Expensive and hidden fees are decimating people’s savings, wiping at least 40 per cent off the value of pensions and even more from investment funds. Banks and insurers make billions of pounds from complex and opaque fees — but how much are you being charged, and is there a cheaper alternative?

Unit trusts

“Many people have simply no idea what they’re invested in, or how much they’re being charged,” says Jason Butler, of Bloomsbury Financial Planning. The “total expense ratio” (TER) of funds, which includes the annual management fee and other administrative costs, can be misleading. It does not include initial charges, exit fees or the cost of transactions made within a fund, known as the “turnover” cost.

Some financial advisers, such as St James’s Place, may also receive trail commission as part of their fee. This is typically 0.5 per cent a year, so if you invested £100,000 the adviser will receive £500 a year. Mr Butler adds: “The more transactions a manager makes, the more expensive the fund will be — and it’s unlikely to outperform the market anyway.”

The FTSE all-share has increased by 53 per cent since March, yet the average managed UK equity fund has increased by only 51 per cent, according to Morningstar, the data company. Only 172 out of 428 UK equity funds have managed to beat the FTSE all-share over this period.

One equity fund with notably high charges is the Absolute Insight International Equity fund, which aims to generate “positive returns in all market conditions”. Someone investing £10,000 will face an initial charge of 5.75 per cent, a TER of 1.46 per cent and — crucially — the turnover impact will cost 3.21 per cent because the manager buys and sells so much within the fund. Assuming a gross return of 5 per cent a year over 25 years, the net return would, in fact, be 0.33 per cent after all the charges, producing only £10,234.

A cheaper alternative is a tracker fund, which mirrors the performance of any given index instead of being actively managed. Vanguard’s UK Equity Index, which tracks the FTSE all-share, would produce £31,904 over the same period, assuming the same 5 per cent [annual] return because there is an annual management charge of only 0.15 per cent. The minimum investment in the fund is £100,000. Another popular option is exchange-traded funds (ETFs), which are traded on the Stock Exchange. The Lyxor ETF, which also tracks the FTSE all-share, has no initial charge and a TER of 0.35 per cent, meaning that the same £10,000 invested over 25 years would result in £30,416.

Pensions

At least 40 per cent of personal pension funds are swallowed up in fees, according to Hermes, the asset manager. Most people have no idea how much their provider deducts in charges, and assume that disappointing returns are on account of poor market performance. All personal pension providers charge an annual management fee, which is usually at least 1.5 per cent. This may sound small but over a long period it adds up. A 25-year-old saving £1,000 a year into a pension can expect about £248,170 at age 65, assuming annual growth of 7 per cent. However, the 1.5 per cent annual management charges will reduce this to £174,560, according to calculations by Hermes.

The Financial Services Authority (FSA) shows on its website the charges that specific providers deduct from pensions — go to www.fsa.gov.uk/tables. Costs vary even among simple stakeholder plans, which have fees capped at 1.5 per cent for the first ten years and 1 per cent thereafter. Several stakeholder providers charge as low as 0.8 per cent so it is worth shopping around. Someone contributing £100 a month for 30 years would, by the time he reaches retirement, have been charged £19,500 by Scottish Widows, one of the cheaper stakeholder providers, while Forester Life would deduct almost £28,000 in fees, according to the FSA.

If a 20-year-old invested a lump sum of £20,000 into the Co-operative’s Individual Personal Pension, the investor would pay £286,306 in fees up to age 65 — more than 14 times the initial investment, the FSA says.

Hermes points out that the impact of fees is generally much lower for occupational pensions — totalling 10 per cent instead of 40 per cent.

Laith Khalaf, of Hargreaves Lansdown, the independent financial adviser, says: “Those with older personal pension contracts, even from the 1990s or early this century, may be charged high annual management fees and should consider transferring to a cheaper provider.”

For those who want more control over their pension investments, a low-cost self-invested personal pension (Sipp) charges annual management fees of 1.5 per cent, but other types of Sipp usually have higher annual fees as well as initial charges of about £500 and flat annual charges of £500.

Mr Khalaf adds that the cheapest fund to hold in a pension is HSBC’s FTSE all-share tracker fund, which has a TER of 0.25 per cent.

With-profits

About 20 million savers with endowments, pensions and bonds have invested in with-profit funds. However, the disastrous performance of many funds and large fees has led to many losing money.

Matthew Woodbridge, of Chelsea Financial Services, the independent financial adviser, says: “With-profits generally have annual management charges of up to 1.5 per cent, but the funds are so opaque it is near-impossible to assess the performance.”

People who bought with-profit funds in the past 20 years were probably charged a 5 per cent initial fee — and the bank or adviser who sold the product may have taken 7 per cent as initial commission.

The biggest problem is excessively high exit penalties, or market value reductions (MVRs), which can be introduced at will and leave people trapped in underperforming funds. MVRs may vary depending on when you invested. If it was 20 years ago the charge may be 2 per cent, but if it was nine years ago it may be 18 per cent.

This week Aviva, the insurer, reduced the exit penalty applied to funds bought in 1989 from 14 per cent to 12 per cent.

Case study

Peter Duffy, 46, started saving into a pension five years ago. He wanted to minimise the impact of fees and charges, so he opted for a low-cost Sipp with Hargreaves Lansdown in which he holds only tracker funds and exchange traded funds (ETFs).

His core investments include Vanguard’s Total World Tracker and HSBC’s UK FTSE Tracker. He also has Vanguard’s Emerging Markets and Technology ETFs. All have total expense ratios of 0.3 per cent or less.

Mr Duffy says: “I really like Vanguard’s low-cost ethos. Investment providers have ripped off people for years with excessive charges. I’m loath to pay 2 per cent in fees for a fund that cannot even better the market.”

Unfortunately, Mr Duffy cannot hold all the low-cost funds that he would like in his Sipp, including Vanguard’s recently launched unit trusts.

All his Vanguard funds are based in the US and are linked to the New York Stock Exchange.

Times Recommends

• How to sell your home in a downturn
• How to boost your spending power
• Unemployment benefits explained