- It’s normal and reasonable to pay for professionally managed funds.
- You need to factor in fees when assessing the potential return of an investment.
- Whilst Australia’s fees are amongst the lowest globally, you still need look out for high, hidden or confusing costs.
Fees are a normal and necessary part of the investment management industry. Just as you expect to pay your dentist or accountant for their expertise, you also need to pay financial services providers for the professional services they deliver. The key to getting good outcomes is knowing if what you are paying is reasonable and how it will impact your returns over time.
You can see in the chart below from the Morningstar Global Fund Investor Experience Study that Australia is in the top category along with countries like Sweden, the Netherlands and the United States.
Another great thing about our investment management industry is that it’s highly regulated. Legally, we must comply with strict disclosure and transparency regulations that protect investors. Disappointingly, however, we still see some firms, large and small, confusing investors with the way they charge for their products and services.
The impact of fees
At first glance, the fees charged on an investment product might seem relatively small. Just a percent or two here and there. However, fees can add up quickly and they can have a significant impact on your investment returns over time.
Let’s look at a simple example that compares the returns from two funds – one charging 1% per year, the other charging 2% per year. We’ll assume that all other variables for the funds are the same – same investments, same time period and same level of pre-fee, pre-tax returns of 8% per year.
If you’d placed $50,000 into each of these funds 20 years ago, what would your money be worth today? Well, your $50,000 investment in the fund charging 1% per annum, would now be worth $191,032. Your other investment, however, would be worth $156,565 – $34,467 less thanks to the extra 1% in fees.
The above example was calculated using ASIC’s MoneySmart Managed Funds Fee Calculator, which you can access here:
Assessing a fund’s fees
It’s all well and good to know that fees eat into your investment returns, but how do you know if you’re being taken for a ride? Set out below are some of the normal – and not so normal – fees you might expect to pay when investing in a managed fund.
- Management fee
This is the ongoing cost of managing your money, expressed as a fixed dollar amount or a percentage of your investment. In return for this fee, the manager uses their expertise to research, assess and select assets for the fund in addition to running costs . In Australia, management fees are on average 1.2% of the total investment for equity funds and around half that for bond funds.
- Administration fee
Some funds charge an administration fee in addition to the management fee. These are typically in the range of 2% to 1.5% of the value of your investment when applied. Sometimes this is expressed as a dollar fee in the order of $50 to $100 a year.
- Upfront fees
Historically some managed funds and platforms charged an “entry fee” or “establishment fee”. Today they are far less common with the majority of funds on our database not charging this fee. If they do show up make sure you assess them as part of your overall cost of investing and see if you can negotiate them down.
- Buy-sell spread
Buying and selling shares attracts transaction costs including brokerage fees, government taxes and bank fees. Funds recover these costs through a fee called the buy-sell spread. You can expect the buy-sell spread to be in the range of 0% to 0.6% of the value of the trade. Remember this doesn’t go to the manager but is kept within the fund to cover the costs of trading. If a manager quotes a 0% spread, it just means those costs are being spread across all unit holders through lower returns instead of having each unit holder pay their specific share.
Fees to dig a little deeper on
- Performance fees
Performance fees are becoming increasingly popular in Australia and they are okay in principle. To earn a performance fee, the investment manager needs to beat a predefined performance hurdle – called a benchmark. Often this will be an index, for example the S&P/As an investor, you need to assess whether the benchmark set by the manager is appropriate. For example, a high growth global fund should not receive a performance fee simply for outperforming cash. Instead, an index of global shares would be more appropriate. The manager should also have to make up periods of underperformance before getting this fee and you would expect the management fee to be lower than a fund that does not charge a performance fee.You can expect performance fees to be in the range of 10% to 25% of the out performance.
- Exit fees
In my experience, exit fees are a thing of past but check for them before you invest. If you do encounter them, consider whether they seem a fair amount to pay to cover the costs your provider incurs as a result of you exiting the investment.
Fees that ring alarm bells
- Low or no fees
It makes sense that some things in financial services are fee free – like withdrawing your money from an ATM. But in the specialised area of investment management, fee free products should ring alarm bells.
Investment managers are commercial businesses that need to get paid for what they do. If they aren’t charging you for their services, it means they’re making money in some other way.
To find out, check the fine print or simply ask them. Whatever their strategy, it’s critical you genuinely understand how your money is being used and the level of risk involved.
Once you’ve uncovered all the fees you will pay on your investment, it’s a good idea to add them up and work out what you are paying per annum as a percentage of your total investment amount. A total fee of 2% or more is at the top end and should be reviewed. If you are paying closer to 1% for active equities you are closer to the zone and it is possible to go lower for index funds. Also consider whether any one-off fees, such as establishment fees, are reasonable in the context of the size of your investment. The lowest cost option might not always be the option for you so be clear about what you’re are looking for. Doing your homework upfront means you can relax in the knowledge that you’re getting the most from your investment.
— Anthony Serhan is the Managing Director, Research Strategy, Asia-Pacific at Morningstar.
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© Morningstar Investment Management Australian Limited (‘Morningstar’) and any related bodies corporate that are involved in the document’s creation. Whilst all reasonable care has been taken to ensure the accuracy of information provided, neither Morningstar nor its third-party providers accept responsibility for any inaccuracy or for investment decisions by any person on the basis of the information included. Past performance is not a reliable indicator of future performance. Morningstar does not guarantee the performance of any investment. Any general advice has been prepared without reference to your investment objectives, financial situation or needs. You should consider the advice in light of these matters and if applicable, the relevant disclosure document before making any decision to invest. Refer to our Financial Services Guide for more information.