The Importance of Cost
The importance of cost.
We can build the best portfolio in the world, perfectly aligned to our investment goals and all within manageable risk limits – and a significant proportion of our good work can be lost due to the cost of implementation.
My name is Neil Cowell, head of retail sales at Vanguard Asset Management.
Costs matter and investment is different to many other areas of life. Paying more does not necessarily buy more. Experience shows the opposite. Over time, lower cost funds will tend to outperform.
Why is this? One reason is that costs create an inevitable gap between market performance and investor returns.
There is a fairly simple reason for this. It is called compounding. Costs are applied year after year, and what may seem a small amount to start off can turn out to be a significant amount over a period of time.
Let’s look at an example. Three individuals each invest 10,000 pounds. For the sake of argument, let’s say the fund returns 6% per annum, and this is reinvested. Investor A pays 0.25%. Investor B pays 0.75% and Investor C pays 1.5% per annum. These may seem small amounts, but look at the difference in the outcome.
After 30 years, Investor C will have 37,000 pounds, Investor B will have 46,000 pounds and Investor A will have 53,000 pounds. That is a big difference. Investor C has given up 16,000 pounds, the equivalent of over 30% of their potential return, just on higher costs.
As we discussed at the beginning of this course, investment is about meeting life goals. By reducing costs, investors can make important choice about meeting their goals sooner, or doing so with less risk.
Do costs matter? They certainly do.
The portfolio balances shown are hypothetical and do not reflect any particular investment. The final account balances do not reflect any taxes or penalties that might be due upon distribution.