Achieving your financial goals depends absolutely on getting the best possible investment performance for your risk-profile, while paying the lowest possible costs.
You have to understand benchmarking to know what good performance looks like. Unpicking the impact of fees and charges is the other, equally important, half of the equation.
It is very easy to think, “What’s half a percentage point here and there?” Well actually, the difference can be pretty stunning. Small improvements to performance compound powerfully; the fee drag on performance works in exactly the same way.
Let’s imagine two individuals found wealth managers able to grow an investment of £500,000 at 5% a year gross (quite a reasonable expectation, by the way). Investor A goes with a firm charging 2.5% in fees, but Investor B looks around and finds a similar service but at 2.0%. At the end of the 20 years, Investor A will end up with £1,034,059, while Investor B will have £1,138,477.
Almost £100,000 extra for trimming just 0.5% from fees? It’s a no-brainer.
Looking at performance the right way
Investors must look at performance in the right way, by which I mean net of all fees and charges. Headline performance can very often look good, but then be eaten away by excessive costs. Many people have also fallen prey to the notion that you have to pay extra to get good performance. You really don’t.
When I advise investors to get really granular about all the fees and charges that could apply to their investment accounts, the reasons are two-fold. Firstly, they need to see where fees might be trimmed. This might be in different areas, and firms may have more discretion to discount than you might think – particularly if you are investing significant amounts. Secondly, wealth managers might apply fees in slightly different ways and you need to be able to make side-by-side comparisons. This is what our easy comparison tools are all about.
You should not take from this that wealth managers are being sneaky in how they charge their clients (or at least the reputable ones aren’t). What this actually reflects is that providing investment management services involves many moving parts. They are complex by necessity.
But, given the differences at stake, it is absolutely essential that you dive in. Moreover, it is incumbent on your provider to help you understand. Insist on transparency in all documentation (or better yet, use ARQ to see the difference at the touch of a button).
Breaking down fees
First up is the annual management fee charged for running your portfolio. Typically, this might be 1-1.5%, charged as a proportion of the total money being run (known as “ad valorem”). Though quoted annually, these might be charged quarterly on a specific date, or as an average of the portfolio’s value over a period.
The management fee covers the expertise and infrastructure of the institution, but may not be all-in since running a portfolio incurs a number of other costs that may be charged for separately.
First, to the admin. To make buying and selling securities easier, investment managers will typically hold them for clients in “nominee accounts” (where the firm nominally owns them but the client remains the ultimate owner). They may be small, but ensure the costs of this arrangement are reasonable compared to other firms.
Second, know that management fees may be quoted exclusive of the relevant taxes and transaction fees on trades. These can add up, particularly if portfolios are “churned” more often than is strictly necessary. Brokerage fees may also apply when assets are illiquid and trade on less usual exchanges, while foreign exchange fees will come into play for international assets.
Underlying manager fees are a big one. To optimise diversification and returns, you may want to invest in third-party funds (as opposed to just direct investments), so then there will be fund manager fees, and these can vary widely. Ensure you are paying for real results here. The same goes for any performance fees, which should only kick in after an ambitious threshold has been achieved.
The bottom line
Conscious that fees are necessarily complex, good wealth managers will give investors a Total Expense Ratio for running their portfolio and this is very much the figure to pay attention to. Any costs outside of this should be minimal – and clearly explained up front.
While wealth management fees may not be the most compelling of subjects, the bottom line is that they impact hugely on your bottom line. Remember that the money you pay out is as much yours as the money your investments earn, and that seemingly small differences in fees really do change the results.
An extra £100,000, anyone?