Why Low-Cost Investing Is More Important Than You Think

Why Low-Cost Investing Is More Important Than You Think

As investing legend Warren Buffet has championed for years, low-cost index funds are the perfect investment for most people. Paying over the odds for an actively managed fund seldom yields the results of the market average that index funds attain, all whilst costing 1% – 2% instead of > 0.3%.

If we accept the notion that the average person cannot beat the market, that is, to reliably return greater than the 9% average the market will return in the long run, then attaining this market average should be our goal. And if it is our goal, we should be looking at the cheapest way to do it.

Many of the top trading platforms in the UK offer ETFs for free, and whilst this isn’t quite the same as a Vanguard Global All Cap Fund, it’s very similar. Furthermore, we can see the many ways investors get tricked into unnecessary costs when we look at Roboadvisors.

Many Roboadvisors entice users into managing their investing for them in an automated, algorithmic way. The thing is, their automated Algo trading is very similar to Vanguards, only they’re trying to appear more accessible with rounding up spending and easy direct debits. The costs are often twice as much as a Vanguard fund (0.5% instead of 0.22%) yet the underlying investments are extremely similar.

Even if you’re looking to invest in something a little less diversified and safe, like individual companies or cryptocurrency, the goal again remains the same: Cost-cutting. Trading platforms offering commission-free trading on equities is a huge reason behind the growth in retail investors in the past couple of years; something further perpetuated by the pandemic.

An example of why costs can ruin an investment

If you invest £100,000 into a fund or account that returned 6% annually, you would end up with £430,000 after 25 years. However, if there was a 2% fee incurred, many would automatically think that the £430,000 return would be 2% smaller – this couldn’t be further from the truth.

If the investment has 2% annual fees the investment would actually return £260,000 – a far cry away from the £430,000. In fact, in the no-cost example, earnings (i.e. not accounting for the original £100,000 investment) is £330,000, whilst in the 2% cost example, the earnings are £160,000 – under half.

So, 2% of costs yielded under 50% of the profit. After factoring in inflation too, and suddenly a seemingly good investment can become a terrible one.

Fortunately, when purchasing crypto and equities, you’re only faced with one-off costs (if at all), but many other investments, such as property syndicates, will incur hefty annual management costs that can unknowingly ruin an investment.

Final Word

How people construct their portfolios is dependent on their goals, risk preferences, and knowledge. Low-cost index funds may not be the answer for someone with a short investment time horizon (i.e. they will need the funds to make a residential house deposit in 4 years). However, whatever the investment, costs need to be accounted for and kept to the minimum. This also goes for retired expats who convert their pension – banks offer horrendous rates that will eat up your pension. You can find fair superior deals (both the FX rates and fees) with newer fintech FX specialists.