Are you heading in the right direction?

Sometimes things are getting gradually worse but you just don’t notice! When I was in my late twenties I ruptured my Achilles tendon playing football and stopped playing sport. I was forced into being a couch potato with 8 weeks in a boot.

What I forgot to do was to modify my diet. I was used to eating anything I wanted due to the amount of exercise I did. I just kept eating! Major error!

Fees are very similar. They are small enough, that you don’t really notice them at the time, and they are often hidden from you, but they just gradually erode your wealth over time. You wake up a decade or two later and you aren’t worth what you thought you would be! Fees are the hidden element in investing that makes everyone else wealthy apart from you! Let’s tackle fees together.

Katie’s initial investments

One of our first investments into the stock market was Katie opening up a stocks and shares ISA and buying a managed fund. Katie tells this one better than I do; so over to Katie.

Katie: I had been working for Deloitte for a couple of years. I had started to earn good money and was feeling pretty pleased with my progress.

One day my desk phone rang. This was quite unusual! No one ever rang me. I felt very important.

Katie Donegan answering the phone at Deloitte

I had learnt not to say “hello” when answering the phone. That was for civilians. Now I answered with “Katie Donegan”. Very professional.

The man on the other end of the phone, James Smith (name changed to protect the “innocent”??), asked if I had thought about investing my hard earned cash. Well the answer was “yes” but I didn’t know how. We organised to meet at his offices in the City.

A few days later I headed over to his offices which were VERY swanky. Glass partitions, a fancy coffee maker. I was impressed. The Company was called Sterling, they even sounded old money! (Sterling doesn’t exist any more, they were bought out by The Penny Group)

I knew what questions to ask, sort of. I asked him about passive investing vs active investing. I also asked him about investing in property instead. I didn’t understand enough to be able to be firmer in my views.

I started off investing £100 a month with him. I questioned the fees and how much higher it was than passive investing and his answers seemed to make sense. He told me they would manage my money, they would work to make sure it was performing for me and their advice was paid for by the fees. I didn’t know any better so I continued…

How did those funds perform over the years?

Alan here again. I know you probably want more Katie, who wouldn’t, but our team works with me telling the stories and Katie doing the data and visualisations! She hasn’t realised that she is a better writer than me already!

Back to our initial investments: we invested for a few years with The Sterling before we learnt about index investing (If you don’t know what an index fund is read this). When we truly understood index investing we sold our investment in the managed fund (they tried to persuade us to stay) and invested it all in Vanguard index funds.

Fast forward many more years and recently our VERY smart friend Matt was staying over at our flat in Basingstoke. He is as much of a geek as Katie and I, together we got excited about analysing our investments with James Smith from the Sterling Group and Vanguard to see which one actually performed better and what the impact of those high fees were.

Katie had found the paperwork for her old investments and we started to read and build a spreadsheet analysing the difference. We know how to have fun when friends come round to stay!

I am not sure how to properly explain how difficult this was. It took three of us 3 hours to work this out. Reading the small print of the investments was really challenging to find out what fees we were actually paying. They were hidden in different paragraphs and on different pages throughout the documentation.

Matt has first class degree from Cambridge and works in cyber protection for nuclear sites, Katie has a degree in Statistics and was an actuary and I eat pizza. Together we have some skills.

undecipherable contract language

It took the three of us the equivalent of an entire work day to work out what we were paying in fees! Katie and I spent another day analysing the figures again to try and understand them. Imagine how confusing it is for someone with no investing knowledge! Have you tried to read the T&Cs of your investments?

There is a real problem in some parts of the finance industry with clarity and inclusion.

Some of the active investing companies make it difficult to understand the fee structure on purpose so that you can never really work out what they are charging you. I am still not entirely sure how much they took but I can tell you the difference it would have made!

What we discovered shocked us.

The fees – making wealth management companies wealthy

Where does the money go? This is the bit that is really shocking about this whole system. The fees are kind of hidden from you. The Annual Management Charge (AMC) is just taken from your investments and you never see it disappear. All you see is how much you’ve “gained” not how much has gone missing from your account. If they made this transparent I think people would be SHOCKED at how much money they are bleeding.

You have to be careful when investing. How much of the money ends up in your pockets versus the financial institutions?

Different types of fees

So let’s look at the different fees that finance companies may or may not be applying to your investments without you knowing:

1. Entry fee: in the example above Katie was charged a 3% entry fee on any money we put into the fund and invested. This is a setup fee to get going. I am still shocked that we just paid this! 3% of our money evaporated instantly and went to???

2. Annual Management Charge (AMC, OCF etc.): this fee has a different name depending on the provider but it is normally the fee charged for managing the fund itself. These can range from 0.05% in some vanguard funds all the way up to 1-3% for actively managed funds. In the example above Katie and I were paying 1.61%. This still makes me cringe!

3. Platform fee: These can either be a flat fee or a percentage. At the moment our money is invested through AJ Bell because they gave us 3 years free platform fee for moving from Halifax. We will shop around after the 3 years free service. With James Smith’s company, Sterling we paid 0.60% which is on top of the AMC. You can see how these fees start to mount up quickly.

4. Platform transaction charges: Some platforms may charge you a fee per transaction as well as the other fees, or in some cases instead of a flat platform fee.

5. Exit Charge: some fund providers used to charge an exit fee which means when you sell and leave the fund you will be charged another percentage (this is no longer allowed! YAY!)

It is incredible how the money bleeds away without you noticing. Then the fund manager gleefully shows you that your account has gone up 5% without really showing you how much they have syphoned off and taken from you. They also don’t tell you how much you could have had if you had a simple low cost, global, index fund.

