It's only 1%
How much of a difference does 1% actually make? What does it do to your investments over time? Katie and I have heard for years that fees are important and that they impact your investments but we really wanted to understand for ourselves (and you) how much of a difference it makes.
We found the old paperwork from one of Katie's first investments when we cleared out our apartment and it inspired us to find out what difference the fees made. The first investment Katie made was with a flashy London investment firm that had high fees. We later changed to a low cost investment, a Vanguard Index Fund. We were SHOCKED at the difference that it made. You can read the whole article here: Impact of fees.
Whilst we were running Rebel Finance School this year we spent a LOT of time talking about fees and Katie got excited! I lost her for two days as she went off and created the tool below. This tool allows you to isolate the impact of fees on your investments. It uses a base index (S&P500) over 30 years and then takes the fees you enter and works out the impact compared to a low cost Vanguard Index fund.
Have a play and then read on afterwards for a bit more about fees, their importance and impact.
Remember this is NOT investment advice, this tool is for educational purposes. Please read our disclaimer
We found the old paperwork from one of Katie's first investments when we cleared out our apartment and it inspired us to find out what difference the fees made. The first investment Katie made was with a flashy London investment firm that had high fees. We later changed to a low cost investment, a Vanguard Index Fund. We were SHOCKED at the difference that it made. You can read the whole article here: Impact of fees.
Whilst we were running Rebel Finance School this year we spent a LOT of time talking about fees and Katie got excited! I lost her for two days as she went off and created the tool below. This tool allows you to isolate the impact of fees on your investments. It uses a base index (S&P500) over 30 years and then takes the fees you enter and works out the impact compared to a low cost Vanguard Index fund.
Have a play and then read on afterwards for a bit more about fees, their importance and impact.
Remember this is NOT investment advice, this tool is for educational purposes. Please read our disclaimer
How to use the tool
The tool compares two funds. Fund 1 is on the left in orange and you can use it to input your existing fees or the fees of an investment you are looking at. Fund 2 is on the right in yellow and the default is set as the fees for the Vanguard FTSE Global All Cap fund which is a fund availabel to investors in the UK.
You can change either or both and compare two different funds and the impact of the fees. You make the alterations in the numbers at the top of the tool and then Katie's amazing whizz bang spreadsheet whirs in the back ground and spits out the results.
This is all expressed in pounds because we're British and most of the people we are helping are British. If £ is not your currency the answers will be the same. Just pretend it says Rupees or dollars or Euros or pesos or whatever your currency is.
What you can change:
If you want a real life example and you don't have one to play with you can use the investment Katie originally had with an active fund manager which was fund name Sterling, initial fee 3%, OCF 1.61%, annual platform fee 0.60% (no cap) and no exit fee.
You can change either or both and compare two different funds and the impact of the fees. You make the alterations in the numbers at the top of the tool and then Katie's amazing whizz bang spreadsheet whirs in the back ground and spits out the results.
This is all expressed in pounds because we're British and most of the people we are helping are British. If £ is not your currency the answers will be the same. Just pretend it says Rupees or dollars or Euros or pesos or whatever your currency is.
What you can change:
- Initial investment - use this to put in an initial lump sum you might invest or the current amount you already have invested
- Monthly Investment - use this to show how much you will be contributing to your investments a month. Most people invest monthly so that is why the tool is set up this way. If you invest in a lump sum each year then just take this, divide by 12 and put this as the monthly number.
- Fund name - put the name of the fund or financial advisor or some other way of identifying what you're comparing.
- Initial fee - this is the amount the investment advisor or fund manager will charge you as a starting fee on your investments. We have been shocked and have seen this as high as 7% on some investments. There are two boxes to fill in. Firstly you put the amount of the initial fee, then you need to tell the tool if it's a percentage or monetary amount (it's usually a percentage). So for example, if your financial adviser is going to take 1.5% of everything you invest, put 1.5 in the first box and make sure the second box is marked as "%". If you invest directly with the Vanguard platform there is no initial fee so this is 0.
