Five things investors need to know
2. FEES AND CHARGES ARE OPAQUE
LOUISE COOPER is a straight-talking journalist who specialises in business, personal finance, the financial markets and investing. She has been a presenter on BBC 5 Live’s Wake Up To Money and BBC Radio 4’s Money Box Live. She also writes for several national newspapers and is a regular columnist for The Spectator. In this series, Louise discusses five important things investors need to know. The key message this time is that working out the total cost of investing isn’t easy, but you absolutely need to try.
What are the different types of fees and charges that investors pay?
This question kind of makes me laugh a bit because the problem with fees, costs, and charges is they are hidden, they are called different things depending on who you talk to, they’re quite complicated, and they’re not fully disclosed. So you can be charged an account fee for investing via a platform, you can be charged a platform fee, and you can be charged a fee for a percentage of the assets that whoever it is looks after for you.
Now, that percentage fee probably doesn’t include transaction costs. So if you think about an underlying portfolio of shares and bonds or whatever, every time a share or bond gets bought or sold, it can incur stamp duty. Depending on how you trade it and which market it’s traded in, you can face a bid offer spread; that means you sell at a different price than you buy at, and that is an effective cost.
If it’s a very large position, that can add to the cost. We’ve seen with the demise in the UK of Neil Woodford’s funds when he had huge positions in vary illiquid stocks that, when it actually came to sell them, the price he got, or the fund got, was significantly below the quoted price. That’s when you move a market because your position is so large. Or if your fund manager is buying, say, ten per cent of a company, often you drive the price up. That’s called a market impact cost.
But what about the total cost of investing?
There are lots of different costs and trying to get to the bottom of them all and coming up with a figure — an all-in cost figure — is almost impossible. Even big pension funds have to hire forensic accountants to try and get to the bottom of what the true cost is and what research has found is the true cost can be double or triple what the quoted cost is.
So it’s very, very difficult to get to the bottom of true cost and what is hilarious about this is that you’re the consumer! So imagine going into a shop and seeing a dress for £10, and then being told by the assistant, “When we come to take the money from your bank account, it’s actually £12.50.” That’s the craziness of this industry. It doesn’t tell you — the consumer, the investor — what the true cost of your investment is.
In your view, is the industry being deliberately obstructive?
Some costs are difficult to quantify, it is true. But I would argue that a lot of the reason why it’s difficult as an investor to calculate the true cost is because the fund management industry, indeed the whole financial services industry, knows quite how much money it makes out of investors’ or consumers’ ignorance. That is why I am absolutely sure that fund management houses, the fund management industry, could calculate that cost. But they deliberately don’t do it because they make so much money out of consumers.
Of course, these are fees that you pay year after year, so they compound over time, don’t they?
That’s right. Albert Einstein is supposed to have called compounding the eighth wonder of the world. It is truly an amazing thing. Compounding means that, if you want to have a fantastic retirement, you don’t actually need to save that much; you just need to start saving early. So if you save 40 years before your retirement, compounding does your work for you, making money out of money, return on return. So, it is a fantastic thing, and you need to understand the joys of compounding to make your money work for you.
What most people don’t understand, though, is that there is a downside to compounding as well. Returns compound, so if the S&P 500 goes up seven per cent a year, you get seven per cent on seven per cent and so on for decades, but fees compound too! So if you’re paying one per cent, or heaven forbid, two per cent in fees a year, they compound as well. There are some great charts online — Vanguard has one, for example — where you can see the impact of compounding fees. At the end of 20 or 30 years you discover that, rather than having 100% of your pension, you’ve only got 60% of it left. That is the impact that fees have in compounding over decades and, for anyone with a pension, this is what you need to think about! So, you need to understand the good side of compounding, which is that returns compound; but you must understand that fees compound too.
A good adviser can help reduce costs, but of course they also charge a fee. Is a good adviser worth paying for?
I am financially sophisticated, clearly, so I manage my family’s money. The thing about advisers is, if they’re good, they will probably direct you to low-cost and passive funds, which will save you so much money in the long term rather than trying to chase the latest sexy fund that does well one year and doesn’t do well for the next ten years. So a good adviser can stop you making some very poor choices.
The other thing a good adviser can do is stop you making behavioural mistakes. So when stock markets are collapsing, typically investors run for the hills, when they should be staying invested, if not increasing their investments. What a good adviser will do is stop non-experts making catastrophic decisions at the wrong time.
Look at the coronavirus crisis, for example. Stock markets collapsed in March 2020, and many people were tempted to reduce their exposure to equities. That was actually by far the worst thing to do, because stock markets have rallied hugely on the back of huge monetary and fiscal expansion from both central banks and governments globally.
So although I don’t use a financial adviser on an ongoing basis, most people, or non-experts, do need them in order to avoid making mistakes. Also, with pensions, there can be a lot of technical details with the terms and conditions of particular pension schemes. The one time I have used a financial adviser was to help me understand the technical complexities of the Ts and Cs of a pension. So if you’re thinking about changing your pension planning, or you’re worried about making poor decisions, then a financial adviser can certainly help.
You can learn more about Louise Cooper on her website.
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