Clean funds save investors from dirty tricks
If you want to generate the best possible returns from investing, it helps if you can keep things clean. That means steering clear of the investment industry's dirty secret, the punitive charges that financial advisers and fund management companies continue to charge expats.
Hidden fees are one of the biggest threats you face when building your retirement nest egg as they are usually buried in the small print, and their impact underplayed.
As I'm going to show you, even apparently modest charges can roll up to cost you hundreds of thousands of dollars over the years.
There is no need to put up with them, either, as you can now choose from a wide range of global investment funds with minimal charges.
These so-called "clean" investment funds should show exactly what you are paying and put the sparkle back into your portfolio.
Clean funds are commonplace in jurisdictions such as the UK, where regulatory authorities have worked hard to ensure that fund managers and advisers treat their customers fairly.
Expats do not have the same level of protection and risk being picked off by commission-hungry cowboys operating on the wilder frontiers of the international advice industry.
Their favourite weapon is the 25-year offshore bond or savings plan, which locks investors in for years with hefty penalties and interest unless they complete the full term, as the vast majority do not.
The charges are murky but here's a rough guide to how they work. Say you commit to paying in $2,000 a month over 25 years, that will add up to $600,000 in total.
The insurance company that created the plan may reward the adviser with commission of up to 4% of that full sum upfront, in this case giving them $24,000 on day one.
The insurer needs to recoup this money from your future premiums and imposes heavy exit penalties so that those who cancel their policies will get next to nothing back.
Investors who do last the course pay product charges of between 4% and 6% a year, plus another 2% or 3% for the underlying funds, which means that their money needs to grow by 6% to 9% a year just to break even.
These plans are banned in many countries but still widely sold offshore. You have been warned.
Leading the charge
Clean funds are far more transparent which gives you a much clearer idea of how much you are paying, and what you are paying for.
They typically have low or even no upfront charges, and only a small annual management fee.
All further costs such as financial advisory fees and commission are stripped out, rather than bundled together in the fund.
So there is no "trail commission”, the annual fee of around 0.5% automatically paid to your adviser year after year, even if they are no longer giving you advice or reviewing your portfolio.
With a clean fund, you only pay for the advice you actually want and use. Just as importantly, they are highly flexible so you can buy or sell your fund whenever you wish, at minimal cost.
Clean funds put you in charge by allowing you to build your own globally-diversified portfolio using a low-cost online investment platform aimed at expats.
Since you know exactly what you are paying, this helps you hunt down those funds with the lowest charges.
Some funds have absolutely no upfront fees at all, while others can charge between 3% and 5%.
If you invest, say, $100,000 in a spread of funds with high upfront charges you will pay between $3,000 and $5,000 straight to the fund manager before they have actually done anything for you.
By contrast, if you choose a clean, low-charging fund with zero initial charges the entire $100,000 will go to work on your behalf, minus your platform’s minimal dealing fee. Clean funds also allow you to see how much you pay in annual fees, which again vary dramatically.
The cheapest exchange traded funds (ETFs) charge as little as 0.07% a year but some actively managed funds can charge up to 1.75%.
This may seem a relatively small difference but as I'm about to show you it can have a massive impact on your final returns.
You will be shocked, I promise.
Low charges, high returns
Say you invest $100,000 in a fund charging 0.07% a year that grows at an average rate of 6% a year.
After 10 years you will have $177,906 and if you leave the money invested for 20 years you will have a pretty substantial $316,504.
Now let's say you invest the same sum in a fund charging 1.5% a year. After 10 years you will have just $155,297, that’s $22,609 less, even if it also grows at 6% a year before charges.
The difference is even more marked over 20 years when the costlier fund would leave you with $241,171, an incredible $75,333 less.
Annual fund charges do extensive damage because they are deducted year after year as a percentage of your growing investment pot.
So the longer you leave your money invested, the greater your losses.
If the higher charging fund also had a 5% initial charge, then you are in double trouble. That means only $95,000 will be invested at the start, which will grow to just $229,112 after 20 years – you have paid $87,392 in total charges, almost as much as you invested in the first place.
Keep it clean
These figures are so astonishing that I have had repeat my calculations several times just to be sure.
They were correct.
As you can see, I was not exaggerating when I was talking about dirty little secrets.
Sticking to clean funds instead doesn’t need to limit your investment choice as a good online investment platform should give you access to a wide range of active fund managers and index-tracking ETFs.
You can also invest in multiple currencies, across different sectors, regions, strategies and risk profiles.
If you are knowledgeable enough to choose your own funds and buy on an execution-only basis, you can save on advisory fees as well.
By keeping charges to an absolute minimum, you can really clean up.
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Please note the value of investments can go down as well as up, and you may not get back all the money that you invest. Past performance is no guarantee of future results.