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.

Sport
The giant banner displayed by Legia Warsaw supporters last night
football
News
i100(and it's got nothing to do with the Great British Bake Off)
News
news
Sport
footballPremiership preview: All the talking points ahead of this weekend's matches
PROMOTED VIDEO
Have you tried new the Independent Digital Edition apps?
Life and Style
ebooksA superb mix of recipes serving up the freshest of local produce in a delicious range of styles
Life and Style
ebooksFrom the lifespan of a slug to the distance to the Sun: answers to 500 questions from readers
News
Angelina Jolie with her father Jon Voight
people
Arts and Entertainment
Tulisa as a judge on the X Factor in 2012
tvLouis Walsh confirms star's return
Life and Style
fashionClothes shop opens on Bill Clinton Boulevard in Pristina
Voices
The Ukip leader has consistently refused to be drawn on where he would mount an attempt to secure a parliamentary seat
voicesNigel Farage: Those who predicted we would lose momentum heading into the 2015 election are going to have to think again
Arts and Entertainment
Cara Delevingne made her acting debut in Anna Karenina in 2012
film Cara Delevingne 'in talks' to star in Zoolander sequel
News
i100
Life and Style
life
News
Melissa and Joan Rivers together at an NBC event in May 2014
peopleDaughter Melissa thanks fans for 'outpouring of support'
Life and Style
tech
Independent
Travel Shop
the manor
Up to 70% off luxury travel
on city breaks Find out more
santorini
Up to 70% off luxury travel
on chic beach resorts Find out more
sardina foodie
Up to 70% off luxury travel
on country retreats Find out more
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

    SAS Developer - DI Studio - Banking

    £450 - £500 per day: Orgtel: SAS Developer, Chester, Banking, DI Studio, £450-...

    Recruitment Consultants - Banking & Finance

    £20000 - £30000 per annum + OTE £40 - £50K first year: SThree: SThree Group an...

    Trainee Recruitment Consultant

    £18000 - £30000 per annum + uncapped: SThree: Do you feel you sales role is li...

    Nursery Room Leader

    Negotiable: Randstad Education Plymouth: JOB DESCRIPTION - NURSERY ROOM LEADER...

    Day In a Page

    Ukraine crisis: The phoney war is over as Russian troops and armour pour across the border

    The phoney war is over

    Russian troops and armour pour into Ukraine
    Potatoes could be off the menu as crop pests threaten UK

    Potatoes could be off the menu as crop pests threaten UK

    The world’s entire food system is under attack - and Britain is most at risk, according to a new study
    Gangnam smile: why the Chinese are flocking to South Korea to buy a new face

    Gangnam smile: why the Chinese are flocking to South Korea to buy a new face

    Seoul's plastic surgery industry is booming thanks to the popularity of the K-Pop look
    From Mozart to Orson Welles: Creative geniuses who peaked too soon

    Creative geniuses who peaked too soon

    After the death of Sandy Wilson, 90, who wrote his only hit musical in his twenties, John Walsh wonders what it's like to peak too soon and go on to live a life more ordinary
    Caught in the crossfire of a cyber Cold War

    Caught in the crossfire of a cyber Cold War

    Fears are mounting that Vladimir Putin has instructed hackers to target banks like JP Morgan
    Salomé's feminine wiles have inspired writers, painters and musicians for 2,000 years

    Salomé: A head for seduction

    Salomé's feminine wiles have inspired writers, painters and musicians for 2,000 years. Now audiences can meet the Biblical femme fatale in two new stage and screen projects
    From Bram Stoker to Stanley Kubrick, the British Library's latest exhibition celebrates all things Gothic

    British Library celebrates all things Gothic

    Forthcoming exhibition Terror and Wonder: The Gothic Imagination will be the UK's largest ever celebration of Gothic literature
    The Hard Rock Café's owners are embroiled in a bitter legal dispute - but is the restaurant chain worth fighting for?

    Is the Hard Rock Café worth fighting for?

    The restaurant chain's owners are currently embroiled in a bitter legal dispute
    Caribbean cuisine is becoming increasingly popular in the UK ... and there's more to it than jerk chicken at carnival

    In search of Caribbean soul food

    Caribbean cuisine is becoming increasingly popular in the UK ... and there's more to it than jerk chicken at carnival
    11 best face powders

    11 best face powders

    Sweep away shiny skin with our pick of the best pressed and loose powder bases
    England vs Norway: Roy Hodgson's hands tied by exploding top flight

    Roy Hodgson's hands tied by exploding top flight

    Lack of Englishmen at leading Premier League clubs leaves manager hamstrung
    Angel Di Maria and Cristiano Ronaldo: A tale of two Manchester United No 7s

    Di Maria and Ronaldo: A tale of two Manchester United No 7s

    They both inherited the iconic shirt at Old Trafford, but the £59.7m new boy is joining a club in a very different state
    Israel-Gaza conflict: No victory for Israel despite weeks of death and devastation

    Robert Fisk: No victory for Israel despite weeks of devastation

    Palestinians have won: they are still in Gaza, and Hamas is still there
    Mary Beard writes character reference for Twitter troll who called her a 'slut'

    Unlikely friends: Mary Beard and the troll who called her a ‘filthy old slut’

    The Cambridge University classicist even wrote the student a character reference
    America’s new apartheid: Prosperous white districts are choosing to break away from black cities and go it alone

    America’s new apartheid

    Prosperous white districts are choosing to break away from black cities and go it alone