The pension and fund management industry tries to get us to focus on performance – not costs – when it comes to investing.
This is pretty ironic, given that most fund managers actually under-perform a simple tracker fund.
Indeed, in its first video on the case for passive investing in index funds, Sensible Investing quoted research that found that merely 1% of fund managers showed any evidence of skill that might be worth charging for.
In 99% of cases, there was no skill on show at all. Given this, performance is clearly a distracting sideshow.
High costs pull down the returns you see from active funds. They simply enrich the industry at the expense of your pension.
Worse, most investors have no idea what they’re actually paying for, as outlined in this second video:
Gina Miller of The True and Fair Campaign – which pushes for fairer, more transparent investing – estimates that there can be 11-13 layers of charges applied to your pension.
And as Nobel Prize-winning economist Eugene Fama says:
“If you’re paying management fees, the cumulative effect of that, given the way compounding works, is enormous. So active managers basically charge on average 1% in the US on management fees and you never know what their transactions costs are because that’s not a reported number but they’ve gotta be way higher than for passive managers because they’re going in and out of securities all the time.”
Instead of the red herring of chasing performance, you’re much better off drilling down the costs you pay to make your investments – including the charges levied by your broker or fund platform.
Check out the rest of the videos in this series so far.
Annoyingly, with employer pensions you often don’t get much say. They pick the provider and you are stuck with them.
I am on a “life management program” and the majority of people are. The website is not clear as to what happens if you switch out of that, I switched from one default to another. There’s an annual management charge which is moderately clear but the documents also show an “Indicative net charge”, that is 1% on my new default as opposed 1.3%, despite the fact that the AMC on this one is higher. Not sure if this equivalent to TER or what.
There’s a “plus” version of the fund I’m on, which seems to perform slightly lower despite higher charges, and the “advantage” version, lower still!
Whilst I appreciate (and largely agree) with the sentiment here, I take issue with the idea of a cost-free investment. This is a straw-man argument used too often in these cases.
It would illustrate the point far better to give a comparison of a £250,000 pension that had been invested in lower-cost investments over 40 years, as opposed to a mythical cost-free investment.
@Oliver From April 2015 all auto-enrolment qualifying pensions will have to cap costs on the default fund to 0.75%, which will be a big improvement for people in your situation.
Clearly these funds do have genuine costs, so we should be willing to pay some fees. I think it’s more to do with the fact that even very simple funds have high charges simply because they can,. Due to lack of awareness, transparency and choice, and on the active front this is an issue in all investments.
The make-up of these funds is probably not going to be all to different from something like the Vanguard Lifestrategy portfolios yet charge many times over that. The cap is a significant help, though, as most default funds are very standard by the looks of it and will have moderate overheads so will help people being completely ripped off.
There is an awful lot of noise talked about costs. I know from first hand experience that in one fund 51% of the costs goes to third parties such as the tax man, brokers auditors, the FCA and the depositary. All these have been kept as low as possible, but they are largely fixed or compulosory so impossible to avoid.
I think you may have linked to it already, but Warren Buffett puts his money where is mouth is by betting $1,000,000 in 2008 that a tracker will beat a basket of hedge funds over 10 years:
In 2013 the tracker was already pulling ahead although I don’t know the figures today.
When it comes to funds i have great difficulty seeing which of the funds i have access to from my discount broker that are actually index funds. Morning Star of course have their notion of which they consider index funds. Checking everything against Morning Star’s site all the time will most likely be too cumbersome.
As i have access to quite a few funds (at least 1000 funds) through my discount broker, it’s quite difficult to sort out those funds that really are index funds from those that claim to be index funds but are not really from those that do not even try to be index funds.
My “solution” to that problem is to take the fund in the category i am interested in with the smallest fee. It still might not be an index fund but as index funds tend to charge the least i think it’s a somewhat fair approximation.
I think reducing costs is a great idea. It just bothers me that sticking to the categories with the absolute least charges will have me miss a lot of investing opportunities.
