eWherever you’re headed at the moment, you see tips for saving money. But a lot of it involves sacrifices and very small amounts of money. However, there is a tip that may save some people thousands of pounds, and it won’t have any effect on their current lifestyle, but will likely make them better off in the long run.
This win-win saving may be hidden in your pension fee if you have an investment-based pension. (It will not be applied to the final salary pension scheme).
If you have a self-invested personal pension (SIPP), making changes should be easy. If you’re contributing to a workplace scheme, it’s more complex but still worth understanding the fees and options.
It’s one of the main themes of a new book that Robin Powell and I are doing, How to Fund the Life You Want. A catch-all we come back to over and over is to “focus only on what you can control”. You can’t control inflation, you can’t control the markets and certainly you can’t control who the prime minister is. But many of us can reduce the fees we pay to administer our pension.
If your money is invested, you will definitely pay a fee
Many people do not notice their pension fees. It is debited invisibly and never touches your bank account. But if you have an investment-based pension plan (“defined contribution” in the jargon), including any type of workplace or stakeholder pension, money managers will always be somewhere in the mix.
They have multiple ways to extract fees.
The investment must be made through a transaction platform, so you have to pay the platform fee. These can vary between nil and 0.45% per annum of the amount invested.
Your money is invested in funds – that is, packages of stocks in companies, bonds or commodities. So you pay the money management fee as well. Again, you can start from scratch. But the most expensive can drain about 4% of the value of your investment each year.
Every time a transaction is made on your behalf, you pay the cost of the transaction. The more frequently your money is traded, the higher the sum of that money will be. Averages are not meaningful here but remember that for frequent trades across many funds, the sky is the limit.
If you keep a financial advisor responsible for all of this activity, it’s a bit like having a personal shopper: you’ll pay their fees at the top. The latest Financial Conduct Authority figures tell us that the average financial advisor charges 1.9% to cover its fees along with platform and fund fees.
Active money costs you more, and could be worse
Our book cites the overwhelming evidence that “active” money is not only much more expensive than “passive” money, but often worse.
Active fund managers pick your stocks. This is a very labour-intensive work, based on a lot of research. And they spend a lot on marketing to promote their stated goal: to beat the market average.
Unfortunately, the definition of averages means that for every fund outperforming the market, another fund must underperform. Evidence shows that in the long run, the majority of active funds underperform.
One 10-year study from Bayes Business School concluded that fund managers’ stock-picking skills have been negated by their attempts to time market, and by fees. The better performance of a (small) group of successful active managers was devoured by the high fees. None of them reached customers.
To make matters worse, active fees can be two to six times more expensive than the alternative: the index, or passive funds. This inexpensive money locks you in the market average. When the market goes up, it goes up. When it goes down, your investment also goes down. That doesn’t sound great, until you realize that despite their volatility, in the long run, the markets have always been going up.
The long-term market average can be a very good settlement outcome, especially with much lower fees. Even a small difference in fees can generate significant gains over the life of the investment your pension requires.
Can you save thousands?
So let’s focus all of this on retired people with investment-based pensions. In the latest Office for National Statistics survey, the average pension for people aged 55 to 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 investment firm Vanguard, or active funds from the Hargreaves Lansdown platform.
I have not assumed not to buy or sell for one year, so there are no transaction fees.
I figured Vanguard would charge £329, but the action via Hargreaves Lansdown would cost £1,161.
Suppose you use a consultant to manage your money instead. The average advisor will charge 1.9%, or £2,039, for the higher bet – £1,710 more than the DIY approach using passive money from Vanguard.
For £200,000, Vanguard’s savings will rise to £3,180 per year.
How are fees reduced?
It is notoriously difficult to de-identify pension charges.
Ask your pension provider to identify the first three predetermined expense categories. If you have a financial advisor, expect them to rank costs for all four categories.
Vanguard is a good example but you need to find the platform and the cheapest money that works for you.
For platform comparisons, we recommend Monevator. It is frequently updated, free and comprehensive.
A good target is 0.33% for the common platform and fund fees. If your provider can’t come close to that, seriously consider moving your pension.
What if you were paid into a workplace pension scheme set by your employer? First, it is worth finding out what fees your administrators pay and whether they are competitive. Second, understand your options. You may be able to move out of active chests to passive chests that charge lower fees. And if you have contributed to more than one workplace scheme during your career, should you integrate into one scheme with minimal fees? This is a complex area. You may need one-time financial advice. But even if you decide not to move, you can at least put pressure on your scheme managers about fees.
As you can see, only one year’s savings can run into the thousands, and you don’t have to give up a single glass of latte. Over the course of 20, 30 or 50 years, the difference in your pension, to name a few, will be “tearful.”