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Right now, you need to obsess over cost

Summer holidays are over, the kids are back at school and we’re back to the usual routine, starting to plan for the months ahead. Somehow, we do the same with our finances. It’s not uncommon to see investors flock to wealth managers in September for a smart money management solution.

We didn’t exactly have a quiet summer in 2016:

  • We were surprised by the outcome of the EU referendum (although MoneyFarm portfolios were ready for a leave vote).
  • Volatility spiked in the first days after the referendum and then surprisingly came down to pre-Brexit levels.
  • The Bank of England joined the club of central banks with very accommodative monetary policies.
  • Risky assets rallied offering interesting returns with low volatility.

The question investors now need to ask is what to do with their savings. Interest rates are even lower, compared to 6 months ago, and many asset classes are hard to evaluate given the pervasive intrusion of monetary policy actions in the investment landscape.

The wise investor acknowledges the fragile macroeconomic picture and is obsessed by minimising the only thing they can control: cost. Just like a big corporation can make more profit just by cutting costs, so can investors. This is particularly true when looking for returns in an uncertain economic environment.

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Let’s look at the numbers to understand the magnitude of the problem.

In the equity space, a well-diversified index like the MSCI World achieved annualised returns of 8% in dollar terms over the last three years. Assuming an annualised return similar to that of the past three years, which for some investors is an optimistic assumption, and loading a 2% fee per year with a five year horizon (which in some countries in Europe is still the norm for retail investors), we should get 34% return. It looks like a good result, but by simply lowering the fees by 1% that return increases to 40.4%, which is more than someone might expect (1% per year) because of the compounding return.

Looking at a 15 year investment horizon with the same assumptions we achieve a return of 144.6% with the higher fees, it sounds promising. But the wise investor who chooses lower fees at 1% obtains 177% return. Increasing the investment horizon to 30 years and using the same assumptions, an investor paying 2% fees can make a 479.1% return, but an investor paying lower fees at 1% makes 667.5%.

It is unlikely that returns would remain consistent over the time period and a financial advisor or wealth manager will not charge you an all-in fee of 2%, but the compounding effect of lowering the fees is astonishing in the long term. With yields even lower right now it is irresponsible to pay all-in fees of 2-3% when returns in risky assets are more realistically in the 3-5% range for many years ahead. The wise investors are embracing the change of low fee solutions across the globe, the central banks are just helping all of us to realise how costs really impact investments.

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