The following article appeared in Nest Egg on 29 November 2018, and discusses the hidden costs of investing.
Investing can be an expensive business. The sad fact is many investors are paying for outperformance and are getting the opposite. Everyone wants a comfortable, padded seat on the gravy train, from brokers and advisors to fund managers and administrators. It all adds up and it is you, the investor, who is paying the price.
Previous data has found in most cases, it is fees rather than performance that makes the biggest difference to your investment balances in later years.
In fact, paying an additional fee of just 1% can mean the difference between being able to afford an annual holiday, a decent car, and the odd bottle of Shiraz in retirement, to just barely scraping by.
Research has found that for an investor with an initial investment of $100,000, paying 1% per year extra in fees would reduce their returns by $361,164 or 25.85% over 30 years. Increase the fee to 2% and the investor would miss out on $629,466 - almost half their potential return of $1.4 million.
The message is simple: fees matter far more than most people think. So, how can investors get a clearer picture of where their hard-earned cash is going?
Here are just some of the fees and costs to look out for.
The cost of financial advice
If you are among the one in five Australians who has a financial adviser, you will either pay a flat fee for a Statement of Advice (SOA) or a percentage of your total portfolio (generally 1- 2%) in fees.
This latter method is usually best avoided, as on a 6% return, you could effectively be giving up a third of your portfolio’s performance every year.
Unless you need a full, holistic financial plan done every year, which most people don’t, you might want to consider some of the lower-cost options available on the market.
Asking your financial adviser to charge a flat fee or using a digital wealth service may be much better for you over the long term.
Platforms can be useful for simplifying the process of tax and reporting, but they also contain a raft of hidden fees that can really impact your investment returns. This includes administration fees of between 0.3 and 0.6%, fees taken on behalf of the adviser, and lucrative fees on cash balances.
While there are now several independently-owned platforms in Australia, many advisers still use the ones owned by the big four banks, which are not only expensive but favour bank- owned products.
Avoiding platform fees can mean taking on more work yourself, for example by using your broking platform to buy, sell, and track shares and exchange traded funds (ETFs).
Product issuer fees
If you invest in any type of fund – whether that is a managed, superannuation or pension fund, or an ETF, you will also be paying fees to the product issuer. For some funds, these can really stack up, incorporating entry and exit fees, transaction costs, switching fees, performance fees, and a management expense ratio (MER).
With product costs coming down across the board, there is no reason to be giving away a
large chunk of your investment returns to product managers.
If you are heading down the passive route, simply look for the ETF with the lowest fee and if you prefer an active fund, ensure it has the performance track record to justify the fees charged.
Admin and other fees
If you operate a Self-Managed Super Fund (SMSF), you will also have to pay accounting, audit, and administration costs, which can add up to around $2,000 per year.
Unfortunately, high administration fees are a necessary evil for SMSF trustees. However, focusing on the first three ways to slash the fees you pay should still help you to reduce the effect of high fees on your portfolio over the long-term.