How 1% A Year Can Change Your Life
The long-running debate over whether active fund management is worth paying for over passive investing won’t end soon.
Regardless of which investment style you choose, many investors don't realise significant savings can be made with simple changes.
Even the smallest of changes can make a difference and with the effect of compounding over time, the benefits can be life-changing.
The real effect of lower investment costs
A huge number of the investing community are still yet to understand the difference between passive and active investing, and larger numbers don't comprehend the true effect of cutting investment costs over the medium to long term.
Despite the additional costs, active fund management will always have a market despite the fact underlying fund costs can be slashed with passive investing. Recent market volatility shows that active management has its benefits, but some investors simply prefer to have an additional driver at the wheel of their portfolios.
The concept of compound interest may be obvious to some, but many investors don't see the potential differences in performance that cutting fees can produce. After years of commission-driven offshore product sales, many advisors have changed their business models to fee-based advice, so reducing costs has never been more important to ensure both advisor and customers benefit from maximising investment potential.
Where can I reduce costs?
The best places to start looking for cost reductions are your investment platform, share classes of your actively managed investment funds and indeed, if passive investments might provide a better alternative.
Investment platforms
The difference in platforms costs is usually small, unless you're invested in an offshore bond on a fixed charge structure. Fees normally range range between 0.1% and 0.4% pa depending on the amount invested, so although there may be savings made here and in trading costs, much may depend on the functionality and features the platform provides.
Fund share classes
If you are firmly in the active fund management camp, alternative share classes of your funds may be available with a lower ongoing charge figure (OCF) or total expense ratio (TER), which are the true running cost of funds. Different share classes of the same fund generally use the same strategy, only with lower costs and improved returns. Price differences can be significant and more so for offshore funds, so investigating cost reductions shouldn't be ignored.
Why do funds have different pricing?
Purchasing power can be a factor as most people would expect to pay less for investing £1m than £1,000. Fund managers create options to cater for different investor audiences, and because institutional investors (like pension funds) make large and frequent purchases, they receive discounts.
Fund managers may also create share classes for overseas investors, where advisors can still benefit from hidden trail and commission payments from the fund. This is where diligence is required as prices rise for the investor and returns reduce, when it's very likely the cheaper 'onshore' share class would also have been available for purchase.
While choosing the best option for the customer may seem the obvious thing to do, many advisors are still commission-driven and take undisclosed payments from funds. Furthermore, 'institutional' purchasing power can be enjoyed by using most modern platforms, so using more expensive share classes is totally unnecessary.
Does it really matter?
To be clear, we do not advocate the purchase of the expensive fund examples below and have used them for illustration purposes only. The GAM Star Global Dynamic growth Fund below has the 'Z' share class (blue) with an ongoing charge of 1.28%, and the 'C' share class (orange) with a 3.25% ongoing charge.
The red box at the top of the image shows the difference in performance over 5 years, a significant 12.54%, but also indicates the C share class is 38.5% overall less efficient than the Z share class.
Passive investing
Active fund managers buy and sell holdings within a fund attempting to out-perform the markets, whereas passive investments (aka trackers or ETF's) track benchmarks without incurring many of the fees associated with active fund management. Results show that fund managers seldom out-perform markets consistently, making the fees they charge a contentious issue owing to the drag on performance they create.
We compared two global equity securities - a managed fund from the very highly respected Vanguard and an MSCI World Index ETF from Invesco, both with similar equity and volatility characteristics. The Vanguard fund's management fee is a very competitive 0.48% and Invesco's ETF underlying cost is 0.19%.
It is generally accepted that actively managed funds outperform passive funds during volatile times. However, the image below shows 5 year returns differing by a significant 13%, with the difference increasing to 24% over 3 years. Ultimately, the decision to use managed or passive funds is down to either your advisor or yourself, but we think it's important for customers to know their options and understand the benefits and potential sacrifices of choosing one strategy over the other.
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The real returns
Regardless of where cost reductions are made, the real impact on your investment shouldn't be underestimated. Below highlights a 1.5% pa improvement in costs and/or returns on an investment portfolio of £500,000 over a ten year term, based on 6% and 7.5% pa respectively.
The difference of £146,333.32 could buy a university education, a second home or a be pension in itself for some. Regardless of the value of your assets, the difference is enough to make looking at your options worthwhile.
What next?
With the right guidance, it's easy to adjust and enhance the rewards from your investments by simply not paying charges you don't have to.
Whether you’re an existing investor or just starting out, contact us to learn more about getting the more from your investments and we’ll show you how small changes can create huge differences to your financial security.
The information contained in this article is provided for informational purposes only and is not intended to substitute formal tax or financial planning advice. While we make reasonable efforts to make sure the content of the article is correct and up to date we do not assume any responsibility for any errors or omissions. Past performance is not a guarantee of future returns. Investment values rise and fall and you could get back less than you invested.