The Effect of Costs on your Investment Returns

The next area to look at in terms of affecting appreciation of your Investments is that of costs.

Most Fund Manager advertising focuses on the overall returns of the Investment over a one, three or five year period. They run full page newspaper and magazine advertisements promoting, for example, a 11.9% return.

What we are really interested in is the nett return of the Investment, ie after all management and related expenses. The difference between gross returns and nett returns can be quite significant for many active fund managers. For example, many range in the 2-4% region.

Whilst this does not sound like a large amount, it will dramatically eat into your Investments over the longer term.

This is best illustrated using a graphical example.

The chart below shows a $10,000 investment placed over 40 years. The blue plot shows the Investment returning at 12%. The red plot shows a 10% return. The difference represents 2% costs.

As can be seen from the chart, the difference in the two curves starts of being relatively small for the first few years, however, by the end of the 40 year period, the costs have absorbed approximately half of the potential returns.

This is one chart the high cost Managed Fund operators do not want you to see. They are not keen to show the effects of costs over time.

In direct contrast, it is a very good argument for low cost fund types, such as Index Funds provided by companies such as Vanguard. Their costs tend to be the lowest in the Industry, ranging in the 0.2% to 0.8% region.