Fees and taxes slash returns

By Mary Holm

Monday 10th December 2001

It's easy for me, an outsider, to criticise financial advisers and fund managers. But when people within the industry do it, that adds credibility.

After my last column - about a couple who were disappointed with their investment results - Paul Dyer, head of investment strategy at AMP Henderson Global Investors, and Rob Dowler, a stockbroker with ABN AMRO Craigs, both got in touch.

Dyer, in particular, was angry. "It makes my blood boil to see this kind of poor investment advice unleashed on the public," he said. "The case "encapsulates all that is wrong with the managed fund industry."

At the suggestion of a financial adviser, the couple invested in several unit trusts, aiming at high growth. Almost two-thirds of their money is in international shares.

They recently worked out that for every $1 invested in 1992, they had $1.46 nine years later, including reinvested dividends. That's a return of 4.4 per cent a year.

Says Dyer: "We calculate that even assuming a full 33 per cent tax rate on all investments, returns should have been around 7 per cent a year post-tax."

At that rate, the couple would have had $1.90 for every dollar invested - double the return. "The difference can be attributed to either under-performance by the managers or fees," says Dyer.

He says that entry and ongoing fees probably account for most of the shortfall.

When these are added to the 1.3 per cent a year the couple has been paying their adviser, they've apparently paid total annual fees of around 5 to 5.5 per cent pre-tax.

"This level of fees is ridiculously high," says Dyer.

"Our best guess is that market returns will be in high single digits going forward. This investment is paying more than half that in costs.

"Keeping fees and taxes low is axiomatic to good investment. This case is a perfect example of why this matters. No portfolio can prosper with this kind of drag on it."

Dyer goes on to say, "Overall your conclusion that the investors would have been far better served by buying low-cost index funds is spot on. These charge well under 1 per cent in fees.

"Of course they were not around as an option in 1992, but they are now. Plus there is no need for ongoing adviser fees.

Stockbroker Dowler had a different point to make.

I had said that if the couple had invested entirely in international shares - as measured by the MSCI gross world index - their $1 would have grown to about $2.75.

"Let's say the adviser takes 6 per cent up front," says Dowler. The couple would then invest only 94c. At the same growth rate, that would have reached $2.59 - a gain of $1.65.

In most unit trusts, that gain would be taxable at 33 per cent, shaving another 54c off the couple's money. That leaves us with $2.05.

Dowler then assumes the unit trusts charged a "fairly standard" 2 per cent a year in ongoing fees. Adding the adviser's 1.3 per cent, he estimates that over nine years fees would have taken 45c. The couple would now be left with $1.60.

"My key comment," says Dowler, "is that your column should have mentioned taxes as well as fees.

"Taxes are the strongest argument to promote index funds or untaxed funds like UK-based investment trusts. They avoid paying tax on gains, and that has a huge impact."

So there we have it. One approach emphasises fees, the other taxes.

But both come to much the same conclusion: Index funds and other untaxed low-fee funds are winners.

Mary Holm is a freelance journalist and author of "Investing Made Simple", commissioned by the New Zealand Stock Exchange to write an independent personal investment column. She can be reached at maryh@pl.net. Sorry, but she cannot respond directly to readers.

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