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Why Low Fees are a Key to Wealth

Photo Credit: NickiMM via Compfight cc

Photo Credit: NickiMM

Investors in Australia have lost about 45% of their returns in management fees over the last 5 years, according to research published last month (check out this article in the Sydney Morning Herald).


How can you lose so much money to fees?

If you get a 5% investment return and pay 2.25% in management fees, you’re losing 45% of your capital growth.

Let’s say you have $100,000 in super and it earned 5% last year, you will have an extra $5,000 in capital. If the fee to manage this investment is 2.25% p.a., you will have paid $2,250 (2.25% of $100,000) in fees for the year = 45%.

Generally, fund managers charge their investment fees as a % of your balance. This way they are paid no matter how well they perform.


Is it better to view management fees as a % of investment return?

I think it is. After all, an investment return is what you’re paying for.

And, calculating your ongoing fees as a % of your return helps you see the huge impact fees can have on your savings if they are not kept low.

Remember, over the stagnant post-GFC period of the research, fees ate nearly 50% of people’s superannuation and savings returns.


Keeping low fees is one of the keys to long term wealth accumulation

Your ability to create wealth is based on 3 factors:

  1. Investment return
  2. Tax
  3. Fees and other costs

You can’t control investment returns, but you can generally control tax and fees.

You might be investing money into superannuation to reduce your tax to 15%, but not consider that fees can cost you 3 times as much.


What are the affect of fees over time?

If you achieve a solid 7% return on your investment, the following table shows the effect various fees will have on the growth of $100,000:

How Fees Affect Savings

Just to make things clear: over the long term, an extra 2% in fees can cost you $100,000’s.

Fees have a huge impact on your wealth. You should make sure your investment management fees stay under 1% p.a. at a minimum – with a little effort, most people should be able to get their investment fees to around 0.5%.

And it doesn’t matter if you are investing for short periods of time. Over your entire life and over each investment, these fees add up to big amounts.


What can you do?

Firstly, get your managed investment or super statement and check the overall management fee you are paying. It will probably be written as something like “Total Management Fees”. Make sure you total all the fees you pay and compare that with the total balance and your investment return for that period.

If you are paying over 1% p.a., here are a few ideas for cheaper investments:

  1. Check if you have a balance large enough to access wholesale versions of managed funds
  2. Use index funds which have been outperforming the more actively managed funds that can cost 3 times as much.
  3. Check if you have access to a good industry fund
  4. Listed Investment Companies can provide an investment spread across a number of stocks, but with management fees below 0.15%


The cost of delaying

Because of the exponential nature of compounding, any delays now cost you considerably down the track. If you wait only 1 year to reduce your fees on a $100,000 investment from 1.5 to 0.5%, you will have $3,310 less in 20 years.


A Rule of thumb

Generally, you should not have to pay more than 1% p.a. in investment management costs.

Most people can easily get their fees down between 0.5 – 1.0% p.a.

Look up your statement and check what you are paying. And make sure you do not pay more than 1% in investment and super fees from 2014 onwards.

Better yet, get your overall fees to around 0.5%.

Call me if you want help working out if you’re paying too much.

 

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Posted by: Justin Brand
I'm an independent financial advisor and blogger doing my best to make financial services less complex, dull and intimidating.
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