Instead of focusing on cutting your food and fuel bills in the cost-of-living squeeze, find out what you’re paying for investment management. It could be more than what you spend on food and fuel combined.
So we’re in a cost-of-living crisis. The cost of everything from corn flakes to a tank of fuel is going up, and the media’s full of ideas for keeping a lid on what we spend.
As a financial journalist, I’m surprised at how these articles tend to focus on the smallest expenses. Sure, every pound counts, but, in the great scheme of things, whether or not you cancel your £4.99-a-month Apple TV subscription is not going to make a huge difference.
As Jonathan Hollow and I explain in our new book, How to Fund the Life You Want, published by Bloomsbury, the key when trimming your budget is to go for big wins. Look first at your largest outgoings. Almost invariably, this will be your home and your car.
Focus on your biggest expenses
So, if you’re renting a home, or you’re about to buy one, do you really need so much space? Do you have to live in such an expensive area?
Do you have to upgrade to a newer car when the one you have has never let you down? Then there’s that second car your son or daughter uses occasionally when home from university; why not sell it, raise some cash and save on the insurance?
Next comes fuel and food. Of course, you shouldn’t consume more than you need or pay over the odds. But let’s face it, staying warm and clean and eating healthily are pretty essential to our general wellbeing.
The whopping bill we never stop to question
There is a bill, however, that most of us overlook. And, for many people, it’s bigger than what they spend on fuel and food combined. I’m talking about the fees and charges you pay to have your pension and any other investments professionally managed.
The vast majority of people have little or no idea how much they pay for investment management, and there are several reasons why. Some find the whole subject of pensions frightening; others find it boring; either way, it isn’t something we feel particularly inclined to investigate.
Also, expressed as percentages, the figures are misleadingly small. We see a figure like one per cent and don’t really think about it.
The problem is that most of us (myself included) struggle to understand the maths. Compounded year on year, paying just one per cent per annum will erode your potential return when you come to retire by 25%. Paying two per cent will reduce it by a half. And paying three per cent a year means you’re handing over a humongous two thirds of your retirement pot to financial intermediaries.
You’re probably paying more than you think
Nor should you assume that you’re only paying one per cent. The financial services industry is keen to ensure that fees and charges are anything but transparent. The annual management charge, or AMC, is just part of the total you pay. There are several other costs — stamp duty, custody fees, bid offer spreads and so on — that you incur on top. Most investors, in total, are paying nearer to three per cent a year, and that doesn’t include the cost of advice.
The evidence tells us again and again that cost is the single biggest predictor of future returns, and yet, until recently, the UK financial media hasn’t properly addressed it. Why? Because all of the emphasis has been on fund performance. Fund managers want us to think that their fund is the one to buy if we want to enjoy stellar returns.
Of course, if you had a good chance of identifying a winning fund manager in advance, there might be a case for using them. But the blunt truth is that it’s all but impossible. Once costs are factored in, only around one per cent of funds beat the market in the long run on a properly risk-adjusted basis.
In the words of the late index fund pioneer Jack Bogle, “the miracle of compounding returns is overwhelmed by the tyranny of compounding costs.”
The main reason why we ignore how much we pay
Yet there is an ever more important reason why investors have so little understanding of what they’re paying. And it’s this: they never get to see the bill. Fees are extracted from their investment accounts without them even noticing. And because, in the long term, portfolios rise in value, we don’t stop to think about whether we’re receiving value for money.
So do yourself a favour and work out how much you’re paying to have your money managed on a monthly basis. If, say, you and your partner have £750,000 invested between you and you’re paying 2.5% in fees and charges, that’s £18,750 a year, or £1562.50 every month.
That’s a staggeringly high number. It’s almost like paying a mortgage. Indeed most well-off investors could easily buy a house, or even two or three houses, with the fees and charges they pay over their investing lifetime.
The good news is that you can reduce your investment management “bill” considerably. My co-author Jonathan Hollow, for example, pays just 0.28%, and it’s made a huge difference in his life. At the age of 55, he no longer needs to work and he spends his time doing what he really wants to.
Does that sound appealing? Our book, and the downloadable workbook that accompanies it, will show you exactly how to do it.
How to Fund the Life you Want by Robin Powell and Jonathan Hollow is published by Bloomsbury on 13th October, but it’s available for pre-order now. Go to tinyurl.com/how2fund.
ROBIN POWELL is the editor of The Evidence-Based Investor. He works as a journalist and consultant specialising in finance and investing, and as a campaigner for a fairer, more transparent asset management industry. You can find him here on LinkedIn and Twitter.
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Picture: Christopher Bill via Unsplash
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