The Costs of Investing in Funds

Growing up, we were being told to start investing. Knowing the importance of it, most of us would start investing in funds recommended by our insurance agents or bankers.

A common thinking: It’s far better to put our money with others because they know best and they tend to outperform the market. Psychologically, most people feel that their money is well taken care when there is someone managing it.

Is that the truth? We’ll explore in this article together.

Please note that for any mentions of funds, I am not recommending them. If you invest in them, I do not gain any financial gain and I would strongly advise you against investing in any of the funds unless due diligence is made or a financial advisor is advising you.

Introduction

A fund is where an active/passive manager would pull in the money collected from several individuals and decide how best to allocate it. All funds have a fund factsheet to state their investment strategy and costs associated with it.

Funds are then split into units to make it easier for smaller retail investors to buy into the funds. By buying an investment fund, an investor would get exposure to several listed businesses via the selection of a fund manager.

This article is motivated by a recent review of a friend’s portfolio. There are 4 funds and most underperformed severely, and I hate to see any of you holding on to funds that underperform and charge high.

Many investors feel it is so easy to trust big names like a Blackrock fund but having a brand name may not mean the fund would perform well. Having said that. there are big names funds who perform.

It’s your own money and it is your responsibility to know what you’re doing instead of outsourcing the entire process to your financial advisors. Do your own due diligence on top of your financial advisors’ recommendations.

How to Select a Fund?

Let’s use Schroder Emerging Markets Fund as an example. Fundsupermart provides details on it (click here)

1. Fund Size and Fund Mandate

Typically, I prefer a fund that is >$300M to get a nicer bid/ask spread.

2. Sales Fees, Management Fees and Expense Ratio

To gain the experience of a fund manager who may or may not be competent, you have to incur fees in three different areas.

Firstly, the sales fees. It is a front-end load that is charged upon the amount of the investment. The distributor of the fund typically charges around 3 – 5%. If you were to invest $1,000, after deducting 5%, the actual money you are investing is $950. This is one-time, and the money does not enter to the fund manager. It goes to the distributors / salespersons.

Secondly, management fee. This is a fee that you are paying the manager for doing his/her work. It is charged upon the value of your investments every year. Most funds charge 1 – 1.5%. I think 1.5% is rather high.

Lastly, miscellaneous fee. It’s a fee that you pay to cover the operations of running the fund. A range of 0.5% to 0.75% is fantastic and 1.5% and above is really high.

Adding miscellaneous fees and management fees, you get TOTAL EXPENSE RATIO (TER).

Extracted from FSMOne

For this fund, you are charged 1.94%. The funds have to make more than 1.94% before you start making money. Your cost is 1.94% every year with or without any fund performance.

Imagine it as a hurdle rate before you get to receive your share of profits. Either way, it is important to not overpay for performance unless the fund is truly exceptional.

3. Top 10 Holdings 

You can find it from the factsheet. If not, request it from your financial advisor. Unfortunately, you are unable to control what the fund is buying and the allocation towards whatever listed businesses. It’s good to roughly know the sectors and the names in the top 10 holdings.

4. Historical Performance

The picture below may be blurred. I was measuring the performance of the fund from 1 January 2014 to 4 October 2019. The cumulative returns were 24.31%.

So, that was 24.31% for 6 years (2014 to 2019). If I were to break it down to an average compounded growth rate, that would be 3.69% per year after accounting for all the expenses.

Bear in mind, funds have to outperform after their total expense ratio.

More Comparison of Other Funds

All of my information was extracted from FSMOne (Fundsupermart). Please do not rely on this table because there could be errors in calculation. It’s excluding dividends too.

If the picture is too small, click here to enlarge.

You see, I took a random number of funds and the net returns were below 3%. However, some of them have outperformed their benchmark. Given all things are equal, would it be better to park our money in CPF and earn 3.5% instead?

It’s risk-free because the government guarantees the returns.

If you’re more enterprising, after due diligence and proper valuation, invest in S&P 500 which gives you an average returns of >7% at very minimal costs.

Use MoneyChimp to play around with different periods to see how has S&P 500 performed.

An example

If you like to invest passively, go for Vanguard S&P 500 ETF (VOO). It is issued by Vanguard, its Assets under Management is >$400b and the expense ratio is 0.03%.

From the table above, you can see that using a set of assumptions ($50,000 as an investment amount with 10% returns every year), the difference in yearly fees will build up as your funds grow.

To compare it with another index, MSCI Index:

Broad indexes have performed better than most funds too. According to CNBC, active fund managers trail the S&P 500 for the ninth year in a row. If that is the case, you have to decide whether do you want to go with an active fund manager or simply buy an ETF that mirrors the index?

Alternatively, you can learn how to select stocks yourself!

RELATED: My Performance for 2019 Year-Till-Date!

Action Plan

I felt the urge to write this article because it is simply not true that funds outperform all the time. Or the fact that if the fund is marketed under brands (LionGlobal, JP Morgan, BlackRock), it will do well.

In fact, when an investment manager is managing 5 – 6 funds altogether, how are we able to ascertain the work is done properly for each fund?

That being said, I know of wonderful stories of investors who was taken care by their financial advisor and invested in very good funds.

After reading this article, I highly recommend you to do a few steps:

Step 1: Go to https://secure.fundsupermart.com/fsm/funds

Step 2: Key in your unit trust name

Step 3: Find out what is Management Charge + Annual Expense Ratio

Step 4: Find out the historical performance and top 10 holdings

Step 5: Call up your financial advisor to discuss, then exercise your own independent thinking on your investments.

It would be good that you share this with your friends and help them to take proactive steps towards wealth creation. 

Hope you enjoyed this week’s read.