This article was contributed to us by Endowus.
“The grim irony of investing is that we investors as a group not only don’t get what we pay for, we get precisely what we don’t pay for.”
– John Clifton ‘Jack’ Bogle, Founder of Vanguard, which now manages US$4.5 trillion
The car salesman has finally convinced you to join the Tesla cult. As you take your new Model S out for a spin, you’re asked to pay a 3% fee for the key (upfront fee), and another fee if you decide to sell the car (exit fee). Of course you expect to pay operating costs such as electricity, maintenance, insurance (expense ratio), but then you find out part of those operating costs are actually paid back to this salesman who sold you the car for as long as you own it (trail fee).
No one would buy Teslas if this actually happened. Why do you not hold your unit trust investments to the same standard? Do you know how much and to whom you are paying these fees?
Let’s dive into the trail fee as it does sound rather odd. The trail fee is paid by the fund manager to the distributor on an ongoing basis for as long as you stay in the fund. This probably causes some natural self-interested behaviour on the part of the distributor, who will be incentivised to sell you funds that pay higher ‘trails’ (industry lingo).
Platforms which advertise ‘zero fees’ are too good to be true – they can likely charge ‘zero’ because they are getting paid handsomely (usually ~50% of the expense ratio) by the fund manager on an ongoing basis. This means that if your fund expense ratio is 2%, 1% is going back to the salesman, and you probably did not even know.
Just how big is the impact of an extra 1% paid in fees?
Lets assume you invested $100,000 in 2 funds that had the same 10% annualized return (a very good return) before fees. Fund A charged 2%/annum (paying 50% in trails) and Fund B charged 1%/annum (with no trails). After 30 years, Fund B would have earned you an extra $320,502. That is 321% of returns that you are missing out on.
There are funds that do not pay trails, and we would urge you to find out how to get your hands on them. Vanguard and Dimensional are two fund managers we love as they refuse to pay trails out of principle. By avoiding trails, your expense ratio is paying for fees associated with return generation, the way it should be.
Ask your financial advisor for a full breakdown of your fees. You may uncover that you have been paying handsomely for those coffees and lunches.
A Dictionary of Mutual Fund (Unit Trust) Fees:
1. Upfront/subscription fees: Fees charged upfront by banks/financial advisors/brokers for selling you a fund (typically 2-5% in Singapore)
2. Exit fees: Fees charged by banks/financial advisors/brokers for when you exit a fund position, usually within a given time from investment (typically ~1% in Singapore)
3. Brokerage fees: Fees charged by banks, financial advisors or brokers for executing the transaction of a fund (this can be a set fee like $20 per transaction or a %-based fee, like 0.25% of the transaction size)
4. “Wrap” fees: Annual fee charged by banks/financial advisors/brokers for use of their platform and/or investment advice (typically 0.20-1%)
5. Expense ratios: Annual fee funds charge for fund expenses, including management fees, administrative fees, and operating costs. This is deducted from a fund’s net asset value (NAV), and accrued on a daily basis. (typically 1-2.5% in Singapore, but can range from 0.05-3.5% per annum depending on the fund)
1. Trail fees: Fund managers pay the bank/financial advisor/broker who sold you the fund an annual fee, which comes out of the expense ratio of the fund and is typically around 50% of the expense ratio for funds that do pay trails.
2. Trading costs: A fund’s total expense ratio does not account for trading costs incurred by the fund itself, such as brokerage commissions, bid-ask spreads, and market impact (a large order can move a price disadvantageously). It’s important to choose funds that actively try to minimize these costs through execution and managing turnover.
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