Returns on investments may look enticing but the many methods of paying for advice and fund management can make a big impact on the financial returns.
Paying for financial help comes in several different guises.
Investors can pay a financial adviser fees based on time, a fixed fee or a percentage of funds under management.
On top of this come the less obvious charges, like set-up fees, transactions fees and a yearly management charge.
Financial advisers and fund managers often present these fees as a percentage that looks insignificant but can add up to a massive amount of money that reduces the value of an investment over a long term.
How fees reduce the value of an investment
Because of the way fees are presented, investors are often unsure about just how much they are paying.
As an example, take a look about how charges can take a chunk out of an investment.
Our investor is managing to save £1,000 a month and earns enough to sustain saving at that level for 20 years.
Whether the investment is a pension, fund or other ‘wrapper’ does not really matter, because the charges will have the same impact.
Our investor is pleased to earn a return of 6% a year, which compounded gives a total at the end of the savings period of £458,852.
Now factor in a 1.5% a year management fee. Effectively, instead of a 6% return, the earnings drop to 4.5% a year.
That drops the total savings by £70,869 to £387,983.
To meet that £1,000 at 6% goal, the real savings amount is nearer £1,200 a month – allowing the extra to soak up the administration charges over the years.
Watch out for the gross/net trick
The moral for investors is to look beyond the headline rates and include management charges in any yield calculations.
Financial advisers and fund managers will quote gross rates because the returns look better, but investors will receive net rates after fund charges are deducted.
Doing the math will shock some investors into understanding for the first time just how much they are paying for advice – and whether the return is worth the outlay.
Switching funds and other transaction fees will also hit the bottom line – along with tax, the other big hitter.
Many investment schemes come with tax breaks, like ISAs , the Seed Enterprise Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS), but most do not.
Suddenly our investor’s £1,000 that looked good as a savings plan has lost some shine when advisers, fund managers and the tax man have taken their bite.
