Monday, June 2, 2008

Expense ratio versus sales charge

It is imperative that you keep your investment cost low no matter whichever instruments you may want to invest in. It applies to unit trusts investment as well. I am sure some of you might have heard of a wrap account which offers funds with no Sales Charge (SC). The advantage of this account is that you are given free switches throughout the year. The catch is you need to pay a wrap fee of lets say 1% per annum. Is it really worth to pay extra fees in exchange for the free switching?

By paying an additional wrap fee, it means your total Expense Ratio (ER) is increased by an additional amount equal to the wrap fees per annum. So now the question is, is it worth to pay a fund with SC and low ER or no SC and high ER? For example, is it better to invest in a fund with 1.5% SC and 1.5% ER or a fund with 0% SC and 3% ER? Let’s assume you intend to do a Regular Savings Plan (RSP) of $1000 monthly for a long term investment. Sit back and think which option is good before scrolling down.

Congratulation if you choose the former. Remember it is acceptable to pay a one time SC than to pay higher ER continuously in the long run. A higher ER means more fees are eroding your returns. Therefore choose a fund which has a lower SC if you intend to keep the investment for long term.

The effects on your final investment value are illustrated in the following table for different cost of investment. You can see a significant reduction in the final value if the ER is higher. If you wish to do your own computation you may download my custom made excel file to see the difference.

Scenario: An investor who wishes to invest $1000 monthly assuming the fund can generate an annual return of 8% per annum.
Option 1: Fund with 1.5% SC and 1.5% ER
Option 2: Fund with 0% SC and 3% ER

Option 1Option 2
Length of investmentTotal InvestedFinal InvestmentTotal InvestedFinal Investment
after 5 years$60,000.00$69,645.52$60,000.00$68,090.02
after 10 years$120,000.00$165,065.92$120,000.00$154,992.06
after 15 years$180,000.00$295,800.14$180,000.00$265,903.52
after 20 years$240,000.00$474,917.34$240,000.00$407,457.78


Finding Mr Lazy said...

what a differences ... fortunately i didn't take up

btw, i think you can pickup intelligent investor at Amazon at good price. otherwise, borrow from library lor

Mike Dirnt said...

hi durio,

long time no see. glad you are still visiting my blog. :)

yup i have already bought at $31+ inclusive of delivery.

Finding Mr Lazy said...

keep up the good work
the "Analysts target price (updated daily)" was rather useful summary. was hoping to accumulate some good dividend stocks

anyway, been pretty busy at work lately, just wish i could have more leisure time available

Mike Dirnt said...

you better find quality time to spend. reminder dont buy based on the target price summary alone.:)