Anyone have a better way of sorting out which funds that really are index funds?
In the best of worlds (Index funds all around would clearly be best but that will never happen) i would like to have index funds in the categories that have them and the cheapest fund in the categories where i do not have access to any index fund. It’s just that small issue of actually finding the index funds….
@qpop — Agree that it’s unrealistic to expect ‘free’, but ‘cheaper’ seems to me well within reach for anyone invested in a basket of active funds on a high cost platform.
Let’s remind ourselves (1) Nearly all active funds fail to beat the market (2) Those active funds charge (ballpark) 5-10x more than the cheapest tracker funds — that they fail to beat.
Given that, I think it’s very hard to argue with the sentiments in the video.
For an illustration of active fund costs versus very cheap tracker costs, see this article:
Over the long-term cheaper is definitely good.
In Oliver’s case the situation isn’t quite as simple as occupational schemes have a fixed administrative cost per account whether that person saves the auto enrolment minimums or 30% of their salary, and if an employee leaves the scheme after 30 days, the provider has to administer a paid-up policy of literally a few quid for an indefinite period.
When that is taken into consideration, the low-cost “master-trust” occupational pensions like NEST, Peoples Pension, NOW Pensions, who all charge ~0.5% PA once their charging structures are simplified, look incredibly cheap (largely due to the legal structure of the scheme and focus on IT infrastructure).
As for individual pension savers, the true cost of a basket of trackers + wrapper is going to be 0.5% or more for the large majority with much less than £150,000 (i.e. most of the population!). The compounding of those costs over 40 years are still going to look shocking, but it’s a worthless comparison against an imaginary alternative.
@Patrick naming convention is one approach. Almost all funds that track an index will either have the word “tracker” or “index” in them.
Also, HL has a good page with the range of trackers on their platform, although take their “preferred trackers” with a pinch of salt; they’re rarely the best, even if they are the cheapest. If you pick the cheapest tracker but it tracks below a more expensive one due to methodology issues, you haven’t really picked the cheapest tracker!
@qpop — I see what you’re saying — that the “no charges” comparison in the video is not a reflection of reality. But I think the point of that section is to show the impact of charges, not to moot a hypothetical alternative cost.
i.e. It shows the fat that the video’s makers and those interviewed in it believe could be cut out from the high and opaque costs you pay with active funds in a pension.
If they had used some other alternative — say 0.75% — then that would have been pretty arbitrary I’d say, and people would rightly ask where that figure had come from.
So I disagree it’s “worthless”. 🙂 It shows how much money is potentially lost to fees, and how much there is to play for.
Perhaps a future video will set out an alternate regime.
Of course Monevator readers can use the SIPP data in our broker table to get a feel for costs which I don’t think need to be wildly above 0.5%, given many offer a fixed cost SIPP charge. But I’m not the maven on Monevator on costs, we’d have to hear from my co-blogger.
Cheers for sharing your thoughts!
30% profits stood out for me
@qpop (comment 10), Far from all index fund have a name that reflects this. For example, look at morningstar.se (swedish) i am able to get a list of the funds that morningstar considers index funds. Looking at that list not even half of the funds have any indication of their nature as index funds in their name.
Even if this list is not that accessible in all contries i would still argue that most index fund does not have anything in their name that reflects the fact that they are index funds. Some that say they are index funds, even in their names, might still not really be index funds.
This means that using the name would produce a quite small selection compared to at least what morningstar considers an index fund.
We really have to be carefull when choosing index funds!
I have a bit of an issue wrapping my head around this problem. A lot of index funds these days are getting fairly high valued. More and more investors seems to come to the conclusion that there will be a huge correction “any time now”. It’s still among the absolute cheapest funds i have access to.
The issue is if i should invest in this fund or something a bit more expensive but far lower valued.
What do you think?
@Patrik — I’ve replied to this on your other comment.