Why an extra 1% in fund fees can cost you nearly a third of your long-term returns.
An extra 1%? It doesn’t sound like much, does it? People are often surprised just how big an impact on returns fund fees can have over the long term. The power of compounding, which has an increasing impact on returns the longer you are invested, has an Evil Twin.
We all know the beneficial effects of compounding returns, growing our investments as the annual return is reapplied to a (hopefully) ever-increasing pot of money. The flip side of this is that the effect that ongoing charges or fees have on your returns is also amplified over time, and by the end of a lifetime of careful investment, the scale of the damage can be unexpected.
Low-fee funds, such as ETFs that track major indices, take a relatively small bite out of your returns over the long run. By increasing ongoing costs by just 1%, over 30 years you will end up paying nearly a third of your returns in fees. At 2%, that’s half your returns gone.
Fund fee wealth destruction over 30 years
To put this another way, let’s say we invest £100,000 and manage an 8% annual return. With a 0.15% fee, our investment will be worth just under £1 million after 30 years having paid £41,000 in charges. On the other hand, had we paid a 1.15% ongoing charge over that period, we would have about £730,000 after paying a quarter of a million pounds in fees.
A 2% fee? Say goodbye to £430,000.
Costs are a vital and often underappreciated consideration in investing. The expectation that higher fund fees = higher returns is common, even though history suggests that most active funds underperform their benchmarks, even over relatively short periods. Over the long term, the one or two percent outperformance needed to justify a higher fee is probably a fantasy.
If Group A (active investors) and Group B (do-nothing investors) comprise the total investing universe, and B is destined to achieve average results before costs, so, too, must A. Whichever group has the lower costs will win.
Warren Buffett
Fund fee calculator
Have a look at our ETF investment returns calculator and play around with some scenarios. Consider the impact even tiny increases in charges can have on your retirement goals. Resist the temptation to see fees as an indication of added value – most of the time, it is just not the case.
Conclusion
Are you getting what you pay for? The main reason active fund managers underperform the market is that their fees negate any extra return. When you look at the eye-watering amount of money you will lose to fees over the long term, you need to be sure that there is significant value being added along the way.
The founder of Vanguard, John Bogle, put it best:
In investing, you get what you don’t pay for. Costs matter. So intelligent investors will use low-cost index funds to build a diversified portfolio of stocks and bonds, and they will stay the course. And they won’t be foolish enough to think that they can consistently outsmart the market.
John C. Bogle
