Understanding Investment Costs: How Fees Impact Your Returns
Fees are incredibly important to consider when choosing a financial advisor, because they have a direct impact on when you will be able to achieve your investment targets. Lower fees will enable you to earn higher returns and reach your financial goals sooner. It’s important that no matter where you end up investing your money, you make sure you know what the annual fees are, as well as what else you may be charged for, because some fees and costs may not be explicitly disclosed.
How fees impact returns
Fee structures are important to understand because the fees paid to your advisor directly impact your returns. And the impact may be larger than you expect.
Let's say you manage to save $1,000 SGD/month for 25 years to build your retirement fund, and you invest it in a unit trust with pre-fees returns of 6% per annum, and 2.0% total management fee per annum. Meanwhile, a colleague of yours also saves $1,000 SGD/month for 25 years for his retirement. He invests in a different product that also has pre-fees returns of 6% per annum, but that only charges 1.0% per annum, compared to your 2.0%.
With the lower fee, after 25 years, your colleague will have $73,000 SGD more than you. This is equivalent to 73 months of savings, or more than 6 years of savings. What’s more is that he’ll be retired, sitting on a beach for a few years before you can even retire.
Traditional management fees
Now, we understand that fees directly impact returns. So let’s break down what's behind a fee, what you should look for when interpretting fees, and how they can add up quickly in traditional investment product structures.
In exchange for a fee, you gain the expertise of the financial advisor or access to certain investment products. Wealth managers will trade stocks, mutual funds, ETFs, and other asset classes. Usually, wealth managers, advisors, banks and insurance companies charge one or a combination of the following fees: fees as a percentage of assets managed, fixed monthly or yearly fees, fixed fee per transaction, or a combination of the above.
Types of fees
- Initial sales charge (also known as “front-end load”): This is paid when you buy a fund, and is typically embedded into the pricing of structured investment products
- Management fee: Funds usually charge a fixed percentage of assets under management that is charged annually
- Trading commissions: Brokers charge a fee relating to processing each transaction
- Withdrawal fee: Portfolio managers often charge a fee any time you want to withdraw funds from your investment account.
- Switching fee: In the case that you want to switch from one fund to another, you often incur a fee that goes to the manager.
Fees add up quickly
If you buy a unit trust from a bank, you will be charged an entry fee of 3% to 5% of assets invested, plus a 0.5% to 2.0% annual management fee (data from Cerulli’s Asian Distribution Dynamics 2015 for “balanced funds”). Assuming you negotiate to pay 3% as your entry fee, you’re charged 1.25% as an annual management fee, and you change funds every 2 years, you will end up paying 1.5% + 1.25% = 2.75% on average every year, in exchange for access to the unit trust.
Pricing for an insurance product can be even more complex. Often, these products involve an annual investment fee that is approximately 1.5%, a fixed monthly fee (e.g., $6 SGD/month), and an admin fee that usually has a higher rate (e.g. 2%) for the first 10 years of the investment and decreases thereafter to a lower rate and a lower value after 10 years (e.g. 0.3%). Often, these plans have bonuses that get paid back to you if your policy is still valid and you’re still contributing after 15, 20, or 25 years. While the math is not easy, the total net cost will usually be in the 2% to 3% annual fee range, assuming you stay invested for the whole period.
Say goodbye to traditional fee structures
Investing just about always comes with a variety of management costs. But not all fee structures are complex or expensive.
StashAway was founded on the value of providing a quality product at a low cost, and transparency. That means that our customers always know exactly what they’re paying for, from the moment they sign up through the time they reach their portfolio target.
Wherever you end up investing your money, make sure you know what the annual fees are, as well as what else you may be charged for.