The true cost of investing

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Paul Lewis has had a summer holiday sitting in his tent reading spreadsheets. I spent the past 24 hours listening to people within the investment industry, either boasting that they were enabling as much as 3% pa of a client’s investment to be “retained” in the financial services food chain or moaning that they were prevented from taking more than 0.75% pa from the member’s pot.

The average pot managed by Nucleus- who have £11bn of our money under management is £134,000, the typical charge on client money is 1.8% (ex hidden charges from fund managers) and they are about the cheapest platform provider you will find.

So when I read that Paul Lewis has had a summer holiday sitting in his tent reading spreadsheets, I decided to read the rest of his email. I was astonished to find he had been doing precisely the sums on his laptop, that I’d been trying to do in my head.

Here’s how his mail reads;-

Paul Lewis

 In a report it insists on keeping secret – sorry, confidential to the client who commissioned it – accountants Grant Thornton found that the typical ongoing annual cost of an investment of £100,000 over ten years was 2.56% a year. That figure was revealed in the FT just before the Bank Holiday and Grant Thornton will say no more about it, but confirms it is correct.

So, fed up with endless sunshine I thought I would put that number into a spreadsheet and see what it means. In other words what does 2.56% a year out of our investment actually cost us? And here’s the shock. However well our investment does at least a third and in many cases most of the returns earned by our money go not to us, the investors, but to them, the financial services industry.

Here are the numbers. I put £100,000 into an investment. Suppose the return is the maximum the FCA allows firms to use an illustration, 7.5% a year. For me that is perilously close to the 8% that many scams promise us. But let’s assume for now that this investment does achieve 7.5% a year over ten years. With no charges the growth on our £100,000 would be £106,000 – leaving us with £206,000 at the end of the tenth year.

But if the Grant Thornton figure is right then £44,000 of that growth would disappear in charges – to advisers, platforms, fund managers and so on. The investor would keep £62,000. So the industry snaffles more than a third of the growth earned by our money. If the return is the mid-range 4.5% a year then nearly two thirds (62%) of the growth goes to the industry – £34,000 to them, £21,000 to us. And if the investment made just 1.5% a year – the lowest illustration the FCA suggests – then the industry would take £26,000 leaving us with a loss of more than £10,000. Yes, the industry would take £26,000 even though the investor ends up with £10,000 less than they started with.

Running numbers through the spreadsheet shows that the financial industry takes most of the growth in fees if the return is 5.86% a year or less. And I should say here that my spreadsheet does the order of calculations in the one that is most favourable to the industry, adding on returns before deducting charges. Another way – deducting charges first – shows the return must be 6.3% before the investor keeps at least half the returns. In 2015 the FT says the typical return was 2.3% on a ‘growth focused discretionary portfolio’. That is less than the Grant Thornton figure for charges. So each year the money invested would go down. We would lose up to £3000 and the industry would charge us more than £28,000 for all its hard work losing us money.

Some believe that the Grant Thornton estimate is too low; one analyst suggested to me it probably excluded the cost of advice – add another 1% at least for that. At that rate it would take a return of 8.72% before we got as much of the growth on our money as the industry snaffled.

At the end of my day of sandals and spreadsheets I was glad my money was safely tucked away in banks and National Savings. It may only earn around 1% a year. But at least I keep it all. And on Grant Thornton’s figures I would need to earn 3.6% a year in an investment to beat it.

Paul’s Moneybox will be confirming this today (12 noon) and I’ll be posting the link on this blog so you can hear the debate.

But let’s be clear, there is absolutely no pressure to get these charges down to reasonable levels (other than some stick-waving by the FCA.

If you want to know where your charges go, here is a reasonable estimate from one industry insider (and I am under Chatham House rules so I can’t say which).

Fund Management Costs  – 1% (100 basis points)

Platform fee – 0.35% (35 basis points)

Discretionary fund manager fee – 0.35%  (35 basis points)

Advisory fee –  1% (100 basis points)

Hidden fees within the fund – anything from 0-1.5% (150 basis points) – can’t be more specific- they’re hidden.

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Of course you don’t have to cop the whole lot, but many people do. One of my post popular blogs ever was called “How can this be”. This was about a statutory illustration given to a school friend of mine which confirmed exactly what Paul is saying. The illustration told the client that if he entered into the agreement with the adviser- DFM manager- platform and fund managers, he would lose money in absolute terms over ten years unless his investments performed at a rate in excess of 3.2%.

As these illustrations took no account of hidden charges (and the IFA had absolutely no idea what hidden charges might be) we can reasonably assume that my school buddy was going to need at least 4% pa growth to achieve break even and probably 6% to keep pace with inflation.

Of course you don’t have to pay these ridiculous sums. Good IFAs will charge you a fee and guide you towards investments that don’t need all the trimmings. You may not get the fancy service but you can get very good management of a multi-asset fund for 0.13% with L&G, add to that 0.3% for platform fees and subtract anything for a discretionary fund manager , an IFA and for active fund managers and their hidden fees and I am paying around 0.35%pa on my lifetime savings.

 

I am incredibly proud to have saved £400,000 into my pension pot. 