- Ongoing charges fee (OCF) - this is the % fee that you are charged for the running of the fund. You might have to look this up on your paperwork but each fund will have a different fee. For the Vanguard FTSE Global All Cap fund in the UK this is 0.23%.
- Annual platform fee - this is the cost the provider charges you for having the account. The platform is the app or website you go to when you invest. This can be stated as a percentage of how much you have invested or as a monetary amount. There are two boxes to fill in. The first one is the amount of the fee and the second box is where you tell the tool if it's a percentage or £ amount. The UK Vanguard platform charge 0.15% per year so you would put 0.15 in the first box and % in the second box.
- Is the annual platform fee capped? - sometimes when the platform fee is a percentage the platform puts a cap on how much you will pay as a monetary amount. E.g. the UK Vanguard platform caps the fee at £375 per year so you would select "Yes" and put the cap as £375.
- Exit fee - this is the amount the investment advisor or fund manager will charge you when you sell your investment or if you want to switch to a different provider. This is also commonly called a "surrender charge". Again this can be expressed as a percentage or a monetary amount e.g. £100 per fund. Again there are two boxes to fill in. The first one is the amount of the fee and the second box is where you tell the tool is it's a percentage or £ amount. E.g. if the exit fee is 1% put 1 in the first box and make sure the second box says %.
If you want a real life example and you don't have one to play with you can use the investment Katie originally had with an active fund manager which was fund name Sterling, initial fee 3%, OCF 1.61%, annual platform fee 0.60% (no cap) and no exit fee.
The difference
Can you really judge a fund by fees alone?? Are fees really the one thing that makes the biggest difference when investing? We harp on about fees on Rebel Finance School and the effect they have and you can see from the tool above that 1% can crucify your long term returns. Whilst the tool only shows the impact of fees there are two things at play here:
The tool above only shows fees but this is only one part of the picture. For Katie's first flashy advisor not only did we pay more in fees but we got worse performance.
The dream these people (I have other names for them) sell you is that you are paying more for better results. If you have to pay 1% in fees but their funds outperform everyone else by 2% then it doesn't matter does it? That is the dream, pay more for the Rolls Royce of funds and advisors and they will make you FAR in excess of what they charge you.
Unfortunately that dream that they sell you is a huge pile of bullshit. It is not only untrue it is the opposite. What do I mean by that?
Well I got geeky this year after reading "Trillions a history of index investing" and dug into some annual reports and studies published on index investing. What I found out shocked me and strengthened my belief that active fund managers should be put out of business as they are ripping people off with a dream that can not be realised.
In one study I read (Shopping for alpha: You get what you don't pay for) they looked at different factors of a fund to see if there was a way you could predict which fund would be successful. An analogy of this would be seeing if you could predict which sports team would be more likely to be successful based on a range of factors like average body weight, average age, finances etc. The factors this study looked at for this were:
They did a huge study of different funds and the factors and then compared that to how successful they had been creating returns. They then checked to see if any of the above factors were predictors of good returns. For example, if the fund was very diversified, did this automatically mean it had a higher chance of creating good returns? Here is what they said:
"Of the metrics (factors) shown in Figure 1 (the list I put above), the ex-ante expense ratio separated poorly performing funds from better performing funds more successfully than all other metrics we analyzed."
What this means is that the cheaper the fund the better it performed on average and JUST by looking at expense ratios, they were successful at predicting how well a fund performed! They then moved on to say:
"We found no meaningful predictive ability to be gained by combining metrics with the expense ratio. The expense ratio remained the most powerful (and, indeed, the only statistically significant) predictor of relative performance."
This means that it didn't matter if you looked at past Alpha and fund concentration OR Turnover and Fund Size -- it always came back to expense ratios. How much it costs to invest in the fund!
You might be thinking "yes but Alan, don't you get what you pay for???"
Turns out investing the EXACT OPPOSITE is true. You get what you don't pay for. The less you pay in expense ratios the more likely you are to get better results or performance in your fund. Here is how they put it in the study:
"On average, lower-cost funds tend to produce better future results than higher-cost funds (Wallick, Wimmer, and Martielli, 2013; Philips et al., 2014)"
I know! CRAZY right?
