As I learned more about the market, exchange-traded funds (ETFs), exposures and fees, I became tempted to chop and change my portfolio, which I did. Sometimes because I found an ETF with a lower TER (Total Expense Ratio/Total Investment Ratio) than I the one I am holding, but with similar exposure. Or sometimes when a platform’s fees are a few basis points lower (platform, admin and transaction costs) than the one I’m on.
It’s often said that fees are the best indicator of returns, as opposed to past performance. Past performance, in fact, has no bearing on future performance. Sometimes the fee difference can be as small as a few basis points, other times the difference can be quite chunky. When considering to move between funds purely because of fees, it’s important to consider how long it would take to break even to determine if the move is worth it or not.
Say you want to sell product A to buy product B or want to move away from your broker or financial services provider because product A’s TER is 0.4% and product B is 0.1%, it seems like a no brainer to make the switch. However, you also need to consider the cost of moving in addition to fees. This includes spreads (the difference between the buy and sell price), transaction fees, tax (not applicable to a TFSA) and a penalty fee.
Suppose products A and B give the same return over 30 years and the fees stay as is over the same period, would you win or lose? How long will it take to come out ahead? To determine the answer, I use the following calculation:
- Calculate the cost to move as a percentage of the current balance
- Reduce the current balance by the cost to move:
E.g. If the cost to move is 2%, your calculation will look like this: current balance – (current balance * cost to move percentage)
- Let’s assume that the returns are going to be the same between the two options (also because we can’t control that part).
- Compound forward subtracting the fee from the return.
This spreadsheet shows how long it will take to break even and how far ahead of the curve you will be at the end of the investment period with an initial investment of R100,000. There are cases where switching is necessary, and where you will be better off with the higher fee if the returns are the same.
On the other hand, it might be worth it to switch from Satrix SWIX Top 40 ETF (TER 0.44%) to the Satrix 40 ETF (TER 0.1%), if the returns remain the same as it will only take about 11 years to be ahead of the curve.
When comparing the above with actively managed funds where fees are often more than 1%, you will be ahead of the curve by 25% as a result of the higher fee (if the returns of the actively managed fund match the index). With a 1% fee, the difference is R328,000. Some unit trusts charge more than 2% – this relates to R780,000 (89%), and you’ll be ahead of the curve in a year if you switch to a much cheaper passive fund.
In these examples I assumed cost to move is 3%, but it can be higher – especially with RA funds. Here the cost to move can be as high as 20%. However, when your fees sit at 3%, you would still be 39% ahead of the curve (over R300k on the R100k example) when moving to an RA with a 1% fee allocation.
All the examples above are based on a period of 30 years.
Just because the numbers of a percentage based fee is small, doesn’t mean they are. Active managers need to knock it out of the park to give the same or better returns after fees to justify staying in an actively managed fund. Many of them cannot outperform the index after fees consistently over the long term. In a world where there are providers offering less than 1% on fees, some fees nearing zero, there’s really no reason to be subjected to a 3% fee.
To switch based on fees is sometimes not worth it. Other times it’s critical, as fees compound out of our pockets.
Njabulo Nsibande is a Just One Lap user-turned-contributor. His “Cash Club” blog details his experiences balancing the financial obligations of a young parent with his investment aspirations.
Njabulo is a founding member of an investment club. In this blog he shares his experiences trying to work out the intricacies of collective investment in the true sense of the word.
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Find him on Twitter: @njabulo_goje.
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