0.35% of £400,000 is £1400 which is about what I am paying L&G to manage and invest my pension pot.

1.8% (the amount I think I’d pay with Nucleus – a very good value platform- is £7,200pa.

3.2% (the amount my friend would have paid if he’d taken up his IFA’s recommendation) – would have meant him paying £12,800 pa for his fully managed service.

And if my friend had been paying median hidden charges (at a further 0.8% pa on this fund) , his total annual bill in perpetuity would have been an eye-watering £16,000. 

 

It would seem that Grant Thornton and I agree, it seems that my friend and Paul Lewis are surprised. I am not surprised because I see the lifestyles of those in this financial food chain.

lamborghini


Simple fees

If you want advice on how much your firm needs to pay  under auto-enrolment ,what workplace pension is right for you and a full audit trail on the decision you have taken, you can pay £199 +vat for the services of http://www.pensionplaypen.com. You pay it once via a credit or a debit card, you will never have to pay us a penny again. That is clear, simple and frankly the value for money you as a customer deserve. Of course you have to pay for your product on top, but most workplace pensions are available for around 0.5% (with low hidden fees) and even the more expensive are not going to hit you with more than 1%.

There are other “robo-advisers” out there, gearing up to offer financial services at similarly reasonable prices. I am afraid I cannot advertise best buys on this website as I would be straying into retail advice which I am not qualified to do, but suffice it to say that when I invest in Fundsmith, – an active fund manager- I know that my total cost of investing will be in the region of 1% pa. If I want to buy an off the shelf ISA with any number of fund managers- I pay for fund management, a small admin fee and not much more.

Non-advised should not be expensive. Of course, the real expert will not need a fund but will build their own portfolio with meticulous care, but how many of us can confidently do this with any degree of certainty of beating the index.

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The harsh reality is that – for most of us – we need to buy funds or buy the market via ETFs. If you want to do this, then keep it simple, pay simple fees, know what you are paying for and stay clear of the hooplah mentioned above!

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About henry tapper

Founder of the Pension PlayPen, Director of First Actuarial, partner of Stella, father of Olly . I am the Pension Plowman
This entry was posted in pensions and tagged , , , , , , , , , , . Bookmark the permalink.

6 Responses to The true cost of investing

  1. Brian Gannon says:

    have to agree that charges are too high. however it is also the case that not all investment solutions are this expensive and that long term good financial planning advice is worth paying for. probably the most expensive and unjustified costs are the fees paid by employers to consulting actuaries. they have managed to extract billions of pounds in fees from employers and yet look at the state of virtually every final salary schemes.

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  2. Trouble is everyone is motivated by margins..or profit. The true cost of any clothing retail product is marked up by at least 100%. Margins at a logistics company I worked at were 52%. They bought stuff in bulk ( pallet fulls) broke it up and made it available in small batches. Now FTSE 100 company. No one bats an eyelid at retailers making a fortune. Still our money and ironically the very companies pension funds invest in so we get the returns we seek.

    Liked by 1 person

  3. henry tapper says:

    I take your point Diana, but consultancy and advice should be different. There is no manufacturing going on , this whole game is about syphoning off small amounts of other people’s money. If I fealt I had a nice peice of clothing at the end of it- I might feel differently!

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    • If however the consumer feels that he is getting value for the advice that he is paying for the provider of that advice should be entitled to a reasonable margin. One of the biggest problems of providing that advice is that the costs of doing so are from a regulatory standpoint continuing to rise particularly in terms of the time required just to deal with all of the various measures you need to take to be compliant. The time involved from a competent adviser to provide advice is not inconsiderable and that doesn’t even take into account the supporting apparatus. Whilst technology may help in terms of the mechanics of investing and the administration and reporting the costs of providing advice are not getting any lower and even those of us content to earn an honest wage for doing so are under constant margin pressure. There needs to be a happy medium. We try to reduce the costs to our clients of the commoditised side of the business to an absolute minimum so that there is still room for a reasonable fee for advice. What’s then important to us is showing the clients their return on investment after all costs. We need as a profession to become better at demonstrating in real terms how we add value.

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  4. Don’t pay percentage fees where ever possible! If you are not happy with % based platforms then don’t use them! Problem is we have millions of small pots at the moment where % fees can look cheap compared to fixed charges. When larger pots are in play a £100 a year fee is much more reasonable. Those that need guidance and are of modest means are probably least likely to complain or litigate. They need simple low cost trackers and lifestyle de-risking if invested for retirement, anything else is prohibitively expensive in a low return world. The wealthy who may like glossy notepaper and smoozing from some parts of the industry can probably look after themselves.

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  5. Andy Woolmer says:

    Henry,

    I’m sure you must have seen the work on hidden fees done by both RailPen and WMPF (http://bit.ly/2bUJn2z) where their implicit fees went from GBP70mm to GBP300mm (328%) and GBP11mm to GBP81mm (637%). The fees were of course being charged to the pensioners all along, but were simply not reported.

    Is it not somewhat likely, given that RailPen and WMPF are two of the largest and most influential schemes in the UK that the figures of up to 1.5% of AUM for implicit fees are possibly substantially too low?

    Keen to know what you think!

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