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Are you paying too much?

Do you know what you pay in investment and pension charges?

In recent months the press has been littered with articles regarding the costs involved with investing. Most people are aware that investment funds publish a headline annual management charge (AMC) as well as published additional charges which culminate in producing the total expense ratio (TER) of the fund. These are fairly easy to find with a bit of digging, however, what isn’t published is the drag on performance that other costs add such as transaction costs, performance fees, stock lending fees, taxes and commissions.

However, in recent weeks the focus has widened to include pension charges. First we had Ed Milliband claiming that pension charges can rise as high as 5% which was followed by the think tank RSA with their report into the pension industry (Seeing Through British Pensions, July 2012). The RSA found that there was ‘a huge danger of inappropriate pensions being sold to unsuspecting customers’ and that pension providers were not very transparent with the exact level of charges on pensions.

A report commissioned by the Treasury and written by Christopher Sier, a former hedge fund manager, and David Norman (Complexity and overintermediation in UK equity fund management, Nov 2011) sought to disentangle the full costs of investing in UK shares. They found that the TER in investing in a UK equity fund was around 1.7% whilst the trading costs were around 1.4% making a total charge of 3.1% per annum.

But why exactly does all this matter?

If we take two mythical portfolios of £1million each invested on the same day with two different managers. The two managers generate growth of 6.5% per annum every year for an investment time period of 30 years. However, the portfolio with manager number one has a TER of 2% per annum whilst the portfolio with manager number two has a TER of 3% per annum. But, it’s only 1% extra… surely this doesn’t make a huge amount of difference?

When we compound this forwards, the portfolio with manager one has finished at a value of £3,745,318 whilst the portfolio with manager number two has grown to £2,806,794. The increase in TER of 1% has lowered the total return by £938,524. This is a dramatic difference and brings home the effect charges can have.

Now, there are many who would argue that you get what you pay for, and that a higher charge can mean access to fund managers with higher levels of skill. However, this is a big difference to make up, especially in the low growth environment we are currently experiencing. Where you are paying fees, these fees need to be reasonable and represent value for money.

So, my suggestion, whether you employ a professional or make your investments, is to ensure you review your investments and pensions in terms of cost as well as performance. If you would like an expert second opinion, please get in touch.