Even though many publications may you tell you investing is easy, the fact of the matter is that to be a successful investor in the long term is actually tough.
There are a number of different studies out there that show that over the long term the average investor has only managed to achieve an annual return of around 3% significantly below the market average of 9.4%.
The big problem investors face is that it is impossible to predict the market's movements. Therefore, it is essential for you to be able to control what limited factors you can, to give yourself the best chance of achieving above average –Â or even average –Â returns. Unfortunately, the only real factor investors can control is cost, but this is enough.
Indeed, all you need to do is be able to cut 10 to 50 basis points per annum off your cost base to unlock hundreds of thousands of dollars in additional returns over the long term. This applies to both active and passive investors.
Costing example
The best way to illustrate the above is to use an example. Today, investors have a wide variety of choices for low-cost passive funds; there’s also a huge choice for low-cost brokers, so you don’t have to be a passive investor just to keep costs low.
Low-cost investing champion Vanguard recently opened a U.K. brokerage service that charges investors a lowly 0.15% per annum in annual management fees. On top of this, investors have to pay an annual management fee to invest in one of the manager’s funds, which will cost an additional 0.08% for a total cost of 0.23%.
Vanguard’s offering is the lowest cost around, and after comparing it to other higher cost providers, you can see why it’s important to keep costs low when investing.
Let’s compare Vanguard’s 0.23% offer to another broker’s charge of 0.45% per annum with an annual fund management fee of 0.08%. If you start off with $1,000 and add $100 every month, assuming a reasonable return of 6% per annum, with a charge of 0.23% per year your fund would be worth $349,386 after five decades. During this period, you would have paid out $28,616 in fees.
Now let’s use the same numbers for the 0.53% total cost for unnamed broker No. 2. In this scenario, an initial investment of $1,000 and an extra $100 a month at a return of 6% per annum would become $315,521 over five years with $62,526 lost in fees. In other words, over five decades you would have spent $33,865 more on fees than option one.
But this is nothing compared to the amount of money you stand to lose over the long term if you end up paying what is still generally considered to be a fair fee for an actively managed mutual fund of around 1.5% (more and more hedge funds are also adopting this cost structure). Assuming the fund manager you’ve picked manages to achieve a stable annual return of 6% per annum your initial $1,000 investment and monthly $100 top ups, would be worth $228,431 at the end of the 50-year period. The total value of funds lost to fees over this time would be $149,616. If that seems like a lot to you, then you should have no problem moving your accounts to a lower cost provider.
A long road to a million
Another way of looking at it is to consider how long it would take you to reach $1 million. If you managed to achieve an annual return of 10% on your money but paid 1.5% per annum in charges, it would take 51 years with an initial investment of $1,000 and a regular contribution of $100 to hit the magical $1 million mark. Over this period, you’d pay a staggering $753,000 in fees. Lowering the annual fee to 0.23% would give you $1.6 million over the same period, with fees of only $146,000 paid.
I know which outcome I would prefer.
