One of the most crucial lessons for investors is that cost matters. The late indexing pioneer Jack Bogle frequently highlighted what he called the "Cost Matters Hypothesis." Simply put, the more you pay, the lower your net returns are likely to be. As he aptly noted in Common Sense on Mutual Funds, “the miracle of compounding returns is overwhelmed by the tyranny of compounding costs.”
However, a new paper, The Structure and Impact of Fees on Investor and Manager Returns, reveals that it’s not just the amount you pay in fees and charges that matters, but also how frequently you pay them.
Researchers at University College London analysed the net performance of hypothetical funds under various fee arrangements, focusing on the frequency of fee collection.
The results were striking: frequent fees—such as monthly charges compared to annual ones—had the most significant impact on investor capital. “The portfolio with monthly fee collection,” the authors noted, “loses a significant amount early on… Over ten years, the portfolio with 30% fees and monthly fee collection lost over 60% of its original capital, compared to a 23% loss for semi-annual fee collection.”
The study found that by charging high fees, particularly performance fees, and extracting them more frequently, fund managers substantially increased their revenue at the expense of investors. As the paper concludes: “Moving from annual, semi-annual, or quarterly frequency to monthly fee collection reduces investor capital by nearly 50% over ten years for large performance fees.”
The Power of Frequent Fees on Your Return
Why does frequent fee collection have such a significant impact? According to the authors, it “constantly drains positive performance, reducing gross return.” In simple terms, it’s compounding in reverse.
The paper explains: “Too-frequent fees negate the positive effects of compounding; effectively, compounding works against the investor to benefit the manager. This effect was demonstrated across all market models explored. Moreover, market volatility amplifies the impact of frequent fee application.”
Fees and charges are notoriously complex and often opaque. Workplace pension schemes, discretionary fund managers, and large financial advice firms frequently apply charging models that are difficult to understand.
Beyond the headline AMC (annual management charge), investors face additional expenses, such as transaction costs (dealing fees, bid-offer spreads, and Stamp Duty), custody charges, platform fees, valuation fees, and reporting fees.
Calculating total costs becomes even trickier if your adviser uses a discretionary fund manager (DFM) that invests in underlying funds managed by different providers. Worse still, some of the costs you’re incurring might not even be disclosed.
This version maintains the depth of information but improves readability and structure for the audience.
Breaking Down Your Investment Costs
For all these reasons, it's crucial to understand how much you're actually paying. While client agreements and Key Information Documents (KIDs) are important, don’t rely on them entirely. If in doubt, always ask for a detailed breakdown to uncover hidden costs.
As the UCL research shows, pay particular attention to frequent fees and charges. While I don’t recommend actively managed funds, if you choose to invest in one, check its historical trading frequency. The annual portfolio turnover for actively managed equity funds in the UK is typically over 50%, meaning more than half of the fund's holdings are bought and sold within a year — and you, the investor, foot the bill.
Another often overlooked cost is the contribution fee. Many pension schemes and advice firms charge a fee on every contribution, often around 1-2%, but sometimes as high as 5%. If you contribute automatically, you could be paying as many as 12 contribution fees per year.
The UCL study also highlights that performance fees can significantly erode returns over time. Investors should be wary of funds that advertise steady returns with low volatility but charge high-performance fees.
In short, understanding how fees are structured and applied is vital for making informed investment decisions. Prioritise transparency, align fee structures with your investment goals and minimise frequent deductions to safeguard your long-term returns.
This article is produced by us for Financial Advisers who may choose to share it with their clients. Timeline Planning and Timeline Portfolios do not offer direct-to-consumer products.
ROBIN POWELL is a freelance journalist and the editor of The Evidence-Based Investor.
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