How to keep hold of more of your money
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In this week's financial column, Peter Sharkey explains why it's so easy to spend too much on fees when you're investing – and how to reduce these costs.
Say it quickly and an annual investment management fee of 1.5pc doesn't sound much; after all, the people doing the work must be paid. Yet for someone aged 25 who conscientiously hands money over to a fund manager for four decades until she retires, the cumulative impact of that innocuous-looking 1.5pc annual fee is colossal. By the time our 25-year-old reaches 65, almost 38pc of her pension saving will have been creamed off by fund managers and advisers.
'The finance industry is not designed efficiently to create wealth for others. It has become positively awesome at creating wealth for itself,' conclude the authors of the best-selling book, What They Do With Your Money which exposes the fees individuals are charged by some institutions for having their savings managed, or simply administered.
Many of those who took out a pension product in the 1980s and 1990s, for example, were overcharged for years.
My brother, for instance, handed over an increasing amount to a pension provider every month for nigh-on 15 years. Inertia ensured he rarely checked how the cash was being invested. Ultimately, however, he was horrified to learn that only just over half (53pc) of his monthly contribution was actually being invested; the rest disappeared in a combination of policy charges (2.0pc); waiver of contribution charges (3pc); contribution protection charges (1.5pc) and an enormous charge for life assurance cover which equated to almost 40pc.
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Prior to consolidating them into one, a decade ago, I had several small pensions, one of which was subject to a raft of charges, including an annual cost of 3.5pc used 'to cover the costs of setting up the plan, or each new payment level to it.' In other words, 'used to pay ongoing commissions'.
Pension-related charges sometimes look so innocuous, many people feel slightly embarrassed to question them, but they mount up.
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Yet reducing fees can have an enormous impact on your pension. Were you to invest £10,000 over a ten-year period into a fund charging 1.5pc a year and the investment enjoyed annual growth of 5pc (the long-term stock market average), you would have around £15,100 at the end of the period. If, however, the management fee was 0.75pc, your balance would be £16,200, more than 7pc higher.
It follows that one of the keys to building a sizeable retirement pot, using tax-efficient products such as an ISA, or a SIPP, is to avoid the mountain of fees and expenses.
'Given the volume of news and articles regarding the state pension and the likelihood of the retirement age rising, it's no surprise that more and more people wish to start their own pension by opening, say, a stocks and shares ISA or a Self-invested personal pension,' concludes Tess Pyrek of MoneyMapp.com, the online finance website.
'People are making these commitments because they appreciate the benefits that can accrue over the long term,' says Ms Pyrek, who adds: 'However, it's imperative that costs are kept to a minimum because if they're not, charges and fees, particularly if they're deducted from capital, can seriously undermine the longer-term effectiveness of your monthly contributions.'
Earlier this month, Investors Chronicle, the respected investment magazine published by the FT, examined ISA costs, including the annual administration charges levied by a number of well-known investment platforms. There was a considerable variance in these costs.
Alliance Trust Savings, for instance, charge £120 a year (which includes four free trades) for administering an ISA, while The Share Centre levy an annual charge of £57.60. Invest over £1 million with Fidelity Personal Investing and you pay nothing, but starting an ISA with a couple of thousand pounds with the same firm will cost you £45.
ISAs have long been associated with generous tax breaks, which has resulted in them becoming the cornerstone of many investors' portfolios. They're considered ideal for those with longer-term investment plans, not least because the funds held within the accounts have time to grow and contend with almost inevitable market volatility.
Where once pensions and investment accounts were opaque at best, transparency and ease of access have become standard features of today's ISA accounts, developments designed to ensure the beneficiaries retain more of their own money and avoid the longer-term dangers of paying too much in peripheral fees. Little wonder they've proved so popular.
To open a low-cost stocks and shares ISA with TAM Asset Management, visit MoneyMapp.com/isa
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For further financial advice, check out Peter Sharkey's regular finance column, The Week in Numbers.