Investment Fees: Take Back Control

Democrafy is designed to show how small financial changes can have a major impact. One such example is the topic of investment fees. While we might spend hours assessing where we invest, we spend less effort assessing the fees that we pay. The result is that we make fund managers and investment platforms richer than they need to be, at our own expense.

There are several types of investment fees, including:

- Investment platform fees, for administering your investment account

- Investment management fees, for allocating your investments

- Underlying fund fees, if your investment managers invest in other funds

- Trading fees, which incorporate the cost of trading stocks, bonds or funds

- Foreign exchange fees

Depending on how you invest, you’ll be exposed to some or all of these fees. It’s important to be aware of the total fee you pay, expressed as a percentage of your assets, and the effect that this has on your investment growth. Let’s illustrate the point with three examples:

SOPHIE

Sophie has £10,000, which she invests in a portfolio of equities, through funds or ETFs. Over a 30-year time period, through many economic ups and downs, she can expect her return to be around 7% per year. Her total fees are 1% per year on total assets.

With a 7%/year average rate of return over 30 years, her £10,000 would grow to £76,000 without any fees. This is a gain of £66,000.

With a 1% annual fee deducted, her return is 6%/year. Over 30 years, her £10,000 would grow to £57,000 – a gain of £47,000.

So the introduction of a fee has reduced her gain from £66,000 to £47,000. In other words, 29% of her gains disappear to fees.

This is quite astounding. A simple – and incorrect – calculation might presume that only 1/7th (or 14%) of the gains would go to fees. But this is an understatement, driven by the effect of compound growth over time. The impact of 6%/year vs 7%/year may seem small over a year, but over thirty years it makes an enormous difference.

DAVID

David also has £10,000 and invests in the same way as Sophie. The only difference is that he pays a 2% per year fee on total assets.

Had he averaged 7%/year over 30 years, his £10,000 would also grow to £76,000 – a gain of £66,000.

But with 2% fees included, his return is 5%/year. Over 30 years, his £10,000 would grow to £43,000 – a £33,000 gain.

So for David the 2% fee, which seems small, has an enormous impact. His gain has fallen from £66,000 without fees to £33,000 with fees. 50% of his gains have disappeared to fees.

He has done the right thing by earning, saving his £10,000, investing it and leaving it to grow for the long-run. But by paying 2% fees, he has enriched his investment manager and platform, rather than himself.

KATE

Kate, seeing the mistakes made by Sophie and David, is smarter in the way she invests her £10,000. She is aware of all fees that she pays on her investment, and she keeps these as low as possible, to keep more of the return that she makes. Her total fees are 0.5% of assets per year.

Her £10,000 would also grow to £76,000 with a 7% annual growth rate – a gain of £66,000.

Accounting for fees of 0.5%, her growth rate falls slightly to 6.5%. Over 30 years, her £10,000 would grow to £66,000 – a gain of £56,000.

Kate has only given up £10,000 in fees out of her £66,000 gains (15% goes to fees, 85% of gains are kept). This is a huge win.

To summarise:

Sophie: loses 29% of her gains to fees

David: loses 50% (!) of his gains to fees

Kate: loses only 15% of her gains to fees

Small differences in fees mean major differences in returns.

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You could spend hours of your life focusing on whether now is the time to buy or sell Tesla stock, whether you should sell Bitcoin to buy Ethereum, and whether the stock market’s next 10% move will be up or down. Or you could just ensure your investment fees are lower.

One takes time, adds stress and is 50:50 as to whether you’re right or wrong. The other works every time, is easy to fix and benefits you year after year.

I know where I’d spend my time.