"The grim irony of investing is that we investors as a group not only don't get what we pay for, we get precisely what we don't pay for."
– John Clifton 'Jack' Bogle, founder of Vanguard, which manages US$4.5 trillion
Imagine the car salesman has finally convinced you to join the Tesla cult. As you take your new Model S out for a spin, you're asked to pay a 3% fee for the key (upfront fee), and another fee if you decide to sell the car (exit fee).
Of course, you expect to pay for operating costs such as electricity, maintenance, insurance (expense ratio), but then you find out that part of those operating costs are actually paid back to this salesman who sold you the car for as long as you own it (trailer fee).
No one would buy Teslas if this actually happened.
Why do you not hold your investments in unit trusts to the same standard? Do you know how much and to whom you are paying these fees?
What are trailer fees?
Let's first dive into the trailer fee. The fund manager pays the trailer fee to the distributor on an ongoing basis for as long as an investor stays in the fund.
This is likely to cause self-interested behaviour on the part of the distributor, who will be incentivised to sell you funds that pay higher "trails", as the fees are called in industry lingo.
Many platforms that advertise "zero fees" are too good to be true — they can likely charge "zero" because they are actually getting paid handsomely (usually about 50% of the expense ratio) by the fund manager on an ongoing basis. This means that if your fund expense ratio is 2%, then 1% is going back to the salesman, and most investors are not aware this is happening.
Just how big is the impact of an extra 1% paid in fees?
Let's assume you invested $100,000 in two funds that had the same 10% annualised return (which is a very good return) before fees.
Fund A charges 2% per annum and pays 50% in trails. Fund B charges 1% per annum, with no trails. After 30 years, Fund B would have earned you an extra $320,502. That is 321% of returns that you are missing out on.
There are funds that do not pay trails, and we would urge you to get your hands on them. For example, Vanguard and Dimensional are two fund managers that refuse to pay trails, out of principle. By avoiding trails and the resultant trailer fees, your expense ratio is only paying for fees associated with return generation, the way it should be.
Ask your financial adviser for a full breakdown of your fees. You may uncover that you have been paying handsomely for those coffees and lunches.
Glossary of unit trust terms
Here's a list of terms commonly associated with investing in unit trusts, which are also known as mutual funds in the US.
- Upfront/subscription fees: Fees charged upfront by banks, financial advisers, and brokers for selling you a fund — typically around 2% to 5% in Singapore
- Exit fees: Fees charged by banks, financial advisers, and brokers when you exit a fund position, usually within a given time from investment — typically about 1% in Singapore
- Brokerage fees: Fees charged by banks, financial advisers, and brokers for executing the transaction of a fund — this can be either a fixed fee, such as $20 per transaction, or a percentage-based fee, such as 0.25% of the transaction size
- "Wrap" fees: Annual fee charged by banks, financial advisers, and brokers for the use of their platform and/or investment advice —typically 0.2% to 1%
- Expense ratios: An annual fee that funds charge for fund expenses, including management fees, administrative fees, and operating costs. This is deducted from a fund's net asset value (NAV), and accrued on a daily basis. It is typically 1% to 2.5% in Singapore, but can also range from 0.05% to 3.5% per annum depending on the fund.
- Trailer fees: Fund managers pay the bank, financial adviser, or broker who sold you the fund an annual fee, which comes out of the expense ratio of the fund and is typically around 50% of the expense ratio for funds that do pay trails.
- Trading costs: A fund's total expense ratio does not account for trading costs incurred by the fund itself, such as brokerage commissions, bid-ask spreads, and market impact (for instance, a large order can move a price disadvantageously). It's important to choose funds that actively try to minimise these costs through execution and managing turnover.
Having learnt about unit trusts, here's a simple glossary of other common investing terms, such as equity fund, passive investing, and dividends.
Endowus charges an all-in fee per annum (inclusive of GST). There is no upfront sales fee and transaction fee, and we give you 100% Cashback on trailer fees, so that you keep much, much more of your returns.
We make clear that the fee we earn is the price tag for access to the funds available on our platform. We want to stay independent to recommend low-cost solutions that best suit your needs, and that lets you keep the returns that rightfully belong to you. This helps us commit to your long-term financial well-being.
Investment involves risk. The value of investments and the income from them can go down as well as up, and you may not get the full amount you invested. Past performance is not an indicator nor a guarantee of future performance. Rates of exchange may cause the value of investments to go up or down. Individual stock performance does not represent the return of a fund.
Any forward-looking statements, prediction, projection or forecast on the economy, stock market, bond market or economic trends of the markets contained in this material are subject to market influences and contingent upon matters outside the control of Endow.us Pte. Ltd (“Endowus”) and therefore may not be realised in the future. Further, any opinion or estimate is made on a general basis and subject to change without notice. In presenting the information above, none of Endowus Pte. Ltd., its affiliates, directors, employees, representatives or agents have given any consideration to, nor have made any investigation of the objective, financial situation or particular need of any user, reader, any specific person or group of persons. Therefore, no representation is made as to the completeness and adequacy of the information to make an informed decision. You should carefully consider (i) whether any investment views and products/ services are appropriate in view of your investment experience, objectives, financial resources and relevant circumstances. You may also wish to seek financial advice through a financial advisor or the Endowus platform and independent legal, accounting, regulatory or tax advice, as appropriate.