People often refer with wonder to "the miracle of compounding". This is the wonderful wealth building that occurs when an investment is held for the long term and returns are reinvested, so you then earn interest on your interest.

It is spectacular when you consider how easily one can accumulate some pretty serious wealth given enough time. If you get a 10% return on $1,000, the next year you have $1,100, so you made $100. A return of 10% on that gives you $1,210, so this time you made $110. By the tenth year you have $2,590, and on the eleventh you will have $2,850. It gets really interesting when you consider the really long term, if you invest for 50 years $1,000 becomes $117,390.

Over 72 years if you had a return of 10%, a thousand dollars would turn into a million. I know this is a bit too long for most people, but you could make your grandchildren and great grandchildren multimillionaires if you really wanted to!

This is truly amazing stuff, and Albert Einstein once referred to compounding interest as one of the great wonders of the universe.

The long term effect of compounding is why you want to try to secure a higher return, and should worry about even small costs. A small increase in performance, sustained over a long period of time can increase your eventual wealth dramatically! But this has a flip side as well...

The tyranny of compounding, why it pays to worry about small stuff.

Compounding works both ways, up and down. Cynics sometimes refer to the other side of this as "the tyranny of compounding". Seemingly minor expenses make a huge difference after many years.

If you can invest for 20 years at 10%pa, you'll turn $100,000 into $672,749.99. That is pretty impressive.

But if you pay 0.5% higher fees than you need to, you'll only get a return of 9.5%, you'll turn $100,000 into $614,161.21, almost $59,000 less!

If you get 9% you'll end up with $560,441.08, that is more than $112,000 less!

So 1% annual fees doesn't mean you end up with 1% less, over 20 years you have almost 17% less money. Extend this out another ten years the difference is even bigger. Think of what a difference it would make if a 20 year old could minimise investment costs and get 1% better returns until he or she retired at age 60. If you consider the fact that many retirees are going to live for 20 years after they retire, one sees that many investors could have as much as 60 years of investing, not to mention what happens when money is passed on to children to invest.

Over the longer term, small costs matter. I know advisers that charge review fees plus trail commissions coming almost to 2%pa, and this is on top of the master trust fees (1.5%pa) and the management expenses ratio of the wholesale funds in that master trust (from approx. 0.2% to over 1.5%), not to mention all the capital gains tax paid when the portfolio gets switched around too often. You can't avoid costs altogether, but unfortunately many advisers don't even try. It is extremely difficult to add to returns much above the market indexes over time, but at least if costs are kept under control you don't lag behind substantially.

Don't accept high fees!

It is easy to convince an inexperienced investor to pay very high fees when they think that;

• future returns will be very high and thus the fees negligible, and
• one has to spend money to make money, and these higher fees are worthwhile because an expensive adviser is likely to be a skilled adviser

Neither of these assumptions are warranted. Investors with a knowledge of history know that returns seen in shares, property and bonds have been well above historical averages in the last decade or two. It is not safe to assume that future returns are going to be as high, in all likelihood not even close.

Secondly, expensive advisers are not usually better. I don't know any adviser that can honestly say he can add a couple of percent per annum of higher returns, either through selection or timing. (And even if he could add this performance, he'd have to overcome his higher fees, so really he'd be shooting for something like 5% outperformance of the market before fees and taxes for you to get any real benefit, and if such a performance could be sustained over 20 years that adviser would have books written about him and become one of the most famous investment advisers in history!)

If an adviser were to actually make such a claim this could well be false and misleading, to add such returns over many years would be to repeat a performance rarely seen in investment for the last century. There are only a handful of living individuals in the world that have achieved this kind of performance over a long period of time, and to the best of my knowledge none of them are commission based financial advisers working directly with members of the public.

In my experience, it is usually the worst financial advisers that charge the most. The really professional advisers aren't running around promising to make people 20%pa without risk, only the unethical salesmen do that.

Never let a commission based financial planner talk you into believing he is so good that you should pay very high ongoing amounts for investment management. There is no way that he can really be as sure as he makes out that the portfolio being recommended will really have that kind of high performance, and it is unlikely that any amount of ongoing fiddling with the portfolio is going to generate such high returns that performance can be boosted enough to compensate for the very expensive review fees, trail commission, master trust fees and active fund fees.

It is your money, and small charges make a huge difference on the end result. You don't owe any adviser any debt of gratitude or otherwise, you are their employer and if the adviser isn't looking after you there are thousands of others out there that would just love to have you as a client.

Remember, small charges also compound, every cent your adviser takes now is going to cost you dearly in the long run, so getting rid of trail commissions is a very good start.