Why is the cost of investing so important? [video]

In the world of investing, you get what you don't pay for...

    It is often extremely difficult for investors to understand that the less they pay to invest, the better

    Because as humans, we naturally assume that the more we pay for something, the better the quality or service will be...

    Neil Cowell from Vanguard Asset Management explains further...

    RP: One of the most difficult things for investors to understand is that generally speaking, the less they pay to invest the better. It is, after all, counter-intuitive. With almost every other product or service we buy, the more we pay, the better the quality we can expect to receive. Here’s Neil Cowell from Vanguard Asset Management.

    NC: I think, in the world of investing, it can be said that you get what you don’t pay for. Costs do create an inevitable gap between market performance and investor return. I think the evidence, again, is very clear when you look at data. We’ve seen some recent data from Morningstar that clearly show that low-cost funds outperform their high-cost counterparts and that alone gives a real indicator of why we attach so much importance to it. In fact, Morningstar actually do use cost as a major predictor of a funds future performance. Every which way you look at it, costs are extremely important to an investors outcome.

    RP: To appreciate quite how much you pay to invest, you need to understand the power of compounding. Say, for example, you’re paying a total of 2% a year. That seems like a modest amount. But remember, you pay that amount each and every year. Over 30 or 40 years, that can make a huge difference.

    NC: When people see funds priced at 1% p.a. and another fund alongside it maybe priced at 50 or 60 basis points, it doesn’t seem a lot in terms of the differential. But, when that’s actually compounded over time, with market return and the impact of that compounding effect, it plays a terrific part in the overall return and takes quite a significant chunk from the final value.

    RP: Of course, you also need to factor in the cost of financial advice. Cost-conscious investors may be tempted to manage without an adviser. But Vanguard says that’s often a bad idea.

    NC: Clients are better served by working with an advisor. We spend a lot of time promoting the value of advice. We have a framework here that we call Advisers Alpha, which talks specifically around the value that an advised relationship will deliver over and above what a client left to their own devices might achieve. So, we don’t say that's for clients who have time, willingness and ability to self-serve that they can’t achieve a great outcome too because that’s certainly possible. We just say, it’s hard and our message around the value of advice and what that adds is really very clear.

    RP: So, keep costs your low. But remember, a good adviser can add substantial value. You should, therefore, be wary of trying to manage without one.

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