Hi and Merry Christmas & Happy New year to one and all.
Thanks for reading this blog over the past year. I’ve enjoyed sharing my research over the last year and I’m pleased to be back in the hot seat now my move back to the UK is finally bedded in.
The New Year is a time for reflection on the year’s successes and mistakes. I feel I learn best from my mistakes, especially when I readily admit to them rather than trying to self justify.
I won’t bore you with the details of my first mistake. This was to chose Virgin Media as my internet provider. It took 8 weeks and multiple calls to their call centre to finally get set up only to find the connection not even at dial up speed. I’m there now, but if your work depends on an internet connection being set up promptly then I would seriously think twice before signing up with Virgin Media.
Ok on to my main mistake of the year (actually from past years, but my fault for not checking it sooner).
Always read the small print with investments.
A few years ago I belatedly set up my personal pension. This was before I’d done so much serious in depth research into the impact of trading & investment costs. I wish I knew then what I know now.
I knew enough to keep costs low. I chose a well balanced portfolio of funds with the average annual management fee being 1%. This is actually relatively high compared to other options available, but they were certainly the lowest fees on offer amongst the various funds presented to be by the Independent Financial Advisor. I could have easily gone for funds with annual fees of 2% or higher. I also made sure that there were no initial investment fees in the funds themselves. What I didn’t check was the small print regarding management fees.
Following this excellent article in the Telegraph on high fees UK investors are paying compared to other countries such as The Netherlands, I decided to take another look at my pension.
Here’s a choice quote:
“If a typical Dutch and a typical British person save the same amount for their pension, the Dutch person can expect a 50pc higher income in retirement.”
Why is that? Are the Dutch and the Danes better investors? No, they simply pay lower fees, which have less of a negative compounding effect on your investments.
The original study was commissioned by the RSA with warning comments about the cost of ignorance on costs such as: “When people hear that they are being charged 1 per cent or 3 per cent, they think they are being charged 3p in the pound or 1p in the pound, and think 'that's fine'. But because of compounding, the pension costs actually add up to 40 per cent"
I had a vague memory about exit penalties from the pension if a decide to come out of it early or switch. However I had never paid much attention to how this was actually structured.
My mouth nearly hit the floor when I clarified this recently.
The pension charges me 5% PA on top of the Annual Management fees for the first few years then it reverts to no extra fee and rebates me by 0.4% for the remainder of the pension.
In other words, for the first few years of my pension I have to pay 6% PA in fees for the privilege of getting fees of 0.6% for the rest of my time.
Although they are in the documentation, these fees were certainly not explained to me in these terms by the advisor. Put another way, it would take me 21 years for the benefits of the 0.4% rebate to start beating a set 1% every year.
The exit penalty is a fixed £362 to boot and I have three years of paying 6% before the rebate starts to kick in. I have three years of paying 6% left.
What to do?
There are various pension fund providers in the UK that provide rebates such as http://www.cavendishonline.co.uk/ allowing you to pick up fees in region of 0.6% straight off the bat. The January edition of Which? Magazine also had a great table showing the various providers and the discounts they provide.
The other option is a SIPP provided the set up costs are low. http://www.sippdeal.co.uk/ look a likely option. The disadvantage with a SIPP is that it is designed around individual purchases not regular investments so I would not be able to make regular contributions each month as the transactions fees would be prohibitive. Instead I would have to make annual purchases and pay fixed dealing costs.
The advantage is that a SIPP opens up low cost ETFs and Vanguard funds we fees in the region of 0.2 to 0.4%.
It immediately became apparent that the decision to switch out is a no brainer.
Say I have £10,000 in my pension pot. 6% of that is £600 lost in fees to my current provider every year for the next three years.
If I switch to another provider and pay 0.6% for that year, then it would be £420 lost in fees and charges, £180 better than keeping with the current provider. I’m up in year one with money back to me over the following two years.
However, if I can find a suitable SIPP provider, I may be able to push annual fees down to 0.3% and by making annual purchases I can keep transaction costs to a minimum.
This could make a dramatic difference over the life of my pension.
I would be £7,000 better off on a £10,000 pension switching to a provider giving me fees of 0.6% from day 1 compared to my existing provider. This assumes 5% growth P.A. and contributions rise with inflation. However, the advantage of paying 0.3% per year and a fixed £60 in fees is huge. Switching to such an arrangement would be worth an extra £40,000 over my current provider.
Aside from the potential for extremely low fees through a SIPP, I like the possibility of accessing ETFs and trackers which I expect to have low hidden fees.
Hidden fees reduce costs even further.
Terry Smith explains more
“There is a justified focus on the Total Expense Ratio (“TER”) of funds which include those expenses which the manager charges to the fund rather than simply on the fund management fee. However, there is one major cost that is not charged to the funds-the cost of dealing in the underlying investments.
This is not insignificant given that, according to FSA research, the average fund manager in the UK turns over their fund 80% per annum. This adds three layers of additional costs: 1. The commissions charged by brokers and investment banks for dealing; 2. The difference between the bid-offer spread for securities sold and bought; and 3. The fact that no fund manager has sufficient good investment ideas to warrant buying and selling 80% of your investment portfolio per annum.”
These costs are generally felt via under performance rather than management fees. I’ve been checking a few ETFS and they seem to underperform the benchmark by a margin that is in proportion to the management fees as expected, but I shall be triple checking this.
Don’t be fooled like I was.
I hope my sharing of this mistake is of use to you. I know the pension systems are different across the world, but from my experience, it does seem that the UK system is highly skewed against investors.
This will become ever more apparent in the coming years as more companies shut down final salary schemes and even the public sector may follow suit if desperate. From 2012 financial advisors will be banned from taking commission on investments which I think will alleviate some of the problems, but not all of them. They will still receive ‘trail’ commission from investments made before 2013.
Of course, this is not financial advice. I hope by sharing my frustrations, it sparks your own investigations.
More musings to come…