Minimising Costs - 'What Does 1% matter?'

[ADrunkenMarcus]

Let's take an example of an equity portfolio which has generated a real (i.e. adjusted for inflation, net of costs) total return of 5% CAGR. Assuming every other factor remained constant, what would happen over an investing lifetime if additional costs of 1% a year were incurred?

If we assume the portfolio is invested for a forty year period then a real total return of 5% CAGR will turn every £100 into £704 over that time. However, if we assume an additional 1% a year in costs then a real total return of 4% CAGR will turn every £100 into £480.10. The cumulative effect of an extra 1% in charges means that the portfolio growing at 5% ends the period about 47% higher than the one growing at 4% - quite a difference for 'only' 1% in costs. (The cost isn't 1% - it's 20% of the annual growth, reducing 5% to 4%.)

Of course, what matters is the real total return net of costs. If a fund manager can, consistently, add 'alpha' to offset their charges then great. The problem is that, all too often, costs eat away at those returns to such an extent as to be seriously detrimental.

There are some things we can control and some we cannot. However, striving to keep costs as low as possible - whether by reducing dealing and associated charges, opting for a fixed-fee account for large capital portfolios or opting for the lowest charging of several otherwise similar investment trusts or funds - is likely to be very beneficial over time.

Best wishes

Mark.

[Steveam]

Yes, indeed.

Related to this is one’s lifestyle expenditure. Without wishing to change my lifestyle I do try to think in terms of expenditure minimisation and I do this by (mentally) constantly capitalising the expenditure.

I was recently having a discussion with a friend who is nearing retirement and trying to build his retirement pot. He doesn’t have a lot but will probably be able to manage. I asked him when he’d last done a price comparison exercise on his utilities and he said he’d never got round to it as it would only save a relatively small sum per year (he did accept that it was job worth doing). He’s now saved £400 per annum! This £400/annum might be looked at as the income from £10,000 and as his retirement pot is about £300,000 it is about 3.5%.

Investment cost minimising is important because of the compounding and the same, in my opinion, is true of lifestyle expenditure. (Just to be clear - I’m not talking about cutting back or thrift. I travel on holidays as I like, class of travel I like, meals I like in expensive restaurants, etc but I look to see if I can have the same purchase or an equivalent at lower cost.)

Best wishes,

Steve

[tjh290633]

I think that this is where the HYP approach, of investing for a growing income, wins. You say 5% net of costs, but why don't you include your costs in the calculation?

Howver 5% is a bit of a low target. I'm just looking at my grandchildren's trust funds, invested in ITs over periods up to 17 years now. Witan has given an IRR of 10.8%, F&C has given 10.9% and ATST 10.1%. F&C get their fee paid outside, by DD, whereas the others take it from the fund, all income being reinvested anyway. At £15 every 6 months, it is a very low percentage. Witan is slightly higher just over £18.

It's all very well striving for low costs, but judge it on the overall performance net of all costs.

TJH

[Gengulphus]

Note that for trading costs, how much a 1% trading cost matters depends on how often it is incurred on any particular 'chunk' of money. Such a cost is plausible for e.g. a £5k investment in a FTSE100 share over a buy-and-later-sell round trip into the share: 0.5% = £25 stamp duty on the purchase, a £10 commission on the buy and another on the sell, maybe 0.1% = £5 on bid/offer spread, totalling £50 = 1%.

Hold such a share for a year, after which you sell it and buy another with the proceeds, and repeat for 40 years, and the cumulative impact of the trading costs is a factor of 0.99^40 = 0.669. I.e. very nearly a third of all your potential final sum goes into trading costs - which is roughly what the figures you quote show.

Hold it for 5 years at a time instead and that factor becomes 0.99^8 = 0.923. That's rather more acceptable, but still quite a substantial 7.7% of the potential final sum. Hold it for 10 years at a time instead and the factor becomes 0.99^4 = 0.961, or 3.9% of the potential final sum disappearing, and while one can reduce it further, one is starting to get a law of diminishing returns - especially as takeovers will occasionally force your hand and cause you to sell earlier than you intended (though with the saving grace that they save you the second commission for the round trip, and are often quite profitable!). This is basically one of the principal advantages of Long Term Buy & Hold strategies.

All of this does of course apply independently to each holding. If I have a 10-share portfolio and I do a round trip every 10 years on each holding, then the amount of money in each holding is reduced by a factor of 0.961 compared with what it could have been - and the total portfolio value will also be reduced by a factor of 0.961 compared with what it could have been. So I would be doing an average of one round trip a year in the portfolio, but only suffering the penalty for a round trip per ten years because that's all that any particular chunk of money in the portfolio experiences.

