Ewherever you turn at the moment, you see savings tips. But many of them involve making sacrifices and quite small amounts of money. However, there is one tip that could save some people thousands of pounds, will have zero impact on their current lifestyle but will probably make them much better off in the long run.
This win-win savings could be hidden in your pension contributions if you have an investment-based pension. (It will not apply to a final salary pension scheme.)
If you have a self-invested personal pension (Sipp), it should be easy to make changes. If you’re contributing to a workplace schedule, it’s more complex but still worth understanding the fees and options.
That’s one of the main themes of a new book by myself and Robin Powell, How to Fund the Life You Want. A refrain we return to over and over again is “focus only on what you can control”. You can’t control inflation, you can’t control the markets and you really can’t control who is the prime minister. But many of us can reduce the fees we pay to have our pension managed.
If your money is invested, you will almost certainly pay fees
Many do not notice their pension contributions. They are withdrawn invisibly and never touch your bank account. But if you have an investment-based pension plan (“defined contribution” in the jargon), including some form of workplace or stakeholder pension, money managers will always be somewhere in the mix.
They have several ways of charging fees.
Investing must be done through a transaction platform, so you pay platform fees. These can vary between almost nothing and 0.45% annually of the amount invested.
Your money is invested in mutual funds – that is, packages of shares in companies, bonds or commodities. So you pay fund management fees too. Again, these can start at zero. But the most expensive one can lose about 4% of your investment value every year.
Every time a deal is made on your behalf, you pay a transaction cost. The more often your money is traded, the more these will add up. Averages don’t make sense here but remember that for frequent trades between many funds the sky is the limit.
If you retain a financial advisor to handle all of this activity, it’s a bit like having a personal shopper: you’ll be paying their fees on top of that. The latest figures from the Financial Conduct Authority say the average financial adviser charges 1.9% to cover their own fees on top of platform and fund fees.
Active funds cost you more and can do worse
Our book cites the overwhelming evidence that “active” funds are not only much more expensive than “passive” funds, but often underperform.
Active fund managers handpick your shares. This is a labor-intensive work, based on a lot of research. And they spend heavily on marketing to further their stated goal: to beat the market average.
Unfortunately, the definition of averages means that for every fund that beats the market, another must underperform. And the evidence shows that over the long term the majority of active funds underperform.
A 10-year study by Bayes Business School concluded that fund managers’ stock-picking skills were taken away by their attempts to time the market and their fees. Better performance by a (small) pool of successful active managers is eaten up by higher fees. None of it reached the customers.
Active fees can be anywhere from two to six times more expensive than the alternative: index funds or passive funds. These low-cost funds lock you into the market average. When a market rises, they rise. When it falls, so do your investments. This doesn’t sound good, until you realize that despite their fluctuations, over the long term, markets have always risen.
A long-term market average can be a very good result to settle for, especially with much lower fees. Even a small difference in fees can generate a large profit, over the investment life that your pension requires.
Can you save thousands?
So let’s sort this all out for people retiring with investment-based pensions. In the latest Office for National Statistics survey, the median pension pot for people aged 55-64 was £107,300.
I calculated the fees for investing this pension in global bonds (20%), “value” companies (50%) and smaller companies (30%).
Then I looked at two contrasting approaches: a passive portfolio managed through the investment firm Vanguard, or active funds from the Hargreaves Lansdown platform.
I assumed no buying or selling for a year, so no transaction fees.
I found that Vanguard would charge £329 but going active through Hargreaves Lansdown would cost £1,161.
Suppose you use an advisor to manage your money instead. The average adviser will charge 1.9%, or £2,039, for the pot above – £1,710 more than the do-it-yourself approach with passive funds from Vanguard.
For a £200,000 pot, the Vanguard saving would rise to £3,180 a year.
How to go about reducing fees
Pension contributions are notoriously difficult to remove.
Ask your pension institution to specify the first three expenditure categories previously highlighted. If you have a financial advisor, expect them to itemize costs for all four categories.
Vanguard is a good example but you need to find the cheaper platform and funds that are right for you.
For platform comparisons, we recommend Monevator. It is updated frequently, free and comprehensive.
A good target is 0.33% for combined platform and fund fees. If your breadwinner can’t come close to that, seriously consider moving your pension.
What happens if you pay into a workplace pension scheme set up by your employer? First, it’s worth finding out what fees your admins are paying and whether they’re competitive. Second, understand your options. You may be able to move out of active funds and into passive funds that charge lower fees. And if you contributed to more than one workplace scheme during your career, should you consolidate to the one with the lowest fees? This is a complex area. You may need financial advice one time. But even if you decide not to move, you can at least press your system’s administrator about fees.
As you can see, just one year of savings can add up to thousands, and you don’t have to give up a single latte. Over 20, 30 or 50 years, the difference to your pension will be, to borrow the words of a new chancellor, “conspicuous”.
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