The true cost of professional advice and fees

What would have happened to our investments if we hadn’t discovered FIRE and we had followed James Smith’s advice and strategy? Would we have made FIRE?

Katie and I retired at the ages of 35 (Katie) and 40 in 2019 and have been travelling the world, running free finance courses and having a blast ever since.

Would we have been able to do this? Would this blog exist? Would Rebel Finance School ever exist. How much did this advisor really cost us?

Katie and I kept the investments above for a few years until we sold them off and invested in property instead. Eventually we found the FIRE strategies and learnt about Index Funds and passive investments.

For this comparison we have taken our current investments and where they have got to and compared that with the two funds that James Smith recommended minus their exorbitant fees!

The chart below shows what would have happened to our investments. The orange line is the investments from James Smith and Sterling and the Blue Line shows our actual investments which are mainly in the Vanguard FTSE Developed World ex UK fund.

Hit replay if you want to see that again!

Yes you read that right.

Our current strategy, investing in Vanguard Index funds. The current value of our stocks and shares is £1,963,276.

If we had invested with James Smith and paid his high fees our net-worth would currently have been £1,030,924.

We would have lost: £932,352

Through worse performance and high fees we would be NINE HUNDRED AND THIRTY-TWO THOUSAND THREE HUNDRED AND FIFTY-TWO POUNDS worse off! If we had taken professional advice, paid the fees, instead of figuring it out ourselves and minimising fees.

Fees destroy compounding and progress and we would not be FI right now if we had chosen to pay the higher fees and trusted the advisor.

But it’s only 1% – the way they get away with it

It doesn’t feel like a lot does it? 1%? It is a tiny amount.

The 1% theory can work for you when you are improving. If you just work to be 1% better at what you do each day by the end of the year you will be 37 times better! Small improvements make a MASSIVE difference over the long run.

The inverse is also true. Small amounts deducted from your accounts seem miniscule at the time but over time they are like a leech sucking the life blood out of your investments. They are an anchor for performance. How big would you like the anchor attached to your investments to be?

Imagine your investments are you on a bicycle climbing the hill towards your financial independence. The cycling and energy you put in is your savings.

Now imagine you had an anchor attached to your bike that you had to drag up the hill.

You get to decide how big the anchor is. You choose who you invest your money with and how you invest it!

The anchor from James Smith and Sterling was HUGE. It was his salaries and his profits that we had to drag up the hill too. In fact the anchor that we had would have pretty much halted our progress up the hill, our investments would have lost money over the long term.

James Smith didn’t even perform as well as inflation. The bigger the fee the bigger the anchor you are dragging along…

Let’s look at Ellie, Larry and Gloria

Is it just the Donegans that these fees affect? Or is it really a universal thing?

Maths is maths. One of the things we love about the stock market is it can treat us all the same. If you and I invest in the same way at the same time we will get the same results. It doesn’t care who we are.

The two things that make a difference are fees and the types of investment. These things are actually closely related. The more you pay the less likely you are to get good investments. In investing you really don’t get what you pay for!

Let’s do an example. If you have been on Rebel Finance School you will have already met our imaginary investors Ellie, Larry and Gloria.

In this scenario these three are investing in the same fund but with different fees. You can see the exact assumptions to the right but as a summary, Larry has high fees similar to Katie’s early investments, Ellie has slightly lower fees and Gloria has invested with Vanguard UK in the Vanguard FTSE Developed World Ex UK Index Fund.

These are all real fees you could pay at different places. Let’s see what happens. See below for the real impact on their investments over a 30 year period. We modelled them all starting with 25,000 and investing 400 a month.

You might be thinking “Alan and Katie, I don’t have 30 years left till retirement! These numbers are too high!” Well our response to this is you don’t stop investing at retirement. You will be investing till you die. If you are 60 you might well be investing for another 30 years. We need to stop lying to ourselves that things aren’t too bad and really see the impact of our decisions!

We used the last 30 years of S&P500 data to isolate impact of the fees and only the fees. So we assumed the actively managed fund would get the same return as the passive; which is not true but we wanted to demonstrate the negative impact of high fees.

The real life situation would be a lot worse than this!

The three ended up with

Larry: 436,220
Ellie: 611,749
Gloria: 852,811

This is insane. Fees can cripple your ability to retire if you choose the wrong thing!

Gloria ended up with nearly double Larry just based on fees alone! Does 1% really matter. YES!

How do wealth management companies make wealth?

In general the only people that get wealthy at wealth management companies are the advisors and the companies themselves. Not you, the customers who are paying the high fees trying to get wealthy!

Read my open letter to Wealthify, a wealth management company in the UK. Their marketing is amazing, they sound fabulous but the proof of their results is that they will make you poorer over time. It is shocking. The FCA and the British Government should not let them get away with this.

It is up to us to stand up to companies like this and not allow them to take advantage of us.

What’s next?!

Homework

Ever been given homework after reading a web page? There is a first time for everything.

Your homework is to look up the fees on your existing investments and find out what they are. All of them. Entry fees, exit fees, advisor fees, the whole shebang!

You need to understand your own investments. If you don’t it could be worth hundreds of thousands to you. Don’t trust the advisors. You need to know this for yourself.

What are good fees?

You might be asking well Alan what are good fees? Let’s set a little bit of context. If you invest through Vanguard your fees for the platform are 0.15% capped at £375 a year for all your accounts, then you pay a fund fee on top ranging from 0.06% to 0.24%. Here is the way we look at it: lower the better!

up to 0.5%: you are rocking it. Lower the better but below 0.5% total is pretty good
0.5% – 1%: not terrible but we would not be happy and this would make us change
1% +: Day light robbery. You should never be paying this much

Now you know! go check those fees and find out if it is time to move and get better performance from your hard earned cash!