How 1% a year can be life changing
Reducing investment costs improves your wealth
The long-running debate over active fund management and passive investing won’t end soon. Regardless of which side you’re on, active fund management will always have a market despite the fact underlying fund costs can be slashed with passive investing as some investors will always prefer to have a driver at the wheel of their portfolios.
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.
The concept of compound interest may be obvious but many investors don't see projected numbers. Years of commission- funded product sales taking precedent over results may have contributed, but regardless of the cause, the results of fee-based advice have never been more important for advisers as income increasing with investment values means cost-cutting is now essential.
Where can costs be reduced?
Three places to look for cost reductions are your investment platform, share classes of actively managed funds and indeed, passive investments.
The difference in platforms costs is relatively small (if not subject to a fixed-term charging 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, as much may depend on the functionality and features the platform provides.
Fund Share Classes
If you are firmly bedded into the active fund manager camp, alternative share classes of the funds you are invested in may be available with lower ongoing charge figures (OCF’s - the true running cost of funds). Different share classes of the same fund use exactly the same strategy only with lower costs and improved returns. Price differences can be significant and more so offshore, so the effect of cost reductions shouldn't be overlooked.
Why are there share classes with different pricing?
Purchasing power can be a factor as most would expect to pay less to invest £1m over £1,000, so fund managers create options to cater for different investors. Institutional investors making larger and frequent purchases expect discounts and in many markets, prices can also rise to facilitate commission and trail payments.
While this may seem standard practice, it can sway the selection of funds towards the benefit of advisers and not customers, also increasing the cost.
We selected the Blackrock Global Equity Fund and compared the 'A' and 'D' share classes. Purchasing power plays a part here with the cheaper D share class requiring a minimum £100,000 investment. However, if purchased through a investment platform, all share classes may be available for smaller amounts owing to the increased purchasing power of the platform, and not just the individual.
The OCF's of the D and A share classes is 0.94% and 1.68% respectively, a difference of 0.74% per annum. The chart below shows the effect that 0.74% pa makes over ten years with the D share class outperforming by 14.6% (source Trustnet/RM).
Here is where bigger differences in returns can be made. Active fund managers buy and sell holdings within a fund attempting to out-perform the markets, whereas passive investments (aka trackers or exchange traded funds (ETF)) track benchmarks without a manager for a reduced cost. Results show that fund managers seldom out-perform markets consistently, making the fees they charge a contentious issue owing to the drag on performance their fees create.
We compared the better performing of the two Blackrock share classes, the D class, against another global all-equity security, the iShares MSCI World UCITS ETF. With an OCF of 0.5%, a further reduction of 0.44% on the Blackrock fund, it's not the cheapest on the market (selected for its inception date) but the difference in growth is clear. The ETF returned 75.5% more over ten years, the effect of which could be life changing if investing to provide an income during retirement. The cost of investments continues to drop in newer issues of securities, so the potential savings continue to increase.
The Real Effects
Regardless of where you find them, the real impact of reducing your investment costs is easliy underestimated. Below highlights the impact a 1.5% pa improvement in costs and/or returns has 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 is a university education, a second home or a pension in itself for some. Regardless of the value of your assets, the difference is enough to make looking at your options worthwhile.
If you’re an existing investor or just starting out, contact us to learn more about getting the most out of your investments and we’ll show you how minimum effort can create maximum reward.
With the right guidance, it's very simple to adjust and enhance the rewards from your investments, so it could be easy money to make.
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.