They say you get what you pay for. You’d be forgiven for thinking this philosophy applies to investing. It’s a schoolboy error – however nothing could be further from the truth.
Over the years, multiple studies have proven that costs depress investment performance over long periods of time.
There are two types of costs, 1) portfolio turnover costs, and 2) ongoing investment management costs
Portfolio Turnover costs
Portfolio turnover is basically how often a portfolio manager buys and sells stocks. When it happens too often, they rack up extra costs for investors. The costs are hidden, rarely disclosed to investors, and they’re crippling to a portfolio’s return.
The table below shows just how much portfolio turnover could be costing you. A global equities fund with a turnover of 100% is costing you 1.70% pa. You now need to make this back, plus more, in order to stay ahead. Not an easy assignment.
Here’s what portfolio turnover looks like (a little old I know), and how it’s increased over time through trading via actively managed funds.
Stock picking organisations “renting” rather than “owning” businesses in the stock market are at a massive disadvantage. The more you trade, the higher your costs. The higher your costs, the lower your return. Capiche?
Let’s move on.
Ongoing Investment Management costs
To set the scene, here’s the average cost of actively managed funds and corresponding index funds and ETFs.
Not only are you behind the eight ball with higher transaction costs, you must contend with higher investment fees (also known as expense ratios).
Vanguard have a great calculator on their website (click here), which shows you how much money has been kept and how much money has been lost over time based on different expense ratios. I’ve run two scenarios:
1) A portfolio with an expense ration of 1.25%, which results in 68.7% of returns captured over 25 years.
2) A portfolio with an expense ratio of 0.50%, which results in 86.3% of returns being captured.
This is hard dollars. Lost.
- Higher costs can significantly depress a portfolio’s growth over long periods.
- Costs create an inevitable gap between what the markets return and what investors actually earn—but keeping expenses down can help to narrow that gap.
- Lower-cost mutual funds have tended to perform better than higher-cost funds over time.
- Indexed investments can be a useful tool for cost control.
Unlike Maserati and Miu Miu, expensive managed investments are not cool, stylish, sexy, or impressive.