The higher the price, the better the quality, right? Wrong. Not always. Because when it comes to investing, the opposite is very often true.

That’s because the cost of your investment is your breakeven point; it’s the hurdle you must clear each year to begin making a positive return. Think of it this way: if you invest £100 and your annual investment costs are 2%, for example, you’ll stay in the red unless/until the value of your investment rises to at least £102. If it’s 3%, it’ll be £103, and so on.

In short, the higher your costs, the bigger the challenge.

It’s why we, at Vanguard, put so much emphasis on keeping your costs down. It’s one of our four key investment principles.

Investing doesn’t have to be complicated. At its essence, the task involves identifying a goal, deciding how much risk you're willing to bear, and then choosing a few suitable investments based on this criteria. By doing that, and keeping your discipline in the interim, you can then spend more of your time on the important stuff – in other words, living your life.

Still, if you pay insufficient attention to your costs, none of these other decisions will matter much.

How it all adds ups

When you invest money, you're trusting someone else to invest it for you. Whether it’s directly through an online investment platform or via a wealth manager, you a pay fee that's based in part on the amount you're investing and the complexity involved in investing it.

It’s not a one-off fee either but something you pay year in, year out, until you finally decide to sell or close the account.

On top of that are dealing charges, when you buy or sell an investment, and product fees – the charges you pay on the funds you invest in. Altogether it can add up to a couple of percentage points or more.

That may seem quite small at first glance but through compounding the impact on your returns can be dramatic.

Think of it in these terms: If you invest £10,000 and over the course of a year that sum earns a return of 5%, you've done quite well. This £10,000 is now, on paper, worth £10,500.

However, if your annual investment costs add up to 2%, you’ll only be able keep £10,300 for yourself. So that’s 40% of your earnings that year gone.

And this drag on your returns can continue over time to even more devastating effect. If we assume the same 5% annual rate of return over 25 years, for example, that £10,000 investment would have grown to almost £34,000 in gross terms but just £21,000 after costs!

Where Vanguard comes in

At Vanguard, we’re committed to reducing the cost of investing. If you know our history, you’ll appreciate that this is something engineered into our corporate DNA. For more than 45 years, we’ve been providing investors with ways to access markets at low cost.

We know that over time, lower-cost funds produce better net returns than their higher-cost rivals, even when they're holding the same underlying investments. And the research backs this. Our own analysis of UK funds across a range of categories over a ten-year period, shows that higher expense ratios are generally associated with lower excess returns.¹

It’s why we believe it's important for investors to know exactly what they're paying and why we've made it easy for them to know what we charge.

You can't control the direction of the markets or the success of the fund managers you choose to try to beat the market. However, you can manage your risks better by diversifying your investments across different markets and controlling your costs.

Investing though low-cost funds not only help you to spread your risks but can also ensure you keep more of your return and build up more money over time.

To wrap up our series on ‘how to build a portfolio’ we look at some alternatives to doing it all yourself.

 

¹ Dr. Jan-Carl Plagge, David J. Walker, CFA and Andrew Hon, 2020. The Case For Low-Cost Investing, Vanguard Research.