Do you know how much of your money was lost on investment charges, costs and fees last year? Even worse, how much has been lost since you first invested? If you could go back and uncover the truth, would you be surprised at what you found?
The investment industry is huge and complex. Charges and costs are many and varied, difficult to spot, and mind-blowingly challenging to calculate. Most investors don’t even try to uncover the truth. Many who do eventually give up.
The investment industry machine rolls on, getting bigger and bigger all the time, hoovering up money in the form of charges and costs at an astonishing rate.
The Investment Association is the trade body that represents UK investment managers. Their 200 members collectively manage over £7.7 trillion on behalf of clients in the UK and around the world. That’s an awful lot of your money.
Who are the investment managers? Here’s just a few of them as a reminder:
- Aberdeen Standard
- Barclays Wealth
- Brewin Dolphin
- Close Brothers
If you want the entire list you can find it here. (Please be aware that by clicking on this link you are leaving Capital’s website.)
This blog has been written to clarify all the confusion and complexity you may be facing around investment charges.
Let’s start with a simple explanation of why costs matter to you.
The marathon runners
A marathon course is 26.2 miles. This works as an analogy because most people save in 30-year periods, commonly from about 30 to 60 years old. Simply link marathon miles to years of investing.
The London marathon has 40,000 runners of all abilities and ages. Imagine that each runner is a different investment fund. Your task is to select a runner/fund who will get you the best return for your money.
Two of the best marathon runners are highly successful twins and winners of Olympic medals. Both are fit and healthy and if all goes well, they should complete the course neck-and-neck.
The same course. The same day. The same fitness. The same weather. The same identical running trainers, shorts and vest.
The starting pistol fires and off go the 40,000 runners. All goes well for the twins over the first mile. They are in first and second place. At the first water station, one twin grabs a water bottle, but the other twin gets a backpack with a brick in it. The average brick weighs about five pounds, give or take.
The same thing happens at each mile marker. Twin two starts to fall back into the pack of runners. After 26 miles twin two is staggering to the finish post, weighed down by almost their own weight in bricks. Twin one finished a long time ago.
The race was unfair. Twin two simply couldn’t compete well with the ever-increasing load on their back. Exhaustion set in and their pace slowed right down.
You get the point. Twin two carried higher charges and costs over their ‘investment’ marathon. At the end of the race, twin two had much less money than twin one. And yet the course was identical. Twin two didn’t come in last. There were even worse ‘investments’ well behind.
Each twin started with the same identical ‘investment’ and yet twin one did far better simply because the drag effect of charges, fees and costs (bricks) was much lighter.
Every marathon runner was doing their very best over the 26.2 miles, but not every runner was of equal merit. Some were running in super-hero outfits; that didn’t end well.
You can imagine this marathon race and see it in your mind’s eye. You get it. It’s obvious that twin two had no chance. But you now have the power of hindsight and know the results, 26 miles (years) on. It’s far too late to do anything about it, or to pick a different runner.
Reading this blog is going to equip you to evaluate the ‘drag’ of YOUR charges and costs before your race is run.
|“In investing, you get what you don’t pay for” Jack Bogle|
In almost all walks of life paying for quality and expertise usually pays dividends. Those skills are worth the extra cost (relative to the peer group). Investing is a notable exception. When you pay more of your money to get better results, it usually ends in failure.
What does the evidence tell us?
Albion Strategic Consulting did a recent study on this very topic. The period covered is 30 years and there are two runners in the race (the twins).
For the perfect runner/fund with a starting value of £100,000, the marathon course with no drawbacks or penalties, will result in a first-place finish value of £242,746 (with inflation accounted for, plus an annual return of 3%, but before fees and charges (the bricks).
Twin one has an annual cost drag of 0.25% and twin two has an annual cost drag of 1.00%. Tiny numbers.
Once the race is run, after 30 years twin one produced £225,660 and was a worthy winner.
Twin two came in huffing and puffing after 30 years with £181,136.
Can you see the problem based on the drag effect of small numbers over a long time? Big numbers. A massive £44,524 cost gap. Here’s the chart:
That’s almost 25% more for twin one than twin two, the only difference being the costs. You may decide to pay more in fees and charges to try and get better long-term returns, but that’s a gamble because you must wait for 30 years. A simpler method for the here and now is to reduce costs.
Take Morningstar as a guide (they are an independent fund data and research firm). Morningstar have been analysing and researching the effect of costs on returns for years. This is their own conclusion:
|If there is anything in the whole world of mutual funds that you can take to the bank, it’s that expense ratios help you make a better decision. In every single time period and data point tested, low-cost funds beat high-cost funds.|
There are other studies from Morningstar, Vanguard and Dimensional Fund Advisors which reach the same conclusion. There is a direct and negative relationship between costs and performance that holds true over most time periods and asset classes. According to Albion Strategic Consulting:
|Based on a simple statistical test, one can be 99% certain that a negative relationship between costs and performance exists.|
This is where MiFID II disclosure notices come in
If you are a UK retail investor and you aren’t yet familiar with MiFID II regulations, then 2019 will be your year of enlightenment.
To quote the FCA (Financial Conduct Authority):
Advisers need to disclose all costs and charges that relate to their retail recommendations. Indications of expected costs and charges need to be provided pre-sale, and details of the actual costs and charges need to be provided post-sale, where applicable on at least an annual basis. These need to be aggregated and expressed both as a cash amount and as a percentage.
In broad terms, therefore, the following must be disclosed: all one-off and ongoing charges, and transaction costs, associated with the financial instrument; all one-off and ongoing charges, and transaction costs, associated with the investment service; all third-party payments received, and the total combined costs of these three categories. These disclosures must also be accompanied by an illustration that shows the cumulative effect of the overall costs and charges on the return.
This sounds like great news for investors, because you get to see just how much has come out of your pot in charges and costs for the previous year. You can then consider the sum and compare it to value for money.
The MiFID disclosure also shows the long-term effect of the charges on your investment. This is all new so investors may need time to become familiar with the information and what it means.
Unfortunately, not every disclosure from every firm will look the same but this will improve over time.
Early indications are that the financial charges disclosure will have a profound impact. Many investors have no real idea of just how much money is being lost in charges. Cages will be rattled.
The facts, evidence and research point in the same direction. Given a choice of two similar investment options, the one with lower costs should deliver the best outcome for you.
The MiFID disclosure statement may cause a tremor in the world of wealth management. Investors may be shocked and surprised at what they read. These same investors may seek out a lower-cost alternative. The power may be shifting from huge institutions to the individual. You will be able to make an informed choice.
If you receive a cost disclosure and want a second opinion from an impartial source, contact Capital today and one of our Chartered Financial Planners will be pleased to explain your options.
At Capital we believe in total transparency and openness at all times.
Please note that Capital is not responsible for the accuracy of the information contained within the linked site(s) accessible from this page.