This article may be of help to those who don’t realise how large investment fees can be when related to the growth of your funds. This will be relevant to those who are forced to consider drawdown pensions or investing for the first time and feel lost.
Don’t make financial decisions without fully understanding the consequences. Verify your plans with your own research and independent financial advice.
Generally, we are told to start with a financial adviser. You would probably do better to consult as many financial advisers as you can and cross-check their answers while you build up a feel for what type of investment strategy is right for you.
Managed Fund Types
You should be aware that you will pay fees even if the fund loses money! The fund management systems aren’t taking the risk, you are! …but its still in their interest to look after you. There are three main management methods: Active, Robo and Passive.
This is the traditional method of investing using a fund with a fee and optionally taking advice for a separate fee. This method involves a more hands-on approach and so the costs are higher than Robo and Passive funds.
Robo-management is achieved by creating a limited set of managed funds between the markets and the customer. The customer sees a suite of funds that have different risk vs performance levels and can choose a suitable one from the range and how much to invest. There may be between 5 and 10 pots representing risk levels.
Its simple to understand and manage. The management team only need to focus on balancing the pots to match the advertised level of risk at a regular frequency and is thus cheaper to maintain.
Passive funds are the cheapest of all to maintain. The fund will be linked to a tracking index that follows the market blindly. Over time, because prices rise, the fund will rise.
There are hundreds of trackers to choose from, or you can use prepared indexes that represent levels of risk in the same way that Robo Managers do.
Because trackers are not managed, they are subject to losing money in a predictable way in certain market conditions. This is not normally a cause for concern since passive management is normally used for long term investments.
The True Cost of a Fee
And this is the point of the article. When I was considering fund management, I thought that the fees seemed to be quite low compared to the total amount of money being invested – somewhere around 1 or 2%; but beware!
Investment fees can turn out to be a large proportion of the growth of the fund. For example, if over the past year your fund growth was 2.5%, and your fees are 2%, you should be aware that the fund managers have taken 80% of your profit with zero
The more sophisticated the fund management chosen, the higher the fee will be. The following fees may be applicable:
- Creating an account
- Closing an account
- Paying money in
- Taking money out
- Trading Charges (if you are doing them)
- Investment advice
The following ongoing fees may be applicable
- Having an account
- Having investments managed for you
The frequency that a fee is charged may also affect the total you pay over a year. A daily fee is more accurate than a weekly or monthly fee for example, and that may cost less in certain situations.
The Growth Required to Offset Inflation
Your fund would have needed to grow by
2.02% annually as well as cover the cost of the fees
in order to break even
- The ‘Cost of Living’ column calculates only the inflation figure for successive years. Note that an inflation rate of 0.9802 produces a reduction of £1000 to £670 over 20 years which exactly matches the real-life measured value.
- The ‘Growth’ column calculates only the growth for successive years.
- The ‘Inflation Adjustment’ column multiplies the inflation value by the growth value. The result is the value of the growth column shown relative to the value of money at year zero.
Protecting Your Investment
Pension scams are not the focus of this article, but its a good place to share this gov.uk information from The Pensions Regulator. Within it, you will learn some basic scam indicators and find a useful scheme transfer checklist.
Although management fees may appear to be small, so too is the growth of your fund. You need to compare the size of the fee to the size of the growth in order to understand the true cost of the fee.
Care has been taken to keep the information in this article as accurate as possible but errors are possible, so be aware of the full disclaimer here.