When it comes to your investments performance the devastating effect of investment fees are something you should not overlook. I have heard numerous times from other blogs, books and podcasts that fees are important but have never bothered to run the numbers until now. Wow! I have a feeling you will be just as surprised as I was with the results.
The Result Of High Fees
It is not uncommon for investors to pay a substantial fee for portfolio management and investment advise. On top of this paying fees for the underlying funds that they are invested in. Lets look at the effect these fees have on a portfolio over time.
There is a good calculator at moneysmart.gov.au that calculates the effect of fees over the term of an investment.
Putting in some figures looks quite scary. An initial investment amount of $50,000 a monthly contributions of $400 over a 30 year period with investment earnings of 6%pa and a seemingly low management cost of 1 percent yields the following results:
A whopping $140,664 reduction in your final balance! Increasing the management fees to 2% increases the effect of fees to $250,000. Over a third of your portfolio evaporated in fees, and well over 50% of your investment returns. Suddenly 1 or 2 percent does not seem so small anymore.
What Can We Do About High Fees?
It is important to understand that all investments have some sort of fees. So we know we cant get rid of fees all together but what can we do to reduce them?
- Check the expense ratio of your current funds and see if you can find a cheaper alternative using a service such as Morningstar to perform comparisons.
- Replace your Actively Managed funds with Passive Fund equivalents. Companies such as Vanguard offer very low cost Index funds and ETF’s. Fees are one of the major drawbacks of actively managed funds and the reason why the large majority of fund managers struggle to add enough value to overcome the additional expenses.
- Watch out for Front-End and Back-End loads. These are fees payed upon entering and exiting the investment and can be quite substantial. If you are planning on holding onto the investment for very long periods of time these fees may work out to be small. You will need to do the math.
- A lot of funds offer you lower fees if you make a larger investment. Have a look at the thresholds and see if this will work in your favour.
- Avoid commissions by doing it yourself, shop around for a broker/manager with lower fees.
The money you loose in fees also looses its ability to compound over time. I am now well aware of the devastating effect of investment fees on portfolios and will endeavour to reduce my expense ratio. A good goal to aim for is an expense ratio of less than 0.4 percent and is fairly easily achieved with a blend of low cost managed and indexed funds.
I hope this article helps you to reduce your own investment fees. Let me know what you found with your own portfolios and any suggestions you may have.