Pension is something we usually don’t think much about in our thirties since it feels distant and abstract. Even if we do try to get our hands dirty with it, we usually give up soon, as the whole thing is complex and requires (at least some) advanced knowledge in economics. With this post I would like to advocate a different perspective: it is not at all distant, it is important now. And it is not complex, it is fun. The post is targeted mostly at readers residing in Sweden, as the topic targets the Swedish pension system, but many considerations are also valid in a broader context.
Over the recent year I learned a lot about the pension system in Sweden and I would like to share my knowledge, as good as I can in a blog post without being lengthy and boring. So I will use simplifications and focus on the most important things, rather than giving a detailed description of the whole system.
Why is it important to think about pension more than 30 years before retiring? Because the default choices of placing your pension savings are not good. They are safe. But in most cases they mean ending up with less money when you retire. How much less? Let’s look at a somewhat simplified example. If you get 4000 Swedish krona (kr) per month in your tjänstepension (I will explain later what that is) over the next 33 years and take the default choice which over the last few years gave an average income of 5% per year, when you retire you will have saved just over 3 000 000 kr. If you instead make an active choice and get an average income of 7% per year, you will have saved just under 4 500 000 kr. Yes, that is 1 500 000 kr more with a as little as 2% more income per year. This sum definitely makes it worth to invest some time and effort into understanding the pension system.
There are three main parts to the Swedish pension system: allmän pension (public pension), tjänstepension (occupational pension) and privatpension (private pension). I will immediately jump over the public pension and private pension and focus on occupational pension. You cannot decide where to place your public pension, except for a small part called premiepension (premium pension), but here the default choice (called AP7 Såfa) has performed very good. Private pension is the money you choose to save yourself towards your pension. This could be in any form you choose: a savings account, stocks, funds, real-estate etc. This leaves us with occupational pension.
Occupational pension are the monthly premiums an employer pays towards your pension on top of the public pension. Every employer pays towards public pension, but not every employer pays towards occupational pension. If yours doesn’t, please consider changing jobs. Having only the public pension means that your future pension will be just over half of your average salary. The default choice for occupational pension is called traditionell försäkring (traditional insurance). This has given an average yearly income of roughly 5% over the recent years, and it means that your money is being taken care of by professional asset managers. What can be wrong with that, they know more about money than us laymen, right? Well the problem is that they are not allowed to make too risky investments, and for larger income you have to expose your savings to a larger risk. Why would you want to risk your money? My somewhat naive reasoning for this is the following. Pension savings are long term savings (in my case more than 30 years are left to retirement). In 30 years there will be more people on the planet consuming more goods and more services, meaning that the total economy will be bigger. Sure, there will be economic crises along the way, the value of the economy will go up and down, but it is quite certain that it will end up higher than today*. In traditional pension insurance, the increase in value of pension savings does not follow the increase in economy, it typically under-performs. To take full advantage of the growing economy, you need to opt for the second option in pension savings called fondförsäkring (fund insurance). This means that you invest your pension savings into funds of your choice. As with the economy, this means your savings go up and down, but should end up being worth a lot more after 30 years compared to traditional pension insurance.
* An update in 2024: When writing this text back in 2017, a growing population was a reasonable assumption that I never heard being questioned. However, a number of countries with advanced economies (for example South Korea and Germany) have a demographic situation that by no means guarantees that their populations will be bigger in 25 to 30 years compared to today. How this will affect their economies is not entirely clear, as the capitalistic economic model has not been tested in the circumstances of a shrinking population.
Ok, funds it is, but how to choose which funds to invest to? There are two general rules: spread your risk and be aware of the fees. Index funds are the answer to both. In my portfolio I have a mix of index funds that follow the economy in Sweden, in Europe, in the USA and in developing countries. This is a good basis that spreads the risk over different geographical areas (please note that this portfolio still is quite risky, as index funds are risky in nature, and a stock market crash in one geographical area typically has consequences in other areas, too). The basis can be developed further in any way you see fit. If you want to invest in a different geographical area, there are funds for that. If you want to focus on a particular industry branch (for instance, if you think that the software industry will perform well), there are funds for that. If you believe in companies that work with clean energy, there are funds for that. If you do not want your money to be invested in dubious industries (like for example weapons), there are ethical funds.
If you have more economic knowledge and can predict when the stock market will go down, you can temporarily move your savings from stock funds to less risky money market funds that are not exposed to the swings of the stock market. Then when the stock market goes down, you can buy a lot of stakes in stock funds cheaply and just enjoy watching as these rise in value again when the stock market recovers. Well in theory at least. In practice, knowing when the market will hit a peak or a dip is not trivial and a lot of people lost their money trying to do so. So instead of timing the market, aim for time in the market – as I said before, the market will go up and down, but the longer your money is invested, the more chance you will end up in plus.
How do you know where your pension savings are placed now? Log into minpension.se (btw. this is where the title image comes from), it is a very good starting point. For more details, for every pension component listed there, visit the Webpage of the institution that manages the specific component. There you will also find information on how to move your savings from traditional insurance to fund insurance. When moving your pension there is one aspect to keep in mind – it is too risky to buy stock fund stakes for a large sum of money at once. Imagine that the stock market crashes soon after you have bought stock funds for a lot of money, this will make you loose a large portion of your savings. A way to get around this is to first buy stakes in a safe money market fund for all of the money you are moving, and then move a portion of the savings into stock funds every month.
Once you start and get the hang of it, you might get hooked and check your funds often. Even if you do not get hooked, try to check how your funds perform at least once per year. A good time to do so is when you get the notorious orange envelope with the specification of your pension savings. Keep in mind that the closer you get to retirement, the more you should lower the risk of your investment. A couple of years before retiring, it might be a good idea to move your savings back to traditional insurance or to safe money market funds.
There is much I have omitted and simplified, not because I wanted to, but because it would make this text into an unreadable mess. For more topics, read about återbetalningsskydd (pension inheritance in the event of death) and löneväxling (investing a part of your salary into pension). I hope I have managed to convey my main points: (i) start thinking about and acting upon your pension now, and (ii) it is not so complex to start as it sounds, actually it is quite fun (ok, I might be stretching it a bit here :-)). I hope also that my text was a worthy contribution into getting you motivated for tackling the pension monster. And in the end (my lawyer said I have to write this :-)), I am not responsible for how your pension savings perform – I presented some general tips which I follow myself, but these cannot be seen as any sort of guarantee. If you have remarks or objections, I would be happy to see them in the comments section.