Personal finance: Always count the costs

Don't just look at returns on your investment, check the costs, too - you could be shocked; The longer you hold your fund, the bigger impact costs can make

Like many investors, it has taken me longer than it should have done to arrive at the realisation that costs are such a major ingredient of long-term investment performance.

Particularly with shares, it is easy to spend too much time looking at the return side of the equation and not enough at the cost element. Whether you are investing directly yourself, or through a fund, the message is the same. Costs can seriously damage your wealth.

Of course in a bull market, like the one we have enjoyed for many years now, many investors have been able to ignore costs because the overall performance of their investments has been so good. If you are making 15 per cent a year tax-free through a PEP, why bother whether you are paying 1 per cent, 2 per cent or 3 per cent to the company which is looking after your money? Many fund managers have grown fat on the back of their investors' seeming indifference to costs.

Now that inflation and interest rates have fallen so sharply, however, nominal returns from all types of investment must come down too. With inflation at, say, 2 per cent, and a long term real return on equities of around 6-7 per cent, even if you are still a long term bull of the equity market, only the foolish will count on shares producing long term returns much above 9 per cent in nominal terms.

With that kind of return, it obviously starts to make a lot more difference whether the cost of your equity unit trust, for example, is 1 per cent or 3 per cent per annum. There is no point in giving back a third of your potential annual return unless you are absolutely convinced that your fund manager can make up the difference in superior performance. In practice, a 3 per cent a year cost burden is an awful handicap for even a brilliant equity fund manager to make up - and 2 per cent a year is almost as stiff a hurdle to overcome.

But how do you find out what the cost of your managed funds are? The answer is: you can't. Fund managers will happily tell you what their annual management fee for running the fund is. But that figure is not the end of the story. There are a whole range of other costs items (such as audit, custody, and administration costs) which the fund management company will deduct from any money you invest with them.

These costs can be highly significant, and can add anything from 10 per cent to 50 per cent to the annual cost of your fund. In the United States, total expense ratios (or TERs) for mutual funds are widely collected and publicised. But in this country, the amazing thing is that, although the unit trust business is now more than 60 years old, as far as is known nobody has ever thought it worthwhile to collect and analyse total expense ratios.

Now, at last, someone is trying to provide commercially what you would have thought would already be an essential service to investors. A consultancy firm called Fitzrovia International, which has been compiling TERs for offshore funds for the last five years, has recently published the first edition of what it hopes will be regular quarterly surveys of TERs for UK-based funds. While the study is aimed at professionals, and priced above the average investor, the firm hopes to publish a retail version in due course, which will be welcome.

Having seen the first report in the series, I can say that it makes very interesting reading. Some of the findings are as you would expect: index funds are generally cheaper than actively managed funds (by nearly 0.5 per cent per annum on average). Funds that invest overseas are generally more expensive those which confine their investment to the UK.

But what emerges very clearly from the consultants' detective work is the huge difference there is between the costs charged by different providers, much of which appears to be unjustified by performance. For UK equity funds, for example, even eliminating one or two obvious non-profit outliers, TERs range from 0.45 per cent per annum to 3.67 per cent per annum. In fact, quite a large number of well-known fund managers are routinely charging their clients more than twice the average fees of their competitors.

This disparity may be only a reflection of a fund manager's exceptional record or marketing skill. There is no law which says that the most successful fund managers (such as Jupiter and Perpetual) should not be allowed to profit from their skill in having compiled a good track record.

But, as usual in these cases, it is the many indifferent fund managers in the middle of the pack who seem to be getting away with more than they should if the market were genuinely competitive, and consumers more aware of the costs they are paying. Banks and insurance companies generally come out worse than specialist fund managers.

The key message is that the longer you intend to hold your fund, the bigger an impact costs make to its performance. The table below, for example, shows the difference it can make if you put pounds 5,000 a year into a UK tax- free equity fund with a low TER (0.85 per cent) compared to one with one of the highest (2 per cent plus). Assume a 9 per cent growth rate (see above), run the numbers and what you find is really quite frightening.

Over 10 years, the burden of these additional costs will cut the value of your fund by pounds 5,000, assuming identical performance in all other respects.

That equates to 6 per cent of your fund and 10 per cent of the total amount you have invested at that point. Over 25 years, the amount you will have "lost" through higher charges is pounds 65,000 - the burden of extra costs has eaten up pounds 1 of every pounds 6 your fund by then should be worth, and over half your total investment has gone in paying these costs!

If the high-cost fund were a racehorse, nobody would think of racing it with such a handicap in place - but then this is fund management where different rules seem to apply.

