Learn About Investing
“It isn’t a big deal if the cost of managing my investments is 0.5% or 1.5%. They’re both pretty small figures, right?”
Wrong. Wrong. Wrong.
When investing, you will run into a number of different types of fee. Often it’s a fixed percentage of your invested money. But this percentage doesn’t just apply to your gains, it applies to the whole amount you’ve invested.
A tiny percentage has a big effect
Imagine your investments grow 5.5% in a year and inflation is running at 3%. This would mean that your real growth is 2.5%.
Now, let’s say your fees are 1.5%. That leaves you with just 1% growth (after fees and inflation).
You’ve just waved goodbye to four-fifths of that 5.5% return.
More than half was lost through the effects of inflation and the fees have eaten up more than half of what was left.
Now what if the fees had been 0.5% instead of 1.5%?
Your investment grew by 5.5% and inflation is the same 3%.
You’re now left with 2%.
The real growth in your savings just doubled.
A big effect gets compounded
Fees are often annual. This means money invested over a decade isn’t charged once – it’s charged 10 times over.
The significant effect one sees over a single year is also amplified over the long-term due to the effects of compounding.
After 10 years, a 1% fee instead of a 2.5% fee could quadruple your returns in real terms.*
* Assumes 6% annual returns in both cases and 3.0% inflation. Real returns on £1000 invested after 10 years are £219 with 1% fees versus £51 with 2.5% fees.
Can higher fees be justified?
The scenario above might suggest that low fees are always better. But this is not the case.
Which of the following do you think is better?
A. Paying 1% costs on an investment that grew 5% or
B. Paying 2% costs on an investment that grew 10%?
The point is that higher costs aren’t necessarily a bad thing. They just need to be justified through higher performance. This can be measured by comparing your investment to an alternative, such as a benchmark.
You may not even realise you are charged fees when investing, but they can have a big impact on your returns - especially over the long-term when the effects of compounding really kick in.
There are numerous types of fees and expenses faced by investors. These soon tot up. And if you invest in funds-of-funds, be aware that you may face two layers of fees rather than just one.
Smart investors always keep a close eye on costs and demand value for money.
Effect of fees on £1,000 invested
Assumptions: annual growth 6%, inflation 3%