The arithmetic of fees
A one percent annual fee sounds like one percent. Held for thirty years, it takes about a quarter of what you would have had.
GetNetwork2 min readAI-assisted
Investment fees are quoted as a small percentage of your balance, charged every year. One percent sounds negligible. The trouble is that the fee compounds in the same way your returns do, only against you.
A worked example
Take 10,000 invested for 30 years in something that returns 7% a year before costs. The only thing that changes between the rows below is the annual fee.
| Annual fee | Return after fee | Value after 30 years |
|---|---|---|
| 0% | 7.0% | 76,123 |
| 0.1% | 6.9% | 74,017 |
| 0.5% | 6.5% | 66,144 |
| 1% | 6.0% | 57,435 |
| 2% | 5.0% | 43,219 |
A 1% fee leaves you with about 25% less than paying nothing. A 2% fee leaves you with about 43% less. The 7% return is an assumption chosen for the illustration and not a forecast, but the shape of the result holds for any positive return.
Why the gap is so large
The fee is not taken once. It is taken every year from a balance that would otherwise have gone on growing. Money paid in year one is money that never earns anything in years two to thirty.
The cost therefore rises with time. Over five years the difference between a cheap fund and an expensive one is modest. Over a working lifetime it is one of the largest items in the whole calculation.
What to do with this
Fees are the one part of an investment's future that is known in advance. Returns are uncertain and costs are printed on the label.
This does not mean the cheapest option is always the right one. It means a higher fee has to buy something that is worth more than it costs, and the comparison should be made over the full period you intend to hold, not over a single year.