2011/12/18

Fixing the City pension fees problem

I read this Guardian article on City fees for pensions (an article which explains why I don't currently have a decent pensions), and a simple fix occurred to me: insist that the fees are charged only on growth, not on capital invested, and that fees are quoted as a %age of the expected growth as well as any absolute amounts.

After all, the reason you pay into one of these funds is that the City promises growth above and beyond keeping your money in the mattress. By restricting the fees to a proportion of the growth obtained over the time period the fees apply to, I would expect two beneficial side effects:

  1. The management fees quoted become easier to understand in comparison to other financial options like savings accounts - if you are quoted as losing 50% of the growth or £50 (whichever is higher) to management fees, and the anticipated growth rate is 4%, it's easier to see that this is likely to be equivalent to 2% interest on a bank account, but has a worse downside in the event that the growth in value never materialises.
  2. There's a built-in penalty for the City if it doesn't meet its promises; if the fees are 1% of capital managed, and you invest £5,000 in the expectation of 10% growth, they collect £55 if they achieve expectations (leaving you with £5,445); they also collect £40 if they lose £1,000 of your money (leaving you with just £3,960). If, on the other hand, fees are limited to the growth they achieve, then they get nothing if they don't achieve any growth (or make a loss with your money).

It's also my gut feeling that the City would have to try harder for its money if people understood just how high the fees they want are; 1% of capital managed doesn't sound like a huge amount. Taking my example earlier, they managed £500 of growth, so would need 11% fees to make the same money; if they average 5% growth, they'd need 22% fees to make the same income; at 1% growth, they'd need to charge fees of more than 100% of growth to make the same money they make from 1% of capital managed, making it obvious that their fees exceed the gain from investing with them.

You could go further - you could choose to insist that fees are capped to the growth obtained, but I suspect that would eliminate high-gain, high-risk investments. I would, however, choose to insist that any investment where fees can exceed the total gain in value from the investment is clearly labelled with an FSA "be aware that you can lose your entire investment to fees, even if the fund makes a profit" warning, explaining the risks clearly. With any luck, the requirement to label high-fee investments as high-risk would encourage the City to mostly offer investments where the fees are capped to growth, so that the City suffers when you make a loss.

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