Vanguard super fund launches in Australia but percentage fees still too high

There has been a lot of excitement about the arrival of indexing giant Vanguard into the Australian super industry.

By and large I really share that excitement, with the arrival of a fund that charges just 0.58% in fees for a default MySuper offering. This will keep up the pressure to cut fees in an industry that has long charged an inordinate amount of money to disengaged customers simply because it could.

I’m not as excited that Vanguard’s main product is a lifestyle fund that uses your age to reduce investment risks as you approach retirement – that is a very simplistic way to approach a wide range of individual circumstances, although it is arguably an improvement on the usual and even more flawed “one size fits all’’ approach.

However, what this concentration on super investment fees does bring into sharp focus is the whole system of charging investment and administration fees within superannuation which really needs a radical revamp – perhaps even more radical than that produced by the Hayne Royal Commission which has seen all of the major banks depart the superannuation space.

Why charge a percentage fee at all?

My one question, to which there has never been a satisfactory answer that I am aware of, is why superannuation and other pooled investments for that matter charge fees as a percentage of assets at all.

Most of the answers are usually along the lines of “we’ve always done it that way” or “it is the simplest and most easily understood method”, which is all a load of nonsense.

There is a cost to administering any super fund but that cost would best be expressed as a flat fee – let’s for the sake of simplicity call it $500 a year.

There is also a cost to invest the money into a variety of asset classes and that cost really should not be expressed as a percentage of the amount invested.

If a Super fund buys 100 shares in BHP (ASX: BHP) or 100,000 shares, its cost to buy is essentially the same and static.

Which is where the fees as a percentage of assets is such a flawed and unfair way of doing business.

Why ramp up fees in line with balances?

Using Vanguard’s fees as an example, why should someone with a $20,000 super fund and a $2 million super fund pay $116 a year and $11,600 a year in fees to have their money invested in exactly the same product?

There is simply no justification for such a massive difference in providing the same service, unless you favour some sort of Robin Hood analysis in which the rich are subsidising the poor through their super investment fees.

That Robin Hood scenario is already catered for within many funds, which cap the administration and investment fees at 3% of the total invested for those with accounts under $6000.

The percentage-based investment fee rip-off gets even worse over time.

For every year the above investors remain in their super fund, the largest chunk remains invested and only the latest year’s contributions are actually invested anew.

This is particularly the case with passive funds such as Vanguard.

Don’t worry, if you do decide to change how you invest – say from high growth to balanced – you will usually get hit with even more fees, either through a switching fee or through a more insidious buy/sell spread fee which tends to disguise what is actually happening.

Even without a change in investment style, there may be some minor tinkering with percentages in various asset classes but by and large there is actually no new brokerage or fee being earned apart from keeping an overall view on asset class percentages and investing the new money.

That is the key to seeing what super funds achieve by having a percentage-based investment fee – a level of fee income that is growing nicely along with members balances irrespective of the services actually offered on the ground or the performance of the investment manager.

Average fees are too high

Canstar has calculated that on average, people in default super funds pay between 0.89% and 1.17% of their account balance in fees every year.

This shows why the entry of Vanguard is such an important force in helping to lower fees for everyone because these percentage fees are one of the biggest factors in how much of your own money you will be left with when you finally retire.

Again, using Canstar’s calculations, two people who both start accumulating super at the age of 25 and retire at 67 and earn the same returns will end up with a difference of $132,138 in their super, if the only difference is a fee of 0.75% compared to 1.50% a year.

Focus on fees and performance

That shows why investors need to have a razor-sharp focus on two things: the size of the fees their super fund charges and the returns they achieve.

The difference between a fund that performs well and has low fees and a high fee/low performance fund can be absolutely life-changing at retirement.

It’s the sort of difference between enjoying overseas holidays every year and eating out twice a week compared to a much more restrained retirement so it is worth the bother of actually being engaged and keeping an eye on performance and fees.

As well as that, I live in hope that the percentage-based system that is still almost ubiquitous for investment fees for super products will one day change to a fee based on services that are actually provided.

That’s been a forlorn hope for many years now but at least if the focus remains on cutting fees, perhaps they can be brought back to more acceptable levels that prevent unnecessary loss of retirement income.

After all, with a good standard of retirement on the line, lower fees and good performance are both things really worth fighting for.