American investment firm Fidelity Investments brought in US$12.6 billion in revenue last year, according to Forbes. Ned Johnson, the son of the company’s founder, is worth US$9.3 billion, making him the 47th richest man in America. Fidelity has done an amazing job bringing mutual funds (or what’s popularly known as unit trusts here in Singapore) to investors around the world. That’s created an extraordinary business: The average Fidelity retirement account in the US had US$89,300 in it last year, and Fidelity’s average management fee was 1.01% of assets, according to Advisor Investments. The average American customer, then, paid Fidelity…
American investment firm Fidelity Investments brought in US$12.6 billion in revenue last year, according to Forbes. Ned Johnson, the son of the company’s founder, is worth US$9.3 billion, making him the 47th richest man in America.
Fidelity has done an amazing job bringing mutual funds (or what’s popularly known as unit trusts here in Singapore) to investors around the world. That’s created an extraordinary business: The average Fidelity retirement account in the US had US$89,300 in it last year, and Fidelity’s average management fee was 1.01% of assets, according to Advisor Investments. The average American customer, then, paid Fidelity US$901 for its services last year. Not even Apple earns that much annual revenue from each customer.
But there’s something incredible about this success. No Fidelity customer actually received a bill for US$901 last year. No customer wrote a check for that amount. No one put US$901 on their credit card, or wired that much to Fidelity through PayPal. No one receives a bill from Fidelity in the same way they receive a phone bill from SingTel, and no one pays Fidelity for its services in the same way they pay their utility bills or their housing loan.
This isn’t picking on Fidelity – it’s just how the entire money management industry works, even here in Singapore. Most mutual-fund and unit trust revenue is received based on a simple calculation: At the end of each day, an annual management fee is divided by 365, and multiplied by the amount of assets under management. That amount – its daily fee – is deduced from the fund. It’s automatic. Customers are charged (big) fees for each day they invest in their funds, but no one pays – or even sees – an actual bill.
There’s nothing sinister about this. Such funds are upfront about their fees and are required to clearly disclose annual management fees in annual investor reports.
But there’s hardly any industry where customers can pay literally tens of thousands of dollars per year and not even realize it. Since fees are disclosed as a percentage of assets, rather than a dollar amount, they’re harder for lay investors to put into context. And since they’re deducted automatically, rather than billed directly, they’re out of sight, out of mind.
Imagine this: You’ve a $10,000 account placed in a fund for 25 years growing at 5.4% on average annually (similar to the compounded annual returns of the Straits Times Index (SGX: ^STI) over the past 26 years since 1988 at its current level of 3,193 points) while charging 1% a year in fees. How much do you think you’ll be charged in total? Turns out, you’d be paying $8,200 in fees. Think about that for a minute – $8,200 in total fees for an initial investment of $10,000 which grew at only 5.4% a year!
That seemingly small 1% annual fee figure could easily blind people to the real effect of fees. The trouble would compound when fees are much higher than 1%, which they are in Singapore.
But what if this were different? What if unit trusts and mutual funds and money managers had to charge fees like all other businesses: a monthly bill sent directly to customers?
You can guarantee one thing: There would be an investor revolution.
Imagine if every month, while paying your housing loan, your power bill, and your cell phone bill, you had to write a check to your mutual fund manager for, say $200, and perhaps another check to a custodian bank for, maybe $25?
You would instantly become keenly aware of fees. You’d probably become obsessed with them. You wouldn’t put up with a high-fee investment manager who chronically underperforms his benchmark. You’d shop around to see who offered the lowest costs.
Unfortunately, very little of that behaviour is happening right now.
Take the USA for example. According to a study by industry researcher LIMRA, 22% of 401(k) (a type of pension account in the USA) participants think they don’t pay any fees or expenses. One-in-five Americans is likely paying hundreds of dollars a year in fees while thinking they’re not paying a penny. Fully half of investors in LIMRA’s survey said they still didn’t know how much they were paying in fees, and most of those who said they knew were wrong, often by an order of magnitude.
Until investors actually have to write a check themselves, they are going to be oblivious to the fees they’re paying. That promises more bad investing decisions, and a wealth transfer from workers to bankers based solely on a lack of understanding.
According to Demos, the average two-earner couple in the USA will pay US$155,000 in 401(k) fees over their lifetime. That’s enough to buy two-thirds of an average American house. Is it asking too much to bring a little light to these fees by making customers pay them directly? It would be naïve to expect any fund company to do this – it’d be a logistical nightmare, and the current system works wonders at maximizing revenue. But, customers – mom and pop investors – would likely make better decisions if they would.
And if the industry can’t change, then at least you –the customer- can change your behaviour when it comes to buying funds or unit trusts: You just need to be acutely aware of fees.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. This article was written by Morgan Housel and first published on fool.com. It has been edited for fool.sg.