Albert Einstein reputedly said that ''Compound interest is the eighth wonder of the world. He who understands it, earns it... he who doesn't, pays it.''
Whether these words came from his mouth or that of another, they are certainly true.
A quick example can demonstrate this. Take David Smith, a 25 year old who invests a £10,000 inheritance sum in a pension fund with a view to retire at 65. He makes no further contributions.
The fund performs admirably, averaging a 15% per annum gain over the term. After 40 years of investment, David's £10,000 has grown to a pot of £2,678,635.46. Very impressive!
Unfortunately, in the real world David wouldn't have made anywhere near this amount, because fees would have taken their toll on his investment, substantially reducing his returns. If compound interest is the eighth wonder, investment charges are the seventh circle of hell.
Let us assume that David's investment has incurred the following annual fees:
- 1.5% Fund Charge
- 0.5% Platform Charge
- 1.0% Adviser charge
Total charges of 3% don't sound too onerous, but lets look at the impact these have over the 40 year term of his investment (charges taken at the start of every year).
After 40 years of 15% returns his initial £10,000 now becomes only £792,105.41. Granted he still hasn't done badly, but Investment charges have reduced his final pension pot by over two thirds which is massively significant.
Now let's assume David went to see a financial adviser with more reasonable charges, who found him a similarly performing fund with a lower fund charge, and put it on a cheaper platform. Total annual charges are now 1.5%
- 0.7% Fund Charge
- 0.3% Platform Charge
- 0.5% Adviser Charge
Now after 40 years of 15% returns his initial £10,000 becomes £1,463,399.27, the 1.5% reduction in fees has almost doubled his pension pot. David can now upgrade his Volvo to a Rolls Royce Phantom.
Joking aside I hope that this post has highlighted the power of compound interest but has also shown the devastating effects that excessive fees can have on your investments. Your financial adviser might be giving you sound financial advice, but how much is it actually costing you?
If you would like a qualified financial adviser to review your investments to see if any savings can be made, Seer Green can help. Feel free to contact me at firstname.lastname@example.org
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