Of course, in real life you probably do some rebalancing between holdings - e.g. if you buy two holdings for £5k each and later sell them at about the same time for £4k and £8k, you probably reinvest into two £6k holdings rather than one £4k holding and one £8k holding. To take account of that, define the portfolio's 'churn rate' to be the amount of sale proceeds reinvested in a year divided by the total portfolio value - then the round-trip trading costs can be multiplied by the churn rate to get the effect of the trading costs per year. E.g. if those two sell-and-reinvests were in a £100k portfolio with 1% average trading costs per round trip, the impact of the trading costs would be £12k/£100k * 1% = 0.12% in that year.

Also, in real life trading costs as a percentage depend quite a lot on purchase sizes, especially at the low end of the scale. On the same basis as above:

* On £1k purchases, they are £5 stamp duty + £20 commissions + £1 bid/offer spread = £26 = 2.6%.

* On £2k purchases, they are £10 stamp duty + £20 commissions + £2 bid/offer spread = £32 = 1.6%.

* On £5k purchases, they are £25 stamp duty + £20 commissions + £5 bid/offer spread = £50 = 1.0%.

* On £10k purchases, they are £50 stamp duty + £20 commissions + £10 bid/offer spread = £80 = 0.8%.

* On £20k purchases, they are £100 stamp duty + £20 commissions + £20 bid/offer spread + £1 PTM levy = £141 = 0.705%.

And for smaller companies with bigger bid/offer spreads, they can be significantly larger percentages...

And of course, purchase sizes don't remain the same as time goes by and one's portfolio gets bigger... All of this says that when one is starting out with individual share investment and working with maybe £1k purchase sizes, selling and reinvesting should be treated with great suspicion: it's sometimes necessary, but try to avoid doing it (and especially doing it frequently!) just because 'it seems a good idea' with no more concrete reason. As one's portfolio and the holdings in it get bigger, it becomes less of a problem - but it's never really completely negligible.

Or more briefly, trading individual shares frequently is a rich man's game - and a trade per holding per year is frequent!

Gengulphus

[GoSeigen]

If we assume the portfolio is invested for a forty year period then a real total return of 5% CAGR will turn every £100 into £704 over that time. However, if we assume an additional 1% a year in costs then a real total return of 4% CAGR will turn every £100 into £480.10. The cumulative effect of an extra 1% in charges means that the portfolio growing at 5% ends the period about 47% higher than the one growing at 4% - quite a difference for 'only' 1% in costs. (The cost isn't 1% - it's 20% of the annual growth, reducing 5% to 4%.)

From the Munro Fund school of mathematics...


GS

[Hariseldon58]

Another thought , buy an Investment Trust on a 10% discount to NAV , employing 15% gearing....

The charges will be around .75% higher than a tracker.

You can enjoy the return on assets that came for “free” can easily completely offset your costs., to become gains.

Recently added one IT on a 20%+ discount that includes more than 20% in US treasuries. (Debt lower than the treasuries, so not just an offset)

These are quite attractive situations, good long term history, attractive management and reasonable costs.

Maybe the costs alone are not everything, of course all other things being equal, lower the cost the better

[Gengulphus]

Another thought , buy an Investment Trust on a 10% discount to NAV , employing 15% gearing....

The charges will be around .75% higher than a tracker.

You can enjoy the return on assets that came for “free” can easily completely offset your costs., to become gains.

You can experience those returns. Whether you'll enjoy them depends on whether they're gains or losses!

Gengulphus

[Aminatidi]

As a novice to all of this I tend to take the view that focussing on platform fees maybe makes more sense than focussing on fund/IT fees.

If I'm paying Lindsell Train or Terry Smith 0.75% or 0.95% I feel I'm getting some value for that or else why choose those funds to start with?

If I'm paying a platform 0.45% across everything I hold with them that feels like a potentially massive overhead.

[OhNoNotimAgain]

As a novice to all of this I tend to take the view that focussing on platform fees maybe makes more sense than focussing on fund/IT fees.

If I'm paying Lindsell Train or Terry Smith 0.75% or 0.95% I feel I'm getting some value for that or else why choose those funds to start with?

If I'm paying a platform 0.45% across everything I hold with them that feels like a potentially massive overhead.

You don't need a platform.

It is possible to buy an OEIC direct and therefore avoid a platform fee. You have to use a broker to buy an ETF or an IT and it will charge a fee.

[Aminatidi]

As a novice to all of this I tend to take the view that focussing on platform fees maybe makes more sense than focussing on fund/IT fees.

If I'm paying Lindsell Train or Terry Smith 0.75% or 0.95% I feel I'm getting some value for that or else why choose those funds to start with?

If I'm paying a platform 0.45% across everything I hold with them that feels like a potentially massive overhead.

You don't need a platform.

It is possible to buy an OEIC direct and therefore avoid a platform fee. You have to use a broker to buy an ETF or an IT and it will charge a fee.

True, but within a wrapper and with multiple holdings it's not exactly practical.