you have less time before retirement, high risk funds would not be recommended and you should now be considering medium/low risk funds.

Between 2-6 years

In the final approach before retirement, we would recommend looking at medium/low to low risk funds – because your investment has less time to ride out the highs and lows of stock market ups and downs and you’ll want to protect the money that you now have.

Less than 2 years to retirement

Most investors should be looking at protecting their investment by buying into lower risk funds, as there would be no time at all to make up any drop in value within such a short space of time.