Harvey Jones

How a tiny 1% charge could destroy your retirement plans

There is only the slither of a difference between a comfortable retirement and one that is a bit of a financial struggle. The difference can be as little as 1%. Seriously. It doesn't sound much, does it? That 1% is a tiny figure.

A rounding error. Insignificant. Nobody pays attention to the 1%. Well you should, because it could shave hundreds of thousands of dollars, pounds or euros off your investments and wreck your dreams of a wealthy and happy retirement. Hard to believe, isn't it? But it is true. I’ll explain.


Guilty as charged

Whether you save for retirement in a pension, or by directly investing in stocks and shares, there are charges for doing so. These include trading platform fees, underlying fund charges and fees, and commission for any financial advice. You need to examine these charges very carefully because they can vary massively and will be deducted from the money you have invested.

The lower the charges, the more money you will have left for yourself when you reach retirement. It therefore pays to keep them to a minimum, particularly annual charges, which can seem tiny but really add up because they are deducted from your investments year after year after year. And because they are charged as a percentage of your holdings they will get more punishing as your portfolio grows in value. You cannot escape them altogether, but with a little effort you can shrink them massively.


Hidden fees

Expats are particularly vulnerable to sky-high investment charges. Commission-hungry, unregulated offshore advisers lure many into buying expensive offshore portfolio bonds or inflexible fixed-term contractual plans which lock their money away for years, with huge penalties for those who try to break free. Upfront and annual charges on both types of plan can be punitive. In the worst cases, they can total 5% a year, which you will pay regardless of how your investments perform. Even if the market grows by 7% a year, you will get just 2%, which is little better than cash.


Big difference

Even much lower fees can erode your future wealth. Say you invest directly in a mutual fund with an annual charge of 1.50%. That doesn't sound much, does it? However, it will still nibble away at your money, year after year, until one day you find you have far less than you expected. Let's say you already have $300,000 of retirement savings, and are investing a further $1,000 every month. You are 40 years old, and plan to work another 25 years. Your money is invested in a spread of funds with an average charge of 1.50%. Now let’s assume your money grows at 5% a year after charges. After 25 years, you will have a total of $1,192,731 in your pot. Congratulations, you're a millionaire, kind of. However, you could have been a lot wealthier.

Low fees, high returns

Let's keep all those figures exactly the same, and change just one. The average annual fund charge is just 0.5%, rather than 1.5%. After 25 years, you have $1,460,478. That is an incredible $267,747 more. And it all comes down to that 1% difference in charges. Let's take this a step further. Let’s say you put your money in a spread of ETFs, most of which have rock bottom charges. If you whittle down your average underlying fund charge to just 0.20% a year, you will have $1,552,548 in your pot. Some ETFs have charges as low as 0.07% a year. Bag one of those and you will have $1,594,303. As you can see, charges matter. A tiny little percentage can add up to hundreds of thousands of dollars, over time.


Time on your side

The longer you invest, the greater the impact annual charges have. Stretching the above calculations over 40 years, you would have $2,237,892 if you paid charges of 1.5%, but $3,087,070 at 0.5%. That is a difference of $849,178. I have double checked these figures because I can scarcely believe them myself. The longer you invest, and the larger your portfolio becomes, the more damage that annual 1% difference will inflict.


Fees, fees, fees

Not everybody has a cavalier attitude to this number. Fund managers take it very seriously. So do independent financial advisers. They know that the small matter of 1% can make them very, very wealthy over time, at your expense. Because where did all that lost investment growth go? To them. When it could have gone to you. If you can build a balanced portfolio of low-cost ETFs or mutual you can squeeze your annual charges to the minimum, and maximise your returns. It helps to invest in clean funds, as they give you a much clearer idea of how much you are paying.

They typically have low or even no upfront charges, and only a small annual management fee. All further costs such as financial advisory fees and commission are stripped out, rather than bundled together in the fund, so you can see exactly how much each fund is costing you, and plan accordingly. Finally, make sure you use a low-cost offshore trading platform with competitive charges that are clearly explained, with no hidden fees. Too many investors fail to pay much attention to charges but as you can see, they can cost you dear. A little 1% can go a long, long way towards making your richer.


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Please note the value of investments can go down as well as up, and you may not get back all the money that you invest. Past performance is no guarantee of future results.