Do Costs Matter?

Yes! And it is the only worthwhile data the small investor has to help him pick a fund.


Costs matter because.....

The mathematics of compounding makes small percentages important.

In a recent study the annual costs of unit and investment trusts in the UK are estimated to range between 0.6% per annum and 3.85% per annum.

Over 20 years, a fee of 0.6% per annum would take 10% of a single lump sum (20% over 40 years). Over the same 20 years, a fee of 3.85% per annum would take  55% of a single lump sum (80% after 40 years).

So fees have got to be justified by enhanced performance

But.......

Nobody has managed to find any evidence that the historical performance of a fund is any guide to future performance. In fact the regulator has gone so far as to ban the use of historical performance figures in advertising (Pick On Performance?). And....

The fund management industry has made no attempt to introduce unbiased measurement methods to allow investors to make informed choices on the basis of the data available. It has preferred instead to rely on traditional advertising techniques. And....

Star managers are a myth

Therefore.......

Even if there are such things as "better managed funds", the average investor has no chance of ever identifying what they are. So he might as well pick on the basis of the one thing he does know, which is costs.

Warning

It's hard to discover what the costs of a fund are. They comprise more than just the investment management fees (which have to be declared). Find out more in Costs Unwrapped.

The Financal Services Authority (FSA) publishes aggregate costs figures in comparative tables on its website, but it doesn't define exactly what's included and what isn't and its effort at simplification has only lead to confusion.

Certainly one item never included in these figures is the cost of dealing within the fund. This has been estimated to be 1.7% each year for the average fund, on top of everything else. Read more in Portfolio Turnover.

What you should do

One or two fund management groups actually provide quite good cost disclosure. If you find them, put them top of your "maybe" list. Information will remain patchy until funds are forced, either by law or investor pressure, to provide it.