We are all aware of the saying that there are two things
which you can't escape - death and taxes.
Well, we would add a third here, and that is COSTS.
When we speak to our many doctor and dentist clients, or
indeed to new clients, they understand that when they make
an investment, there will be associated costs.
We always ensure that these costs are explicit, and agreed
with the client at outset as to what they are:
- What they pay us
- What they pay for administration
- What the fund costs are
If you had invested say £100,000 yesterday, you would
have these costs listed with an accompanying quotation
called a Personal Illustration.
So thats ok then, its all there in print, and you are in
possession of all the facts. If only it was as simple as
that!
What clients are almost always unaware of however, is that
there is a major "hidden" cost, that is not calculated
within your illustration.
Regular readers of this newsletter will be aware that we
favour 'passive/asset class' investment rather than
'active'.
What does this mean?
Well, an active fund manager is frequently buying and
selling shares to get the best return he/she can. This of
course means that if they, say, sells £100,000 worth
of Barclays shares and buys HSBC shares, there are costs
involved in doing so.
(Studies in the US have concluded that the higher charges
associated with portfolio turnover were not recovered by
better performance***).
Over a given year the average manager will trade circa 70%#
of the shares in their fund, meaning that by the end of the
year if the fund owned 100 shares, only 30 would be
unchanged. This percentage varies widely, and can be as
high as 300% plus.
In a Financial Services Authority report called 'The Round
Trip'*, the Portfolio Turnover Rate (PTR) were calculated
at 1.8%, and similar costs apply around the world**.
So the above trades would typically cost the fund - and you
- £1,800.
A government commissioned report by Paul Myners estimates
that these portfolio turnover charges costs UK investors
£2.5 billion each year!
These costs of course reduce your returns, and are termed
'Performance Drag'.
This means that it is common for many active funds to have
explicit costs of say 2%, but also portfolio turnover costs
of an extra 1-3%.
The Financial Tips Bottom Line:
As these charges can clearly eat into the returns on your
investments the best course of action is to review your
portfolio so that you know where you stand.
ACTION POINT
Look at your ISAs, PEPs, or Unit Trusts.
Find out what the portfolio turnover rate is - details can
be found in the companies prospectus.
*Financial Services Authority (FSA) Occasional Paper 6
**Wilcox (1993) 1.2%, Carhart (1997) 0.95%, Orton (1999)
1%, James (2000) 1.3%
***Performance of Mutual Funds, J Chalmers, R Edelen & G
Kadlec Nov 1999
# A typical passive fund for comparison would be nearer
7-8% pa PTR. This adds around 0.13% in trading costs.
----------------------------------------------------
Ray Prince is an Independent Financial Planner with
Rutherford Wilkinson plc, and helps UK Resident Doctors and
Dentists get the best deals on mortgages, protection and
investments, as well as helping them achieve their
financial objectives. Just visit
http://www.medicaldentalfs.com to get your free retirement
planning guide. Rutherford Wilkinson plc is authorised and
regulated by the Financial Services Authority.
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