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Rushman's Rants

04 July, 2014

Those index funds aren’t going to pick themselves

It isn't every Wealth Management practice that has their own resident Professor as a member of their Investment Committee. Here, Prof. Jon Rushman offers us his perspective on how the costs of fund management have reduced over time, and how this benefits us all...

Perhaps it’s because I have spent much of my professional life working with and advocating for index funds that my favourite Dilbert cartoon is this one:

licenced from UniversalUclick.com - thanks to Scott Adams

Of course, the funny thing about this is that to follow an index the securities do pick themselves. At least, they do if you are a fund manager following a single index published by a recognized index provider. $10 million would be an outrageously large fee for even this billionaire to pay to have someone do this for a year.

Fees are really important. Twenty years ago it was common for active fund managers to take fees exceeding 2% per annum. A way of understanding how wealth-eroding fees at this level can be is to consider a manager who makes returns just high enough to keep your fund at constant value after taking 2.5% p.a. in fees. It therefore takes just 40 years before that manager has captured your entire initial wealth for himself. No wonder the traditional managers and wealth management businesses are happy to give free tea and biscuits to new clients!

Institutional investors pay much less than this on their large funds. Fees less than 0.1% p.a. are typical. One of the great things about the ETF (Exchange Traded Fund) revolution is that these types of cost efficient investments are becoming available to smaller retail investors. Vanguard have always been a leader in low-cost indexed investments in the US, and I was delighted to see them enter the UK market a few years ago by seriously under-cutting the fees of competitors’ products. For example, their FTSE 100 ETF is available to retail investors at just 0.1%, and the very-diversified FTSE All-World ETF at 0.25%. Thanks to Vanguard, a healthy dose of price competition has broken out in the UK market, with leaders iShares responding by cutting the cost of their ‘core’ range of ETFs. This can only be a benefit for retail investors.

Of course, your advisor takes a fee as well. At Walden Capital we are transparent in the fees we charge for our advice. We also do something for that fee. We diversify your investments appropriately across a range of asset classes and we target a risk level that is right for you. We also review our investment choices relentlessly to insure that they offer the best exposures at the best prices. Of course a great investment solution only works if it works for you, and we ensure this is all incorporated within your personalised Strategic Financial Plan.

Oh, and if you do happen to have $1 billion to invest, you will find the fees quite a bit less than 1%!

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