How Much Does It Really Cost To Invest?

The Real Cost of Investing. A look at Fees. 

Since the introduction of the Retail Distribution Review, on 1st January there has been much comment in the press about the fees that are charged for investing money. This can only be a good thing as it helps to raise awareness in the market of the issue and get people asking about the real cost of investing.

This is a drum we have been banging for over 10 years but it is a topic that we never tire of revisiting as the industry is trying it’s hardest to keep consumers from knowing the real facts. As such, we are setting out here a brief breakdown of the fees a typical investor would pay for an actively managed portfolio of retail investment funds.

Fundamentally there are four charges an investor will have to pay, whether they know it or not.

  1. The Annual Management Charge or AMC.  This charge is expressed as a percentage of the assets you have invested and includes the costs of managing the fund such as paying the manager and his team. It is typically 1.5%pa for a legacy retail fund as is declared in the prospectus or fund fact sheet.
  2. The Total Expense Ratio or TER. This is the AMC plus additional costs for things like marketing and advertising the fund, legal costs, banking costs and audit fees amongst other costs. Once these are added to the AMC on a pre RDR legacy fund the TER will typically be 1.7%pa but this includes the AMC and is not in addition to it.
  3. Asset Custody Fees. These are administrative fees that pay for the trading platform on which the assets are held enabling the manager to trade. If the funds are held directly with the fund manager these fees are built in to the TER. It is possible however that the funds are held via a third party platform and if so there can  be an additional charge of up to 0.75% pa for this.
  4. Portfolio Turnover Fees. These are charges that are not explicitly declared to the client within the fund literature and yet can be responsible for doing significant damage to your wealth. They are the fees charged to cover the costs of trading the assets within the fund (stock broking commissions) and stamp duty if it is a UK based fund.

To understand how big these are we have to study the main academic works on the subject* which conclude that for a fund that places trades each year up to the value of the assets it holds you can add a further 1% in charges plus 0.5% stamp duty bringing the total to 1.5% for a UK based fund. These fees are not explicitly deducted from your portfolio but turn up as a drag on performance, such that if the fund grew by 7% you would only see a 5.5% return. In essence it has exactly the same effect as though they were explicitly charged but the industry likes the current status quo as they don’t have to declare them.

If we add up these costs we arrive at the following:-

Total Expense Ratio                  1.7%

Portfolio Turnover                     1.5%

Total Cost of investing              3.2%

If the assets are held on a platform you can up to an additional 0.75% to this figure bringing the total to 3.95% pa.

Thus if you had a portfolio valued at £250,000 you could be paying £8,000 pa without a third party asset custody service or up to £9,875 pa in fees with one, just for the management of your money.

This is shocking and the above costs are purely for the management of the money and exclude the cost of advice from a financial adviser. If the adviser then charges an additional 1% on top, this figure rises to 4.2% or 4.95%, which may equal, and remove, pretty much all of your return.

There is another way

It is for these reasons that for over 10 years we have adopted a passive investment strategy for our client’s core holdings, that invests in Institutional funds (those only open to large professional investors) not retail funds. The effect of this is to reduce the costs substantially as institutional funds have TER’s of between 0.15% and 0.5% rather than 1.7% and the passive approach (not actively trading trying to beat the market) means that the costs of portfolio turnover are almost nil.

If we examine the costs of our portfolios under the same headings above, the figures are as follows for a £250,000 holding:-

Portfolio

TER

Asset Custody

Portfolio Turnover/Trading

Total

Cost

Cautious

0.37%

0.37%

0.05%

0.79%

£1,975.00

Prudent

0.40%

0.37%

0.05%

0.82%

£2,050.00

Balanced

0.42%

0.37%

0.05%

0.84%

£2,100.00

Growth

0.45%

0.37%

0.05%

0.87%

£2,175.00

You can see immediately that by adopting a strategy that cuts out the costs of active management and trading, the result is a huge saving to you, the client, which can help to protect the gains made over the planned investment timescale. Critics of this approach will argue that we will never make our clients a fortune as we are not employing clever fund managers to make clever decisions and so will miss out on some stellar returns.

Our response to that is that we are not in the business of speculating with our clients’ money and want instead to provide a higher degree of certainty, in a very uncertain world. To do this we need to remove the “human” risk from the equation and strive to get back for our clients what their financial plan says they need back and not what might be possible through speculation. The tortoise and the hare springs to mind.

 

*Source Portfolio Turnover of Funds Fitzrovia 2nd Edition

Studies by:- Wilcox 1993, Carhart 1997, Orton 1999,James 2000