The dark side of compounding
02 May 2019

Half a percent. It doesn’t sound like a lot. Just 50p of out every £100 – a small proportion that you’d barely notice if it wasn’t there.

In terms of charges on your investments, you could easily glance at innocent-looking figures that differ by only 0.5% and think there’s not much in it. But you might be surprised to know what a difference just half a percent could make.

Costs matter

In the world of investing, compounding is usually presented as a powerful force for good. And rightly so – by reinvesting your returns, your investment has the potential to grow larger and more quickly over time. You’ve probably studied numerous charts displaying elegant curves showing the positive effects of compounding over the long term.

But the magic of compounding also has a flip side. It works against you when it comes to fees. The effects of seemingly small differences in charges can have a stark eroding effect on your investment earnings. These costs could cut the size of your precious retirement pot in half.

Illustrating the (decimal) point

Here’s an example to show you how mere decimal points of a difference can have a big impact on your investments.

Imagine you had a £200k lump sum of savings, growing at 7% per annum over 30 years. You can see in the chart below how the potential outcomes would look with different fee rates applied – the results may surprise you.

The varying effects of costs on an investment portfolio

Source: 7IM

As you can see from the table below

Starting sum Annual Fee Ending sum
£200,000 0% £1,522,241
£200,000 1.5% £996,790
£200,000 2.0% £864,388
£200,000 2.5% £749,064

 

  • A 1.5% annual fee might leave you with a pension pot worth just under £1 million.
  • Increasing the charge by only half a percent, to 2%, would reduce your final pot by more than £130,000.
  • A fee of 2.5% makes the final pot almost half what it would have been without fees.

The fee is the key

Investment management is both an art and a science and, like most things in life that are worthwhile, it takes time, effort and expertise. There’s nothing wrong with paying reasonable charges for a good, professional service, but do stop to think about exactly how much you’re paying.

Many investors just aren’t aware that fees can have this level of impact on their savings over the long term. They keep their eyes fixed firmly on performance, forgetting that costs can be a key factor in whether or not they reach their retirement investment goals.

Costs should be well up on the list of considerations when it comes to your long term financial plans. Make sure you give them the weighting they deserve when you’re planning your portfolio.

If you’d like to discuss how fees can affect your retirement savings, or find out more about our fees, give us a call on 020 3823 8678 or complete the form at the bottom of this page.

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