High fees erode returns

15 July 2014 | Portfolio construction

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Indeed, a large proportion of higher-cost, actively-managed funds have struggled in the past to even match their indexes or benchmarks once their fees are taken into account*.

The annual fee charged by a fund manager might seem not such a large percentage but the dollars can really add up over the years.

Fortunately, ASIC's personal finance website MoneySmart publishes a managed funds fee calculator that - based on broad and simplified assumptions - should leave investors with the clear impression that the size of a manager's fees can make a huge impact on their actual returns.

Basically, the calculator works like this. An investor can enter into the calculator: the initial capital being invested; how long the investment is expected to be held; the amount of regular contributions that may be planned; projected annual earnings as a percentage on a before-fee, before-tax basis; and the annual management fees. (There is provision to enter other fees into the calculator.)

Next, the calculator gives the user the option of comparing the fees charged with another managed fund. A useful exercise might be to enter the identical details for the initial amount invested, time the investment will be held and for projected earnings but to increase or decrease the fees - depending upon the funds being considered.

You could be surprised by the figures produced by the calculator, particularly if you are comparing a higher-cost, actively-managed fund with an index fund or perhaps a lower-cost, actively managed fund. Maybe you may decide to bring a low-cost, index-tracking Exchange Traded Fund (ETF) into the comparison.

ASIC's calculator assumes that investment returns are reinvested. And its projected balances do not take account of inflation, buy/sell spreads or any performance fees.

Significantly, a footnote to the calculator makes the crucial caveats: "A model is not a prediction. Results are estimates; the actual amounts may be higher or lower. We cannot predict things that will affect your decision such as movements in investment markets."

The underlying message illustrated by the calculator is that the size of investment management fees really matter. A seemingly small difference in the basis points being charged can make a big difference in returns over the long haul.

Yet these costs can be easily overlooked by investors who focus on the headline, pre-fee returns.

* See past Smart Investing columns: The low cost debate we need to have, June 20; Higher fees - a global investor issue, May 9; The case for index-fund investing, April 29.

 

Written by Robin Bowerman, Principal, Market Strategy and Communications at Vanguard Australia.
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