retirement investing low charge portfolio in vehicles like Exchange Traded Funds (ETF’s). I won’t go into the justification for passive versus active in this post today as there is plenty of information out there on the web already. A Google search of ‘passive versus active investing’ or ‘Bogle investing’ would be a good start for those that are interested.
Instead what I am going to talk about today is the fact that in my excitement to snap up this great performing fund I ignored the fees the fund was charging and the potential long term effect that fees can have on your total return. The active fund that I first purchased had annual fees of 1.78%. However that’s not all. In addition whatever money you invested also had 4% removed before it even made it into the fund in the form of a contribution fee. The only piece of luck (yes it was luck not good management) I had was that I bought through a provider that refunded my contribution fee however I still had the 1.78% annual fee to contend with.
It however gets worse. This fund seemed to be performing well and so I bought myself an actively managed leverage share fund. This one had annual fees of 3.22%. Obviously this fee was justified because of the superior skill of the fund manager [sic]. When I came to my senses and sold this fund I achieved $5.30 per unit in 2007. As I write this post to buy into that fund today the unit cost is $1.66. That could have really hurt. As an aside I no longer have any leveraged my investments but that’s for another day.
In comparison to my 1.78% active share fund (which still exists today) I could now buy a passive ETF buying into the same stock market (obviously different share choices and allocations though) for a fee of 0.27%. So how much difference do fees make? Firstly some assumptions:
- I’m going to assume that the passive and active share funds will achieve the same market return. My readings make me happy to make this assumption however once you’ve finished your reading please feel free to disagree. I’m going to assume that the return these share funds return is 8% per annum.
- I’m going to assume that inflation is 3% per annum.
- I‘m going to use passive fees of 0.27% and active fees of 1.78% along with the active fund contribution fee of 4%.
Now I’m going to invest $10,000 and then mix in the miracle of compound interest for a 20 year investment period. The results are shown in my table today. The results are really quite surprising. Firstly you need $18,061 just to have the same buying power as your $10,000 originally had. This is the effect inflation can have on your savings. Your active fund has compounded up to $32,092, which is 78% more than the $18,061 needed to just hold purchasing parity against inflation. In stark contrast though, your passive fund has compounded up to $44,334, which is 145% more. That gives you nearly twice the return once you’ve considered inflation.
That in my opinion is a significant difference and is the reason why I now do everything I can to minimise fees when investing. A final note I also work hard to minimise taxes as well.
As always do your own research.