Happy anniversary day to my fellow Wellingtonians.
Investment fees are a big deal.
You may be keen to go with an active investment provider aiming to beat the market index. You could be thinking “so what if they charge 2%? I’d be charged 0.5% if I went with a passive index investment provider. 1.5% difference in fees is nothing.”
I know because that is how I used to think. I thought 1.5% more in fees out of a return of 100% is nothing to worry about.
But the problem with that thinking is that fees aren’t charged as a percentage of your returns. They are charged as a percentage of your total portfolio balance.
Let’s show with an example:
Let’s say you and a friend each have $50,000 invested in KiwiSaver, your total contributions are $5,000 per year (increasing by $200 a year), and your returns are 6% per year for simplicity sake. You are in an active fund that charges 2% and your friend a passively managed index fund charging 0.5%. We will assume no annual administration fees in this example to keep things simple.
If both funds return the same before fees, after 30 years your friend will have over $210,000 more than you.
But, I can hear you argue, active fund managers will beat the market index. First of all, how do you know that over a 30 year period in the future? Let’s say your 2% active fund does return a whole 1% more per annum over 30 years. How is it looking then?
You are still $90,000 worse off than your friend in this example.
You would need returns of 7.7% to match your friends returns. A whole 1.7% better than the index. That is a substantial outperformance and a lot of faith in the active fund provider.
We are talking up to $200,000 differences and higher here on a 1.5% difference in fees using these numbers and timeframes.
This is because not only are you paying fees on your current balance, but those extra fees cut into the amount of future compound interest you will receive. Unless your active fund can outperform by more than the fee difference.
Percentages are dangerous things. As I said 1.5% doesn’t sound like much, but when you start expressing the differences in dollar terms, you start to realise the impact of your investment decisions.
You can control the fees you are paying. You can’t predict a companies outperformance by such a large margin.
If you need an investment plan or recommendations , then get in touch today.
The information contained on this site is the opinion of the individual author(s) based on their personal opinions, observation, research, and years of experience. The information offered by this website is general education only and is not meant to be taken as individualised financial advice, legal advice, tax advice, or any other kind of advice. You can read more of my disclaimer here