Three reasons why you should care about costs

By Vanguard

Investing strategy

Minimising costs is a critical part of every investor’s toolkit. This is because unlike other purchases in life (like a budget model car versus a luxury model), you generally don’t get more if you pay more.

Indeed, in the investing world, the more you pay means the less you get because every dollar paid away in management fees or trading commissions is simply a dollar less available to you.

Here are three reasons why you should keep a watchful eye on investment costs.

 

1. Just a slight difference in fees could significantly impact your long-term returns

A few percentage points here or there may not seem like much. But over time, thanks to the magic of compounding, this can really add up. Fast forward a few years and you can find it translates into thousands of dollars less in your final investment.

The graph below illustrates how strongly costs can affect long-term portfolio growth.

Over a 30-year horizon, a hypothetical portfolio starting at the value of $100,000 grows an average of 6 per cent annually.

If an investor pays 0.25 per cent in costs every year, their portfolio will reach $532,899 in 30 years.

If an investor pays a higher fee of 0.62 per cent every year, their portfolio will only reach $477,141 in 30 years.

That’s a difference of over $55,000.

 

The long-term impact of investment costs on portfolio balances

Assuming a starting balance of $100,000 and a yearly return of 6%, which is reinvested.

^{Notes: The portfolio balances shown are hypothetical and do not reflect any particular investment. The rate is not guaranteed. The final account balances do not reflect any taxes or penalties that might be due upon distribution. Costs are one factor that can impact returns. There may be other material differences between products that must be considered prior to investing. The example should not be taken to contain or provide an estimate of portfolio value.}

^{Sources: Vanguard calculations, using data from Morningstar, Inc.} 

 

2. Costs are the one thing in investing you can control

Vanguard has long advocated for the importance of focusing on the things you can control in investing.

Markets are unpredictable and investors can’t control its performance on any given day. The one thing investors can control however is what investments they choose and how much they pay for them.

Index investments such as managed funds and ETFs tend to have relatively lower costs than other investments. As a result, indexed investment strategies can actually give investors the opportunity to outperform higher-cost active managers, even though an index fund seeks to track a market benchmark and not exceed it.

This is because it can be very difficult for active managers to outperform year on year, with many actually underperforming relative to the market benchmark.

 

3. Tax is a cost that should also be managed

Unfortunately, while there’s never certainty in markets, there will always be certainty in taxes. Considering tax as an investment cost can give investors a clearer whole-picture view of their returns.

Index ETFs can be a tax efficient way to build wealth because they generally pursue a ‘buy and hold’ strategy as they seek to track their benchmark. Because of this, there’s likely to be a lower turnover in ETF portfolios which minimises capital gain distributions and thus, capital gains tax.

If you’re unsure of the tax implications for your personal situation, consult a licensed financial adviser.