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RP: The impression you generally get from the financial media is that if you want higher investment returns, you have to pay higher fees. But the evidence tells a different story.
Nir Kaissar writes for Bloomberg’s Gadfly column. In a moment, he’s going to explain why costs are so important. But first, what exactly is Gadfly?
NK: It is devoted to a data-driven approach to writing in other words what we try and do is, we look at the news and then we ask ourselves, "Is there evidence to understand the news better or to explain, you know the financial phenomenon better, for example?" and we go and we look at the data and look at the evidence and then we try to write about what the inescapable conclusions are, but we show the evidence. In other words, we will show you in the Gadfly pieces what the data shows and that allows you to make up your own mind, you can agree with our conclusions or not but we think that's a more transparent way to write opinions about the financial markets and so on. In other words, don't trust us, here’s the evidence, take a look and see what you think.
RP: The problem with fund performance is that it’s unpredictable. Fees and charges, on the other hand, are nailed on. You know those are the costs you’ll pay pretty much regardless how your fund actually performs.
But for Nir Kaissar, there’s another important reason why costs are so important.
NK: Purveyors of financial products want you to believe that the returns that you are going to get, that you are likely to get from markets and so on are higher than they actually are. This is true on an absolute basis in terms of you know the returns you’ll get and it’s also true on a relative basis, in other words, an active manager is likely to tell you that they can give you a return above the market that’s higher than they can give you even if they were to succeed. The reason that’s important is if you look at the data and it tells you that the returns are actually going to be more modest than what people say, then fees become incredibly important because there actually a higher percentage of what you going to enjoy than you actually believe. And so the first priority has to be to keep your costs as low as possible.
RP: Something else you need to consider is compounding. We normally hear about compounding in a positive sense, in relation to returns. But compounding can also work the other way round.
NK: When you look at fees, you're looking at a snapchat of a particular year but what you don't see is, if you look at the fees you pay over a 30 year period, there’s a big difference, for example, the difference in getting 1% a year over 30 or 40 years could be double the amount of money and so if you're paying a management fee, say for example 1% or 2% in fees, then you could be twice as rich at the end of your life then you otherwise would be. So it has an enormous impact but we don't see those numbers and we probably should see those numbers.
RP: In summary, costs have a far bigger impact on your eventual net returns than the fund industry likes to admit.
Costs are also one aspect of the investment process that you can control. Keep costs in check and you really will reap the benefits.
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