This note is a bit techie, however please bear with it, as it might set you on a path which will make you significantly better off.
First of all, investing costs money. However, not all investments cost the same. Even more importantly, the FCA, in their market study MS15 / 2.3, recently found minimal correlation between the cost and the performance of an investment. Here it is.
Specifically of note is paragraph 1.12 on page 4 of the final report. (I said it would be techie!)
Let’s just have a quick pause and consider that for a moment, as it is pretty astonishing.
In plain English, what the FCA found is that retail investors – that’s us – are often paying higher-than average fees to an investment manager, in exchange for below-average investment performance. The manager is effectively taking their money, and repaying them by losing them even more.
Looked at another way, you could have two investments, with exactly the same underlying returns, but one costs five times more than the other.
Would you pay five times as much for the same car as your next door neighbour? Or for your weekly food shop? Or for your holiday? Not unless you are as mad as a box of frogs!
So why do the same with your investments?
Over-paying for an investment can make a big difference to your lifetime wealth which in turn limits what you can spend it on (it is ultimately for spending, isn’t it?)
To paraphrase a client, “Why do I pay an investment manager to fly first class, while I fly economy?”
Let’s look at an example – made up, but typical – to see illustrate the shocking magnitude of the situation.
Investment management costs vary between 0.22% and 2.00%. Let’s use 1.35% as a typical mid-range cost.
The product or platform cost to hold the investment can vary from 0.20% to 0.65%. Again, let’s use 0.50% as a typical cost.
A typical financial adviser fee across the profession is 1.00%, although this is often lower for larger investment amounts. It pays for the financial planning work, too, of which investing is only a part.
Let’s now assume an investment “pot” of £500,000, which is going to be invested for 20 years. It doesn’t really matter whether this is a pension, ISA or whatever. It will be put into a “balanced” investment solution, which has an average return of 5.5% per annum.
The total cost for the expensive investment solution, using the “typical” values above would be:
1.35% + 0.50% + 1.00% = 2.85% or £14,250 per year.
If, costs are minimised, by investing in a similar “balanced” investment solution and using a lower cost platform, but with the same 5.50% annual return and ongoing adviser fee, then the overall charge for the “Fair Value” investment solution is as follows:
0.22% + 0.29% + 1.00% = 1.51% or £7,550 per year. This is a reduction in charges of 1.34% a year, every year, or in this case = £6,700 per year. That’s an average family’s weekly food shop, right there.
When this is compounded over 20 years, then the results are as follows:
Expensive Portfolio Final Value £830,539.59
Fair Value Portfolio Final Value £1,080,637.06
That is a difference of just over a quarter of a million pounds.
And that is a LOT of first class flights.
We cannot control the markets, but we can control the costs of accessing the markets. So if you would like to see whether this applies to you, and what might be done about it to ensure that you can achieve your best life, then please get in touch.