The Annual Management Charge (AMC) is one of the most useless terms bandied around the world of investing. It’s trumpeted time and again in the media, in errant fund screeners, and by online forum dwellers as evidence of low cost funds that are worth investing in.

But the AMC is as misleading as a price that doesn’t include VAT. The sting is in the final bill.

What is TER?

The Total Expense Ratio (TER) is the cost to look out for when comparing funds. It’s a FSA-approved measure ¹ that offers a more accurate picture of the annual operating expenses that drag down the performance of your investment.

These operating expenses include:

• Annual management charge
• Legal fees
• Administrative fees
• Audit fees
• Marketing fees
• Directors’ fees
• Regulatory fees
• The mysterious ‘other’ expenses (biscuits, perhaps?)

Unlike reading that list, the TER will never make you yelp with pain. It’s not deducted directly from your bank account. It’s a stealth cost: a percentage silently shaved off your fund’s investment return over the course of a year.

The lower the TER the better, although you’ll struggle to beat a TER of 0.27% on a UK equity tracker fund. A TER of 1% on a similar fund would be like daylight robbery with extra kickings.

What difference does the TER make?

As fund firm Vanguard put it in their own prospectus:

Even seemingly small differences in expenses can, over time, have a dramatic effect on the Fund’s performance

We can witness that drama like an episode of 24 by comparing the TER cost of two otherwise identical funds:

	Fund A	Fund B
TER	0.27%	1%
Initial investment	10,000	10,000
Annual return	7%	7%
Holding period	25 years	25 years
Total return	£50,952	£42,919

Fund B has been whacked for over £8,000 more in charges over the period. That cuts your return by a painful 15.77%.

This sort of needless loss can be avoided by choosing funds with the most competitive TER wherever possible. You can compare TER damage yourself using a fund cost comparison calculator.

The illustration above also shows why it’s important to deal in TERs not AMCs. For example, Fidelity’s MoneyBuilder UK Index Fund declares an AMC of 0.1%, which is nearly three times smaller than its TER of 0.27%. A difference guaranteed to knock your calculations out of whack if you listen to lazy journalists.

TER twists

Beware that TERs are not fixed. You can find the TER in the fund fact sheet or prospectus, but you’ll also find small print explaining the fund manager reserves the right to charge extra for any unexpected operating costs.

That’s because the TER is a calculation based on the previous year’s events. Published TERs therefore represent an expectation of costs rather than a guarantee.

Don’t expect listed TERs to be accurate when you’re screening for funds, either. I’ve yet to find a fund screener that’s 100% up-to-date, or above occasionally quoting the AMC. The only way to be sure of an accurate TER is by checking the latest fund literature.

Hidden costs not in the TER

Sadly for the weary investor, the TER is not the one-stop cost-shop it’s often thought to be.

Though it’s the most practical tool we’ve got for instantly comparing funds, TER doesn’t tell you anything about:

• Initial charges and exit fees
• Brokerage fees
• Bid-offer spreads
• Market impact costs
• Taxes (e.g. stamp duty)
• Interest on borrowing
• Soft commissions

You’d need to subject most funds to a forensic examination to suss the impact of that lot upon your costs. Happily though, there are some useful rules of thumb that help show the way. I’ll return to that in a future post.

Suffice to say, the passive investment strategies adopted by index trackers make them far less prone to these costs than active funds.

Take it steady,

The Accumulator

1. TER = Total Operating Costs / Average Net Assets[↩]

My post of the week, plus plenty more worth reading across the Web.

I can’t get enough well-argued explanations as to why UK houses are overvalued. These people might be as wrong as me, prices might (or more specifically, ‘do’, at least here in London) go up regardless, but at least you feel you’re wrong with the smart money.

True, that won’t keep us refuseniks warm when we’re 68 and forced to live in some huge commune/squat in Milton Keynes with a bunch of other people who posted evidence of prices falls that never really came at House Price Crash like a middle-class cargo cult.

But heck, you can’t take it with you.

So on the property theme, my post of the week comes from Alan Dick, a financial planner from Glasgow.

Alan writes (apologies for going straight to informal Christian names, but to use his surname seemed provocative):

Most of us apply dubious mental accounting to convince ourselves that we have made a substantial profit on property.

Unfortunately, this is largely an illusion. Much of the so called profit is actually just the effect of inflation. Anyone over 50 probably paid more for their last car than they did for their first house. As house sales and purchases are generally infrequent activities we have plenty of time to put on our rose tinted glasses and ignore the effect of inflation.

