Part 2: The Smoke Screen of Inflation
In Part 1: What’s the Problem? I highlighted the effects of deductions on investment returns.
In this blog, we’ll look at the effects of inflation, identify the real returns on your investments and answer the above question.
Prepare to be horrified…
The investment industry likes inflation because the higher it is, the higher the returns (although not necessarily higher real returns) which makes the charges relatively lower and to be fair to the industry, their charges are a lot lower than they were in the 1980’s and early 1990’s, when inflation was much higher. Having said that, I don’t think it can be given credit for making these reductions voluntarily…
In their publication Rates of Return for FCA Prescribed Projections, September 2017, the Financial Conduct Authority (FCA) estimates that, inflation (the Consumer Price Index) will be 2.5% over the next 10 to 15 years
This means that if you have £100 this year, you can buy 100 items from Poundland. Next year, you may still have £100, but your items will be reduced to 97.5.
Let’s add the effects of inflation to the calculations in last week’s blog
Effective Growth Rates:
Traditional Charges Professional Fees
Average Annual Growth Rate % 6 6
Product charge % 0.38 0.38
Annual management charge 0.78 0.3
Adviser charge 1.0 0.5
Total deductions 2.16 1.18
Less inflation 2.5 2.5
Effective growth rate 1.34 2.32
(A financial calculator is invaluable for these calculations!)
Managed Fund Portfolio Passive Portfolio
Initial investment £100,000 £100,000
Term of investment (N) 20 years 20 years
Investment after charges (PMT) £97,000 £98,830
Maturity value (FV) £126,587 £156,350
Interest (1/yr) 1.34 2.32
Gain (less the initial £100,000) £26,587 £56,350
Once inflation is factored in, the traditional charges provide real returns of less 47% of the professional fees!
Why pay the higher charges? Many advisers and product providers will say because they are worth it! Really? Consider my earlier blogs and remember; charges are guaranteed, returns are not.
You may ask yourself why you would bother investing money, why not just save it in the bank? Let’s look at those potential returns.
Initial investment £100,000
Term of investment (N) 20 years
Investment after charges (PMT) £100,000
Interest (1/yr) 1.5%
Real Value £81,790
After the original £100,000 is deducted -£18,210
Money invested in deposit accounts, over the longer term, is almost certain to be eroded by inflation.
Over the longer term, inflation is probably the biggest threat to your wealth. It is probably sensible to invest it, but do not allow the investment industry to use it as a smoke screen to drain your wealth.
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