Financial Planning

Compounding – Why 1% Matters

This article was originally published on Quadrant Group’s website. Quadrant Group was acquired by Progeny in March 2017.

A sign showing current unleaded fuel prices at a Tesco superstore

Have you ever driven several miles out of your way to save a penny on a litre of petrol? Do you collect vouchers or enrol in loyalty schemes to save a few pounds on grocery items? Did you complain when the Government added another penny in tax on a pint of beer?

Well, how about the cost of your investments? When it comes to our pensions, one of the biggest financial investments we’ll ever make (often the biggest), most of us either don’t know what we’re paying or don’t even seem to care.

The continued decline of company final salary schemes means that more people, possibly over 12 million by 2018 (according to the Investment Management Association Annual Survey 2014), will be regularly contributing to defined contribution pension schemes. The pension business is growing. And with low returns on short-term cash savings, the need for investors to secure better returns on long-term investments at an appropriate level of risk, is in great demand.

Much has been said lately about the dismal returns typically produced by active fund managers. Only around 1% of funds beat the market consistently. But more significant than their underperformance, what is truly shocking, is how much investors are paying.

Perhaps it’s because when you start a pension, retirement is so far off that you’re not too concerned about the impact of charges on an investment you might not need for another 40 years. But another problem, at least here in the UK, is that pension charges are complicated and not always easy to calculate.

The full costs incurred by consumers when making long-term investments are not consistently and comprehensively defined, nor are they understood. It’s staggering that investors are expected to agree to schemes when they are so uninformed about the overall impact it will have on their wealth.

The problems of cost opacity and cost control are widespread across the industry. Fund managers too frequently exercise poor controls, or worse, use smoke-and-mirror tactics. In fact, even institutional investors of multi-billion pound pension funds may not know the full costs of investing. It took a major study by Hymans Robertson, a pension’s consultancy, to recognise that switching the Local Government Pension Scheme to passive investments, away from the under-performing actively managed funds, would save tax payers a staggering £660 million per year – and deliver similar, if not better, performance.

What charges can you expect to pay?

Let’s say you invest £100,000 over 40 years. For simplicity, let’s assume it’s a one-off capital investment. A typical annual management fee is 0.75%, but this is just the start of it. There’s also a platform charge of around 0.35% and an average adviser charge of 0.82%. Initial adviser charges, annualised, come to 0.24%. Then there are fund custodian and administration costs, which average 0.17%.

On top of all this are transaction costs. And the problem is, these could be anything, depending on how much trading your fund manager chooses to do. You really don’t know. But we’ll say 0.41%, which is the average figure for transaction costs.

In total, that means that the cost of investing, on average, is 2.74%.*

If you think that this sounds like a bargain, you haven’t factored in the effect of compounding.

What is Compounding?

As an investor, you don’t pay this percentage of fees once. The same percentages are annualised over and over again. As the value of your investment grows, so do the pounds and pence charges you incur. This significantly impacts the value of your return over the lifespan of your investment.

An annualised return of 8% before charges of 2.74% nets down to 5.26%. 40 years on, when you’re ready to retire, the £100,000 you invested would be worth £2,172,452 if there were no charges. With the charges, it would be worth a mere £777,203. Your actual gain would be just £677,203. You would have paid a total of £1,395,249 in charges – that’s almost 65% of the final value of your investment before charges.

Now you can see why, at Quadrant Group, keeping our costs low is an absolute priority.

How does Quadrant Group keep investing costs low?

We offer clients transparent and low fee investing. There are no hidden charges or surprises. We believe investors should understand clearly the value of our management services. When we launched our new proposition in 2009 the average all-in cost to a client investing £500,000 in our AstutePortfolio 60 was 1.68%. This covered everything, including platform costs, advisor charges, administration and, most significantly, transaction fees. We were well below the average figure of 2.74% per annum.

But we wanted to do more. We wanted to offer our clients more savings. So we spent a significant amount of time with our platform providers and fund managers reviewing costs. I am pleased to say that we have reduced our fees across all our services. For example, our AstutePortfolio 60 which was 1.68% is now 1.54% per annum. That’s a saving of 0.14%. On a £500k portfolio, that’s a saving of £700 per year. Compound that saving over the life of your investment and it could be the greatest discount you will ever redeem.

* Research figures based on calculations from the True and Fair Campaign.  The report can be downloaded hereQuadrant Group champions The True and Fair Campaign, which lobbies for fairer and more transparent charges.

This article does not constitute financial advice. Individuals must not rely on this information to make a financial or investment decision. Before making any decision, we recommend you consult your financial planner to take into account your particular investment objectives, financial situation and individual needs. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested. This document may include forward-looking statements that are based upon our current opinions, expectations and projections.

Photo of Andrew Pereira

Author Andrew Pereira

Director, Progeny Wealth

Andrew has been working with families, high-net-worth clients and business owners for well over 20 years.

Learn more about Andrew Pereira

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