Alan has crunched data since 1956 on house prices, shares, government bonds and RPI inflation, which is summed up in the following graph:

Pretty definitive win for shares. It’s worth noting, however, that the mid-1950s was when the ‘cult of the equity’ took off in the UK; I wouldn’t expect share prices to outperform over all timeframes like this (though right now, after two bear markets in a decade, is probably as good a starting point as any).

On the other hand, Alan also offers supporting data from the US and – intriguingly – Amsterdam, where records going back over several centuries for the same row of highly-prized townhouses shows prices rose by merely 0.2% per year in real terms (that is, after inflation) across 350 years.

Houses cost a lot to maintain and update, too, and they’re illiquid.

On the other hand, they have the great advantage of being the only way the average person can safely borrow to invest – provided they pay a reasonable initial price when they do so. It’s the gearing from a mortgage that in fact produces the bulk of the returns for anyone who isn’t lucky enough to buy at the start of a house price boom (most recently the late 1990s, in the UK).

A fair price for property

So what’s a reasonable price to pay? Alan cites the famed US writer William Bernstein’s suggestion of 15x the fair rental value of a property.

That would put my London place I rent at about £300,000, which seems about right – still eye-wateringly expensive, but understandably so given London wages and housing restrictions – as opposed to the £450,000 that similar places around here sell for, which just seems bonkers.

Do download the PDF and have a read yourself (there is good US graph, too, and details of a 100-year bear market for US property!)

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My weekly waffle, plus some decent links from around the web.

I am sure everyone is getting fed up with me blowing my own trumpet about predicting ongoing growth in the UK, against the backdrop of general despair at the start of the year.

But I’ve got to admit that this week’s release of a 0.8% GDP growth figure for the past quarter for the UK made me chuckle.

As the Motley Fool recounted:

Consensus estimates were of a modest 0.4% growth in the economy in the third quarter (Q3) of the year. Instead, GDP growth came in on Tuesday morning at a surprising 0.8%, a level predicted by only a handful of economic forecasters.

What’s more, growth was broadly spread, with construction, services and manufacturing all posting strong gains; and only the agriculture, forestry and fishing sector failing to increase output.

The contrast with the gloom expressed in the media couldn’t be more stark.

Not all the media, dear Fools, if we can count humble Monevator amongst such ranks.

The real question is what happens next? As ever, it’s difficult to say – certainly more difficult than most of the knee-jerk gloomy predictions of the past 18 months made out – but I’ll have a bash at risking my own track record.

In my view, it was pretty clear that the UK would grow this year. The signs were that the slowdown had plateaued, and the banks were at the least on life-support. Add that to spectacularly low interest rates and a weak pound, and it would have taken – literally – a bomb for UK GDP to slip below zero in my view (or possibly the break up of the EU, though that never seemed immediately likely).

The consensus now is this 0.8% GDP growth represents a last fling before the storm of pain to come from the spending cuts next year.

I doubt it:

• State spending is actually increasing in nominal terms – the idea that money will drain from the economy is nonsense. Services may suffer, but business won’t fall off a cliff.

• I don’t see any reason for interest rates to rise presently, and low interest rates are pumping millions into middle-class mortgage owners’ pockets every month. Provided they’ve kept their jobs, many in the key 35-55 demographic have never had it so good.

• At worst, I think unemployment will be flat. This displacement of jobs from the public sector to the private sector is very credible.

I don’t doubt the private sector is better at allocating capital and finding useful productive work for workers to do than the public sector. The only dispute for me is the extent to which we need to redistribute the gains from private enterprise to limit inequality (I think we should, up to a point) and how much the State should step in to do work private companies can’t or won’t (certain aspects of health care, for example, and the upkeep of our nuclear missiles).

So I see most of the cuts as highly desirable. Indeed, if I look at my 10 things I didn’t want to pay taxes for any more article from May, I see the Coalition is making inroads into most of them. I’d take some credit, except that most of these cuts were so blindingly obviously required, it’d be more shocking if they weren’t enacted.

Anyway, my prediction is for another year of growth from here, perhaps below trend at say 2% GDP if there’s another Euro-wobble, but with the potential to surprise to the upside. The key domestic risk I see is a second slump in the property market, which does seem to be listing again. That would be great for me, but it wouldn’t be great for UK GDP.

If you’re a UK equity investor, the balance of risk and reward seems even clearer. Insignificant domestic interest rates and potential QE, awful yields on bonds and cash, and 70% or more of UK company earnings coming from overseas is all hugely supportive for further stock market growth.

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