News
Ben Little, right, is a Labour supporter while Jonathan Rogers supports the Green Party
general election 2015
News
The 91st Hakone Ekiden Qualifier at Showa Kinen Park, Tokyo, 2014
news
Life and Style
Former helicopter pilot Major Tim Peake will become the first UK astronaut in space for over 20 years
food + drinkNothing but the best for British astronaut as chef Heston Blumenthal cooks up his rations
News
Kim Wilde began gardening in the 1990s when she moved to the countryside
peopleThe singer is leading an appeal for the charity Thrive, which uses the therapy of horticulture
Have you tried new the Independent Digital Edition apps?
Life and Style
ebookNow available in paperback
ebooks
ebookPart of The Independent’s new eBook series The Great Composers
Sport
Alexis Sanchez celebrates scoring a second for Arsenal against Reading
football
Life and Style
health
Voices
An easy-peel potato; Dave Hax has come up with an ingenious method in food preparation
voicesDave Hax's domestic tips are reminiscent of George Orwell's tea routine. The world might need revolution, but we like to sweat the small stuff, says DJ Taylor
News
i100
News
Japan's population is projected to fall dramatically in the next 50 years (Wikimedia)
news
Life and Style
Buyers of secondhand cars are searching out shades last seen in cop show ‘The Sweeney’
motoringFlares and flounce are back on catwalks but a revival in ’70s car paintjobs was a stack-heeled step too far – until now
  • Get to the point
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs General

    Recruitment Genius: Project Implementation Executive

    £18000 - £23000 per annum: Recruitment Genius: They work with major vehicle ma...

    Recruitment Genius: Chiropractic Assistant

    £16500 per annum: Recruitment Genius: A Chiropractic Assistant is needed in a ...

    Recruitment Genius: Digital Account Executive - Midlands

    £18000 - £26000 per annum: Recruitment Genius: They work with major vehicle ma...

    Recruitment Genius: Web Developer

    £28000 - £30000 per annum: Recruitment Genius: This company provides coaching ...

    Day In a Page

    NHS struggling to monitor the safety and efficacy of its services outsourced to private providers

    Who's monitoring the outsourced NHS services?

    A report finds that private firms are not being properly assessed for their quality of care
    Zac Goldsmith: 'I'll trigger a by-election over Heathrow'

    Zac Goldsmith: 'I'll trigger a by-election over Heathrow'

    The Tory MP said he did not want to stand again unless his party's manifesto ruled out a third runway. But he's doing so. Watch this space
    How do Greek voters feel about Syriza's backtracking on its anti-austerity pledge?

    How do Greeks feel about Syriza?

    Five voters from different backgrounds tell us what they expect from Syriza's charismatic leader Alexis Tsipras
    From Iraq to Libya and Syria: The wars that come back to haunt us

    The wars that come back to haunt us

    David Cameron should not escape blame for his role in conflicts that are still raging, argues Patrick Cockburn
    Sam Baker and Lauren Laverne: Too busy to surf? Head to The Pool

    Too busy to surf? Head to The Pool

    A new website is trying to declutter the internet to help busy women. Holly Williams meets the founders
    Heston Blumenthal to cook up a spice odyssey for British astronaut manning the International Space Station

    UK's Major Tum to blast off on a spice odyssey

    Nothing but the best for British astronaut as chef Heston Blumenthal cooks up his rations
    John Harrison's 'longitude' clock sets new record - 300 years on

    ‘Longitude’ clock sets new record - 300 years on

    Greenwich horologists celebrate as it keeps to within a second of real time over a 100-day test
    Fears in the US of being outgunned in the vital propaganda wars by Russia, China - and even Isis - have prompted a rethink on overseas broadcasters

    Let the propaganda wars begin - again

    'Accurate, objective, comprehensive': that was Voice of America's creed, but now its masters want it to promote US policy, reports Rupert Cornwell
    Why Japan's incredible long-distance runners will never win the London Marathon

    Japan's incredible long-distance runners

    Every year, Japanese long-distance runners post some of the world's fastest times – yet, come next weekend, not a single elite competitor from the country will be at the London Marathon
    Why does Tom Drury remain the greatest writer you've never heard of?

    Tom Drury: The quiet American

    His debut was considered one of the finest novels of the past 50 years, and he is every bit the equal of his contemporaries, Jonathan Franzen, Dave Eggers and David Foster Wallace
    You should judge a person by how they peel a potato

    You should judge a person by how they peel a potato

    Dave Hax's domestic tips are reminiscent of George Orwell's tea routine. The world might need revolution, but we like to sweat the small stuff, says DJ Taylor
    Beige is back: The drab car colours of the 1970s are proving popular again

    Beige to the future

    Flares and flounce are back on catwalks but a revival in ’70s car paintjobs was a stack-heeled step too far – until now
    Bill Granger recipes: Our chef's dishes highlight the delicate essence of fresh cheeses

    Bill Granger cooks with fresh cheeses

    More delicate on the palate, milder, fresh cheeses can also be kinder to the waistline
    Aston Villa vs Liverpool: 'This FA Cup run has been wonderful,' says veteran Shay Given

    Shay Given: 'This FA Cup run has been wonderful'

    The Villa keeper has been overlooked for a long time and has unhappy memories of the national stadium – but he is savouring his chance to play at Wembley
    Timeless drama of Championship race in league of its own - Michael Calvin

    Michael Calvin's Last Word

    Timeless drama of Championship race in league of its own