On Saturday afternoon I visited the Vikings exhibition at Melbourne Museum. Over 450 artefacts were on display, making it the largest collection of it’s kind in Melbourne, and boy was it packed! Two things I learned from the exhibition:
1) Vikings’ swords weren’t that heavy, and
2) The importance of silver during trade.
This precious metal became such an important component of trade during the Viking period. Silver coins and ingots were used to balance transactions. Vikings would carry around their own set of small scales to ensure each transaction they entered into was measured accurately and precisely, and the transaction was completed fairly and that they weren’t being cheated.
When I look through the funds that have been used to construct a portfolio for individuals, families, and/or superannuation funds, I am always stumped by the high fees that are being paid by investors.
In business, there’s an old saying, you need to spend money to make money. When it comes to investing however, the more money you pay, history tells us that it has an adverse effect on what you have left in your pocket. Don’t get me wrong, every investment has a cost, even though it may seem as though you’re not paying anything. I recall being told by one “wealth management” firm, their fee to trade international shares for their clients was nil…NIL!? (I wasn’t aware you were a charity). After we did some digging around, we uncovered the firm would take a large clip from the foreign currency exchange. Sure, the brokerage was nil, but unless you understand how these things work, on face value it may seem as though you’re not paying anything.
Most people don’t evaluate the expenses incurred in managing their investments within their portfolio. When you understand how investment fees can dramatically reduce your returns, and when you understand how fees are a strong predictor of future returns, investors should spend more time in evaluating their investment fee.
Why costs matter 1
Sure, 0.50% here, 0.25% there, it doesn’t sound like much over the course of a year, but when you compound this number over long periods of time, it could mean the difference between retiring at age 65 instead of 69.
The impact of fees is two fold. Not only do you lose the annual fees you pay each year, you also lose the growth that money may have had for future years into the future.
To illustrate the significance of fees on an investment, I plotted the below chart, which shows 4 portfolios. Each earning 6% pa, and each invested over a 30 year period. Each portfolio has an internal fee of 1%, 2%, 3%, and 4% respectively.
As you can see, over long periods of time, the net result to the investor is significant. And if for one second you think a 4% pa fee on an investment is unrealistic, just think hedge fund.
Why costs matter 2
You’d be forgiven for thinking that the higher the fee, the higher the quality of the manager. This could not be further from the truth. Research on managed investments has shown that higher costing funds generally under perform lower costing funds. The more one charges, the more difficult it becomes to add enough value to overcome the additional expense.
Research by Vanguard illustrates funds with lower costs have outperformed more expensive ones.:
Nobel Laureate William Sharpe once said:
“the smaller a fund’s expense ration (cost), the better the results obtained by it’s stock holders”
The Australian Securities and Investment Commission (ASIC) in 2017 made changes to Regulatory Guide 97 which forced funds to disclose more information about their fees. Now, disclosure documents issued by investment managers should provide greater transparency to investors in order to help them make a more informed decision.
In my personal and professional opinion, your portfolios’ investment fees should not exceed 0.50% pa, in fact, you could probably get it down to as low as 0.30% pa for a properly diversified portfolio.
There’s an old Chinese proverb that says, “If the river is too clean, you will catch no fish.” Meaning, by being too transparent you will not win new business. There are many different kinds of costs when it comes to the world if investments, but they all have one thing in common: If the money is going somewhere else, it’s not going to you.
Like the Vikings, maybe investors should be carrying around their own set of scales.