Much has been said lately about the dismal returns typically produced by active funds managers.
Only around one per cent of funds beat the market consistently.
But just as shocking is how much investors are paying for that underperformance.
The figures we’re about to show you are for the United Kingdom, but total charges in the UK are not dissimilar to those in most countries around the world.
Let’s say you’re lucky enough to inherit £100,000 and you’re sensible enough to put it away for 40 years for your retirement.
What charges can you expect to pay?
Well, a typical annual management fee in 0.75%, though some investors pay far more.
On its own, 0.75% seems fairly modest. But the management fee is just the start of it.
There’s also a platform charge of around 0.35% and an average adviser charge of 0.82%.
Initial adviser charges, annualised, come to 0.24%.
Then there are fund custody and administration costs, which average 0.17%.
On top of all that are transaction costs. And the problem is, these could be anything, depending on how much trading your fund manager chooses to do. You really don’t know.
But we need to put a figure in here, so we’ll say 0.41%, which is the average figure for transaction costs.
And that means the total cost of investing, on average, is 2.74%.
Now you might look at that figure and say, OK, it is a significant chunk, but surely it can’t have a huge impact on the returns I end up making?
To which I would give you a one-word reply…
Compounding.
The effect of compounding can be huge.
You see, you don’t just pay these fees once. You’re paying the same percentages over and over again. And as the value of your investment grows, so do the pounds and pence charges you incur.
So what sort of impact do these charges have on the value of your investments over the long term?
Well, let’s assume an annualised return of 8% before charges which, after charges of 2.74% nets down to 5.26%.
40 years on, when you’re ready to retire, that means the £100,000 you invested would without any charges be worth £2,172,452 and after charges a mere £777,203.
So your actual gain would be just £677,203.
That’s because the effect of your total charges would have reduced your potential return by a staggering £1,395,249.
That’s right… More than two thirds of your potential gains have been lost.
Just think about that for a moment.
You’ve provided all the capital. You’ve taken all the risk.
And yet you’ve only kept 33% - one third - of the returns.
It’s a similar story for investors in North America, Australasia and most of Europe.
Investors in southern Europe, most of Asia and Central America are paying even higher charges than that.
Now you can see why, for sensible investors, keeping costs low is an absolute priority.