How Investment Fees Drag Down Returns Investment fees (including trading and advisor fees) drag down returns in unimaginable ways.
Investment fees (including trading and advisor fees) will eventually drag down your portfolio returns in unimaginable ways.
A Washington Post report revealed that the top 25 U.S. hedge fund managers were paid a staggering $12.94 billion in 2015. Guess who paid most of those salaries and bonuses? The fund and its investors.
Just how badly do investment fees hurt your returns? Read on because I was shocked when I first discovered how costly these small fees really were.
Before I knew how to invest, I used a financial advisor who invested my small sums in a mix of single stocks and unit trusts. Just to be clear, I’m not here to bash financial advisors as good ones do exist and they help people who wouldn’t invest on their own. I just want you to be aware of how expensive investment fees really are.
If I hadn’t started out using an advisor and tried self investing, it would have been pure gambling as I had no clue how to DIY invest. I was happy to make 6-7% annually through the advisor since bank savings rates were paying 2-3%.
My advisor investment fee schedule looked like this:
Advisor Annual Fee: 0.75%
Platform Fee: 0.25%
Purchase Fee: £15 per transaction
I estimate I was paying about 1.15% per year in investment fees; to start.
Then I added the unit trust funds annual fees which were averaging about 1% in “viewable” fees and about 0.5% in fees you couldn’t see. My investment fees were now totaling an estimated 2.65% per year! Even though unit trusts are supposed to make fees transparent, there are some fees which are hidden in plain sight. An example is trading fees. These managed funds have high turnover due to the constant trading of shares. Some funds trade and turnover 100% of their portfolios annually. Just like you and I, when a fund trades a share, they have to pay fees. Imagine trading millions of shares each year; these trading fees add up and guess who pays for them? Investors in the fund. Also managed funds are generally not tax efficient so when they constantly trade, they have to pay tax on capital gains. This all equates to higher fund expenses that ultimately comes out of investors pockets.
When we talk about small percentage investment fees such as 1% or 2.65%, it can’t amount to that much right? Wrong.
When most people calculate fees, they forget to factor in loss of compounded interest. For example, Stan invests £100,000, reinvests all dividends and pays a 1% annual fee. He thinks he’s paying £1,000 per year in fees. When you calculate losses in compound interest over decades, these numbers are far more shocking and painful.
Instead of handing your money to an advisor, you can invest the money yourself in low cost index funds. After the advisor, platform fee and unit trust fee savings, instead of paying 2.65% in fees like I was, you’re now only paying 0.3% saving you 2.30% in yearly fees.
How would that look financially over 30 years on £150,000 investment?
Yes you read that correctly. If you invested £150,000 with a financial advisor like I did, the fees would end up costing you £894,363 over 20 years!
What about a £500,000 investment?
Does the thought of losing £2.9m to investment fees depress you because it sure depresses the hell out of me.
Don’t take my word for it, play around with this compound interest calculator and see how punishing a mere 1% in fees can be on your returns.
At the March 2016 Berkshire Hathaway annual meeting, investment billionaire Warren Buffet (Tesco’s owner) repeated his long standing investment advice:
“Just buy an S&P Index fund and sit on it for the next the next 50 years”
A recent article in the Washington Post reported that the top 2 hedge fund managers were paid $1.7 billion each in 2015. The top 25 hedge fund managers were paid a combined $12.94 billion in 2015! Some of these hedge funds actually lost money for investors. Other funds only made a few percent in profit. I’m all for people making money if they can, but it doesn’t mean the wise (Financial Thing readers) have to fall prey. Just one more reason for you to stay away from “investment professionals” and their high society investment funds and trusts. In the end, their fees win.
Buying low cost index funds / trackers that outperform nearly all managed funds can make you financially wealthy. All you have to do is:
- Fire your financial advisor unless he can prove to you his advice has substantially outperformed the market over 20 years
- Buy your own index / tracker funds through a low cost broker such as iWeb
- Stick to your strategy and don’t try to time the market
- Keep buying the funds through the market highs and the lows and don’t sell unless you have to
That’s it! Stay away from managed funds and use a buy and hold low fee investment strategy. It’s the time tested way to win at the retirement game.