The less you spend, the more you make. Investing is probably only one of the places this is true. The reason for this is that lower fees probably means passive investments and higher fees probably means active investments, and historically passive investments have outperformed active in nearly all instances.
If you want one predictor of good returns it is fees -- the LOWER THE BETTER. Not only do fees affect you because they are charging you more but also because with higher fees normally comes worse returns as well. You get screwed twice by fees.
You may have seen a recent open letter I wrote to Wealthify which was entitled Wealthify or Poorify. Wealthify have high fees and poor performance. They promise the dream of investing with us will create better returns, but they have FAILED to do this over the long term.
If you want to have a read of the overview from Vanguard, you can see if here and then dig down further if you want to. The impact of investment costs | Vanguard
- Fees - the cost of the fund which ranges from 0.04% for some of the American Vanguard funds all the way up to 7% for some of the expensive flashy advisors!
- Performance - this means how well your fund does over the long term. Does it return well? Do the stocks and shares go up in value and do they return dividends?
The tool above only shows fees but this is only one part of the picture. For Katie's first flashy advisor not only did we pay more in fees but we got worse performance.
The dream these people (I have other names for them) sell you is that you are paying more for better results. If you have to pay 1% in fees but their funds outperform everyone else by 2% then it doesn't matter does it? That is the dream, pay more for the Rolls Royce of funds and advisors and they will make you FAR in excess of what they charge you.
Unfortunately that dream that they sell you is a huge pile of bullshit. It is not only untrue it is the opposite. What do I mean by that?
Well I got geeky this year after reading "Trillions a history of index investing" and dug into some annual reports and studies published on index investing. What I found out shocked me and strengthened my belief that active fund managers should be put out of business as they are ripping people off with a dream that can not be realised.
In one study I read (Shopping for alpha: You get what you don't pay for) they looked at different factors of a fund to see if there was a way you could predict which fund would be successful. An analogy of this would be seeing if you could predict which sports team would be more likely to be successful based on a range of factors like average body weight, average age, finances etc. The factors this study looked at for this were:
- Expense Ratio (cost) - this is the cost of the fund, how much you are charged for having it.
- Fund Concentration - this is how diversified the fund is which can be seen by number of stocks included in the fund. The FTSE Global All Cap fund has 7000+ stocks included within it and is not very concentrated
- Turnover - is a measure of how quickly the stocks and shares in the fund are bought and sold. How quickly do the fund managers turnover (buy and sell) the investments.
- Fund Size - this is the overall fund size, how many people have invested how much in the fund
- Past Alpha - Alpha is a measure of performance. i.e. how much did the fund gain in profit from dividends and growth. Alpha is quite often used to mean excess return above the market average. Did that particular fund deliver Alpha; more profit than average.
They did a huge study of different funds and the factors and then compared that to how successful they had been creating returns. They then checked to see if any of the above factors were predictors of good returns. For example, if the fund was very diversified, did this automatically mean it had a higher chance of creating good returns? Here is what they said:
"Of the metrics (factors) shown in Figure 1 (the list I put above), the ex-ante expense ratio separated poorly performing funds from better performing funds more successfully than all other metrics we analyzed."
What this means is that the cheaper the fund the better it performed on average and JUST by looking at expense ratios, they were successful at predicting how well a fund performed! They then moved on to say:
"We found no meaningful predictive ability to be gained by combining metrics with the expense ratio. The expense ratio remained the most powerful (and, indeed, the only statistically significant) predictor of relative performance."
This means that it didn't matter if you looked at past Alpha and fund concentration OR Turnover and Fund Size -- it always came back to expense ratios. How much it costs to invest in the fund!
You might be thinking "yes but Alan, don't you get what you pay for???"
Turns out investing the EXACT OPPOSITE is true. You get what you don't pay for. The less you pay in expense ratios the more likely you are to get better results or performance in your fund. Here is how they put it in the study:
"On average, lower-cost funds tend to produce better future results than higher-cost funds (Wallick, Wimmer, and Martielli, 2013; Philips et al., 2014)"
I know! CRAZY right?
