Every fee that eats into your return
The order fee you see is only part of it. Ongoing fund charges, custody fees, foreign currency mark ups and the spread often weigh more, because they come up again and again.
Learning objective: After this lesson you can estimate what an investment really costs you, not just the visible order fee.
There are two kinds of costs: one off costs when buying and selling, and ongoing costs that hit your whole wealth every year. The second kind is the more dangerous one.
One-Time and Ongoing Costs
One off costs are the order fee, the trading venue's fee, the spread and for some products an initial charge. Ongoing costs are fund charges, custody fees and foreign currency mark ups. If you trade short term, you pay order fees on every entry and exit. There the type of order often decides how much it costs. More on this in the lesson Maker, taker and funding.
The Difference in Numbers
The difference is huge. A €5 order fee is €5. One percent in ongoing costs on a €50,000 portfolio is €500 a year, and that amount grows along with your wealth.
The Effect Over Thirty Years
Over thirty years, one percentage point of ongoing costs can eat up roughly a quarter of your final wealth. That's why a close look pays off here more than anywhere else.
Costs sit in two places: in the product and in the account. In the product there are ongoing charges, trading costs inside the fund and sometimes a performance fee for the manager. In the account there are custody fees, order fees, trading venue fees and currency conversion mark ups. Those come up when you buy and again with every distribution in a foreign currency.
Effect on Final Value
Ongoing charges hit the whole holding every year. Mathematically your end value shrinks each year by the factor (1 + return minus costs) divided by (1 + return). Over many years that multiplies up. At 7 percent return, 1 percent costs and thirty years, you're missing about a quarter at the end.
Hidden Costs
Some costs you don't see anywhere. They include trading costs inside the fund that aren't in the cost ratio, and taxes other countries already withhold on dividends. How high they are depends on where the fund is domiciled and how it replicates the index. That's why the actual deviation from the index over several years tells you more than any single cost figure.
Data as text
With a 0.2 percent fee, the balance after 30 years is €236,000. With a 1.5 percent fee it is €184,000. The difference is €52,000.
Summary
- Ongoing costs hit your whole, growing wealth.
- One percentage point over thirty years costs roughly a quarter of the end value.
- The actual deviation from the index says more than the cost ratio.
Did you get it?
Which costs weigh more in the long run?
Ongoing costs, because they hit your whole growing wealth every year.
Why isn't the cost ratio alone enough?
Because trading costs inside the fund and tax effects aren't included in it.
When do foreign currency mark ups apply?
When buying and selling, and with every distribution in a foreign currency.
Check your understanding
Your task
Calculate what ongoing costs of 0.8 percent a year cost in dollars on $50,000. Then check in the fee calculator, with $50,000 starting capital, a $0 monthly contribution and 7 percent return before costs, what the same rate takes off the end result over 30 years, and write both numbers side by side.
Sources and further reading
- The European securities regulator ESMA's annual market report on the costs and performance of retail investment products documents how ongoing costs erode net returns over the holding period. View source ↗
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