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Did you know that a relatively small difference in fees could reduce your super balance by 70%?

I realise that most dentists pay very little attention to their superannuation. But please, can I ask for a few minutes of your time to communicate this simple message which will probably save you over well over $100,000. And let’s not forget that at least 9.5% of your income is going into super, which is a lot of money, so it deserves a few minutes of your time.

The cost of ignorance

Three friends aged 35 all have $100,000 to invest in super[1]. The three invest their money into 3 different super funds but are lucky enough to all benefit from the same gross investment return of 8% p.a. At age 65 they get together to compare their super balances. They didn’t realise, like many people, how fees have such a big financial impact.

  • David invested in a retail fund (like MLC, Colonial, etc.) and paid 2% p.a. in fees. His balance was $574,349
  • Mark invested in an industry super fund (like First State Super) and paid 0.90% p.a. in fees. His super balance was $782,860
  • Sophie invested in a passive (index) investment option and paid fees of just 0.20% p.a. Her balance was $951,838.

The same investment amount, the same returns and Sophie has nearly 70% more in retirement savings than David! Half a percent here and there doesn’t sound like much but fees definitely do add up (compound) and that’s why you need to be super-focused on them.

You have three to five options

There might seem like a myriad of super fund options available but you can typically classify them into three to five options[2]:

  • Retail funds – these are funds that are often sold by financial advisors. The fund providers are typically owned by the banks and are operated to make a profit. The largest retail fund providers are AMP, Colonial (CBA), BT (Westpac), MLC (nab) and OnePath (ANZ). On average, retail funds tend to charge fees in the range of 1.30% to 1.90% p.a. (or more) depending on your investments.
  • Industry funds – these funds are operated as not-for-profit entities and you may have seen them advised on the TV. The larger industry funds are AustralianSuper, UniSuper, REST, Sunsuper, HESTA, CBus, etc. Industry super funds typically charge fees in the range of 0.70% to 0.90% p.a.
  • Self-managed super funds – this is the fastest growing selector of the market – not really for any good reason in my opinion. Fees to run a SMSF can range from $1,000 to $5,000 p.a., depending on the complexity of the investments.
  • Employer funds – your employer may run its own fund – the largest being Telstra Super Scheme. Fees for these funds tend to be somewhere in the middle of what are charged by retail and industry super funds, depending on the fund’s size. Most people can elect to not use the employer’s super fund but there may be benefits from doing so (e.g. free insurance). Employer super funds typically charge fees in the range of 1.00% to 1.20% p.a.
  • Public sector funds – If you work for the government, you might be able to join a public fund such as Commonwealth Superannuation Scheme, Public Sector Superannuation Scheme, Qsuper, First State Super and so on. Fees charged by public sector funds typically charge fees in the range of 0.60% to 0.70% p.a.

Once you have selected the right fund you can lower the cost even further by selecting the right investment methodology

There are two types of investment methodologies, being active and passive. Active fund managers tend to charge fees at least four times higher than passive fund managers i.e. an active manager will tend to charge a fee of 0.80% or significantly more whereas passive funds can charge fees as low as 0.20% p.a.

More importantly, historically, studies have shown that 96% of active fund managers fail to outperform (in terms of investment returns) passive fund managers in any 10 year period. Therefore, if you invest in an active fund manager and pay the higher fees for the privileged, you only have a 4% chance of making more money than a lower-cost passive (index) fund over the long term (i.e. > 10 years). Active versus passive investing will be the subject of a future article.

Case study: Dr Morrison will save over $375,000 due to lower fees

Dr Morrison is 40 years old and his super is currently invested with a retail provider. He has a balance of $200,000 invested in a pre-mixed growth option. His super fund charges 1.98% p.a. in fees. Between now (age 40) and retirement (age 60), Dr Morrison plans to make the maximum annual contributions of $30,000 into super.

If Dr Morrison stays with his existing retail super fund provider I estimate his super balance will be $1.425 million and he would have paid $286,651 in fees by the time he is 60.

However, if Dr Morrison rolls his super into a low cost fund and invests his super in index funds (with investment fees of 0.20% p.a.) and assuming the same rate of return (of 7% p.a.[3]), his balance will be $1.8 million and he would have only paid $33,790 in fees by the time he is 60.

Therefore, based on these calculations, I estimate that Dr Morrison will be $375,000 better off by age 60 simply by spending a small amount of time optimising his super (i.e. switching into a low cost option).

To give you an actual real life example, the most recent comparison I did for a dental client based in Perth, I calculated he and his wife would be better off by over $600,000 over 20 years simply through switching their super into a lower fee environment. How could anyone question the value of quality financial advice with those findings?

You are not wrong to focus on fees

A small difference in fees adds up over time. Of course, fees are only one element. We need to look at returns too – and in my next article I will provide you with strong evidence that a passive (index) investment approach will almost always produce higher returns over the long run. But for now, the purpose of this article is to get you focused on fees. Remember, it’s your money you are paying out each year, so if you are not convinced you will get value from the people investing your money (and I wouldn’t be if you invest in active funds) then it stands to reason that you should pay as little in fees as possible.

You get what you tolerate

If you tolerate high superannuation fees, that’s what you will get! If you are not going to tolerate high fees anymore, you need to take action. However, I must remind you that I have not given you any specific advice in this article because it would be irresponsible to do so. You need to get personal advice on what’s right for you because there are many things to consider including any existing insurance, benefits with existing funds (particularly if it’s an employer fund), exit costs, other investments and so on.

I don’t know every reader’s situation so the information in this article is general in nature. Make sure you get advice from an independent, commission-free financial advisor (because commissions increase investment costs). Of course, we are ready and willing to help.

 

[1] The fee example used at the beginning of this blog has been adapted from Tony Robbins’ book, Money Master the Game.

[2] Super fund “type” fee estimates obtained from research published by Chant West in May 2008

[3] A significant amount of historic research demonstrates that there is a 96% chance that long-term gross investment returns will be higher with a passive investment mythology, despite fees being dramatically lower. This will be the subject of my article in June.

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