The less you spend, the more you make. Investing is probably only one of the places this is true. The reason for this is that lower fees probably means passive investments and higher fees probably means active investments, and historically passive investments have outperformed active in nearly all instances.
If you want one predictor of good returns it is fees -- the LOWER THE BETTER. Not only do fees affect you because they are charging you more but also because with higher fees normally comes worse returns as well. You get screwed twice by fees.
You may have seen a recent open letter I wrote to Wealthify which was entitled Wealthify or Poorify. Wealthify have high fees and poor performance. They promise the dream of investing with us will create better returns, but they have FAILED to do this over the long term.
If you want to have a read of the overview from Vanguard, you can see if here and then dig down further if you want to. The impact of investment costs | Vanguard
Judging a fund by fees alone
There is a lot that you have no control over with investments. You can't control whether Russia invades someone, if there is a pandemic or a recession. Fortunately, the fees you pay to invest is one of the things you absolutely can control.
The single act of minimising fees can be the most important thing you can do in your investing career.
If you are in the UK or USA, this is pretty simple for you. Invest directly through Vanguard and you will be minimising fees massively. Investing in Vanguard funds around the world can still be achieved, but you might just have to go through another platform to get there.
After reading this and looking at the impact of fees, here is your homework. In every investment account you have (pension, ISA, 401k, ROTH and more) you need to find out the following things:
The more you know about your investments, the better you can take control and build the financial future of your dreams. Take back control, reduce your fees and don't leave your financial fate in the hands of people that make money out of you and don't care about your outcome.
THANK YOU for reading. For more on investing you can go to the overview page here: Investing with the Donegans
Below are all the assumptions Katie has made creating the tool so you can understand the tool and it's limitations
The single act of minimising fees can be the most important thing you can do in your investing career.
If you are in the UK or USA, this is pretty simple for you. Invest directly through Vanguard and you will be minimising fees massively. Investing in Vanguard funds around the world can still be achieved, but you might just have to go through another platform to get there.
After reading this and looking at the impact of fees, here is your homework. In every investment account you have (pension, ISA, 401k, ROTH and more) you need to find out the following things:
- What are your existing investments?
- What are the underlying funds they are invested in?
- What are the fees (platform, ongoing charges fee (OCF), entry and exit and other advisor fees)?
- What employer pension do you have and do they match contributions? Is it defined benefit or defined contribution?
The more you know about your investments, the better you can take control and build the financial future of your dreams. Take back control, reduce your fees and don't leave your financial fate in the hands of people that make money out of you and don't care about your outcome.
THANK YOU for reading. For more on investing you can go to the overview page here: Investing with the Donegans
Below are all the assumptions Katie has made creating the tool so you can understand the tool and it's limitations
Assumptions
The first thing to understand about the above tool is that it is designed to show you the impact of fees on an investment. That is all it is meant to do. It will not show you the difference in performance between funds, it will not show you the impact of taxes or other factors. It is purposefully designed to show you the impact of fees so you can understand this one element. We will be creating other tools that will break down other elements and eventually working towards creating our own retirement calculator but for now this tool will help you compare fees between providers.
Here are the underlying assumptions:
Here are the underlying assumptions:
- The return and performance is based on the performance of the S&P 500 over the 30 years from 1st June 1992 to 1st June 2022. This is a USA index so is not a global index however it is hard to find data going back for 30 years (most funds are much younger than that) and the USA is such a dominant part of the world economy that this is a good replacement for the whole world.
- Past Performance. This tool is based on PAST performance and what WOULD have happened if you had invested in the 30 years prior to June 2022. It is NOT a guarantee of future performance.
- Tax. This tool does not allow for tax and assumes that you get to keep all the growth in your fund! Unfortunately in practice this probably isn't true although there are tax efficient ways to invest in most countries (in the UK this is through your pension, SIPP and/or ISA)
What do you think?
We would love to know what you think of the tool and any comments you have on what we've created here. Please let us know what you think
