The late Jack Bogle – the founder of Vanguard and the grandfather of index investing – left us all with a simple mantra that he repeated almost every time he wrote an article or gave an interview: ‘costs matter’. He also often used to say, ‘in investing you get what you don’t pay for’. And therein lies the rub.  In day-to-day life, we often feel that you get what you pay for. It can be worth spending more on some things to avoid having to buy the product again or to have work redone. Yet when it comes to investing, broadly speaking, the exact opposite applies. The more you pay in ongoing charges to invest in a fund and on all the costs associated with owning the fund over time, such as those it incurs when buying or selling shares, means, on average, there is less money left to put in your pocket. It would be easy to select a good fund if all you had to do was pick the most expensive manager, which might set you back significantly more than 1% a year. Yet we know, for example, that over 85% of all US equity funds failed to beat the market over 20 years, not least because of the high costs they incur[1]. Trying to pick – in advance – skilled managers who will beat the market in the next 20 years is extremely taxing.

In fact, if you reverse your strategy and pick the cheapest fund, it is likely (although never guaranteed) to be a better option. Taking equity funds available for sale in the UK[2] – both index funds delivering the market return (295 in all), and non-index funds (4,969) seeking to beat the market return, the average costs and the difference between them are set out below.

Figure 1: Equity funds for sale in the UK – Ongoing Charges Figure (OCF)

If we assume that both sets of managers (index and non-index) capture the same market returns before costs – a reasonable position to take, in aggregate, as winners and losers have to net out to zero – we can calculate the differential wealth outcomes over time between the less costly index funds and the more costly non-index funds. The seemingly small difference of 0.85% makes a huge difference to what an investor’s retirement might look like. The chart below shows you how much more money you would have with the lower cost strategy over different time frames[3].

Figure 2: Wealth outcomes differ depending on costs – lower = generally better

Put another way, at the end of 40 years – not an unreasonable investing horizon – if the high-cost strategy ended up with £1 million, the lower cost strategy would have £410,000 more to spend, all else equal.

As investors, we should not lose sight of the fact that we put up 100% of the capital and take 100% of the risk of doing so. Surely, we deserve to pocket the bulk of the returns on offer. So, all together now, one last time, ‘costs really matter!’

[1]  US Scorecard 2021. http://us.spindices.com/resource-center/thought-leadership/spiva/

[2]  As of 30^th June 2021.  Open-ended, UK domiciled funds and ETF, or funds with UK reporting status, publishing KIID OCF data.

[3] This uses Nobel Laureate William Sharpe’s Total Wealth Ratio calculation

Duncan R Glassey
Managing Director – WealthFlow
duncan.glassey@wealthflow.com

This article is distributed for educational purposes and should not be considered investment advice or an offer of any product for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed. Past performance is not indicative of future results and no representation is made that the stated results will be replicated. Errors and omissions excepted.

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WealthFlow Group Ltd. Registered in Scotland No SC635011. Registered Office: 10 Charlotte Square, Edinburgh EH2 4DR.

Head Office & Consulting Rooms: 10 Charlotte Square, Edinburgh EH2 4DR.

Mail correspondence to our Central Scotland Admin Hub: WealthFlow Group Limited, PO Box 14947, Grangemouth FK3 3AU.

Authorised and regulated by the Financial Conduct Authority

For your protection, unresolved complaints can be referred to the Financial Ombudsman Service.

To contact the Financial Ombudsman Service, please visit www.financial-ombudsman.org.uk.

WealthFlow Group Ltd. Registered in Scotland No SC635011. Registered Office: 10 Charlotte Square, Edinburgh EH2 4DR.