When it comes to investing, there are many jargons, concepts and financial instruments we need to understand. This can be quite challenging, especially when much of our day is taken up doing our day jobs, spending time with family, maintaining a social life, and, of course, sleeping.
For this reason, many of us may neglect investing or choose to invest our money with a professional manager. Parking our money with a professional fund manager means we have to pay for their services, and they don’t come cheap.
We’re not trying to argue that these fees are hidden in any way. In fact, we recognise that many of these fees are told to investors or stated quite explicitly in factsheets for most funds. Rather, the problem we want to highlight is that while these fees may look low, many of us don’t realise just how much it’s eating into our retirement nest eggs over decades.
Common Types Of Fees
Firstly, we list the most common types of fees that investors have to bear when investing into funds, including exchange traded funds (ETFs) and unit trusts, and even when we invest through robo-advisory firms.
Exchange traded Funds (ETFs)
ETFs are listed passive funds that track an index for basket of assets, including stocks, bonds, commodities and even indexes.
There are two types of costs mainly associated with investing in an ETF – trading fees (buying and selling) and management fees. Investing through ETFs usually cost us less in management fees as they mainly track an underlying index. We also incur low trading fees as they can be bought and sold like common stocks.
Unit Trusts And Mutual Funds
Unit trusts and mutual funds are typically actively managed funds that invest into stocks, bonds, commodities and other types of financial instruments.
Similar to ETFs, there are also two main types of costs commonly associated with investing in unit trusts and mutual funds. Being actively managed by a team of professional fund managers, unit trusts and mutual funds usually charge higher management fees than ETFs.
It is also sold by banks and fund houses via Over The Counter (OTC) markets, which tend to mean a higher cost to buy and sell.
Investing our money via robo-advisory firms is a relatively new way for retail investors to grow our wealth. As its name suggests, these firms tend to utilise automation and algorithms to invest and manage investors’ funds.
As robo-advisory requires less human intervention and typically invests into index-linked funds, they tend to charge lower fees, usually in the form of a management fee or platform fee, when we invest with them.
|Investment Vehicles||Types Of Fees||Approximate Fees|
|Management Fees||0.5% p.a.|
|Unit trusts/ Mutual Funds||Sales charge||4.0%|
|Management Fees||2.0% p.a.|
|Robo-advisory||Management Fees||1.0% p.a.|
These charges are just estimates of what you may typically experience when investing via these methods. Of course, there may also be other types of fees charged by these investments or they may charge more or less. Putting our hard-earned money with them, we have to scrutinise the fine prints and get as much information as we can to understand what we’re investing in and how much we’re being charged at the end of the day.
How These Fees Eat Into Our Retirement Nest Egg
Being told and acknowledging the different types of fees that we incur is just one part of the equation. While these fees may seem innocuous on paper at just a few percent, they may have long-lasting implications on our retirement nest egg over the course of the next three to four decades we have to grow it.
Below, we highlight three ways many of us don’t realise how our returns are being chipped away.
# 1 Compounded Cost Of Front-Loaded Fees
Front-loaded fees mean any charges that we incur near the time we initially invest. This is typically the sales charge or commission fees that we have to pay at the point of investment.
The problem with front loaded fees is that it is charged upfront. When we allow our investments to compound, early cash flows are the most important factor when it comes to compounding our wealth.
Paying close to 2.0% (or in some cases as high as 5.0%) in an upfront charge means we cut out a substantial proportion of our wealth in the early days and deny it the chance to compound over several decades. This 2.0% of our wealth could have grown into a considerable sum over 30 years.
# 2 Compounded Cost Of Management Fees
Management fees are typically an ongoing cost for our investments. As long as we are invested in the investments highlighted above, we will incur a management fee whether we make or lose money.
Over the years, this 0.5% to 2.0% siphoned off our portfolio every year would have been able to grow into a tidy sum.
# 3 Management Fees Will Grow Over
Apart from the compounded cost of management fees that we have to deal with, we also have to understand that the management fee we incur today will only grow over time. Here’s why:
Image we invest $50,000 today. The amount we pay for management fees will come up to $1,000 a year at a rate of 2.0% p.a. Let’s assume our investments grow to about $249,200, based on an approximate return of 5.5% p.a (after fees) in 30 years’ time. The management fees we would be paying then would be close to $4,984.
This is because even though the rate is the same (at 2.0%), as our portfolio grows in value, the management fees we incur also grows.
What Is The Long-Term Impact Of These Fees On Our Retirement Nest Egg?
For simplicity in this calculation, we’ll be using the returns of the Straits Times Index (STI) ETF as a benchmark for what retail investors can hope to achieve in the long term. Since 2002, the STI ETF has delivered a return of 7.5% p.a.
To depict how fees affect our investment portfolio value, we calculate how much a $50,000 investment today will look like in 30 years with the various types of fees.
|Investment||Gross Returns p.a.||Sales Charge||Management Fee||Redemption Charge||Value Of Your Investments||Amount Lost To Fees|
|Replicating STI ETF Returns (In A Perfect World)|
|Replicating STI ETF Returns On Your Own|
|Investing In STI ETF|
|Investing Via Robo-advisory|
|Investing In Unit Trusts And Mutual Funds|
We depict what the “perfect world” for investors would look like in the first scenario – where there aren’t any fees for investing and we receive the full $437,700 our portfolios would have grown into. Of course, this is an impossible situation.
A more realistic scenario, even for the savviest retail investors, would be to incur the 0.3% sales charge at the point of investment and another 0.3% redemption charge at the point we exit the investment, from using a local broker to carry out their transactions. In this situation, we assume that retail investors are able to replicate the returns of the STI ETF without having to buy the actual STI ETF. If we are able to achieve this, we’d only be losing the buying and selling fees which would amount to $2,600 compared to the “perfect world”.
In the third scenario, we explore the returns we would have utilising robo-advisory to aid us in receiving the returns the STI ETF was able to garner. This way, we leverage on modern tools such as automation and technology to reduce costs and potentially spotting better investments.
Most robo-advisors do not charge any sales charge (for now) and levy a minor management fee (for now). If they do not alter their business models for the next 30 years (we’re not sure how likely this is), we would have $323,800. For this, we’d lose close to $113,900 for the convenience of “not having to worry about our own portfolio” over the span of 30 years. This is more than double the amount of our initial investment.
In the last scenario, we explore investments made via unit trusts and mutual funds. We can clearly see the impacts higher sales and redemption fees, coupled with higher management fees, will have on our investment portfolio.
Going down this route would only make sense if the unit trusts and mutual funds are able to beat the STI returns over the long-term. Many studies have shown that professional fund managers do not regularly beat the market returns. So, to warrant an investment in such instruments, we need to ensure we know what you’re getting into and trust that the investments will beat the market returns.
One interesting point to note is that we would much rather pay a higher sales and redemption charge of 4.0% and incur a fund management fee of 1.0% compared to a low sales and redemption charge of even 0.3% and incur a 2.0% management fee. Of course, this is because fund management fees are charged yearly, while sales and redemption charges are one-off.
One thing that is guaranteed is that you will incur the fees and charges that’s already on paper, but returns are never guaranteed. They’re always based on long-term projections.
Learn More About Investing
If you’re interested to learn more about investing, you can join the Singapore Investment Week 2018. This investor education initiative is organised by the Securities Investors Association (Singapore) and will be held from 19 to 26 May. Click on the banner below for more information.