What investment fees really cost

Two people can hold the same fund and pay very different amounts, and the reason sits in how the bill is written. Almost every investment fee is quoted as a percentage of what you hold, not of what you make.

A fund's ongoing charge accrues out of the fund's assets, usually a slice on each day the fund is valued, so the published price is already net of it and no invoice ever arrives. A platform or adviser fee is normally taken by selling a small piece of the holding, so it shows up as a slightly smaller position rather than as a payment. Either way the amount charged is a fraction of the balance, and the balance does not have to have grown for the fraction to be taken.

That is the whole of the asymmetry. Against a fee of 1 percent of assets, the year's return decides only what share of your gain the fee turns out to be:

Performance fees, which take a share of gains above a hurdle, work the other way, and they are the exception. The standard arrangement across funds, platforms and advice is a percentage of assets, charged at the same rate in a bad year as in a good one. The amount is smaller in a bad year only because the balance it is taken from is smaller. That is what makes a weak decade expensive twice over: low returns, and a bill that never noticed.

A fee costs more than the payments add up to, because the money it removes would otherwise have kept earning. What leaves this year is the payment plus everything that payment would have produced by the end.

The arithmetic is unusually clean. If the holdings grow by $g$ in a year and the fee takes a fraction $f$ of assets, the balance is multiplied by $(1+g)$ and then by $(1-f)$. Run that for $n$ years, call the fee paying balance $B_f$ and the same run without the fee $B_0$, and every growth term cancels:

$$\frac{B_f}{B_0} = (1 - f)^n$$

The return has dropped out. For a sum left alone, what share of a balance a percentage fee removes depends on the fee and the number of years, and not at all on how markets did. Each share below is measured against the balance the same holdings would have reached with no fee:

Two qualifications keep those figures honest. Money paid in later has spent fewer years being charged, so a saver contributing monthly gives up less than the table shows: in the worked examples below, an extra point of annual cost takes about 18 percent of the balance the cheaper arrangement reached, rather than the 22 percent in the table. And subtracting the fee from the return, running 7 percent as 5.75 percent, is a quick approximation rather than the exact charge: the exact figure multiplies by $(1+g)$ and then by $(1-f)$, which is lower by $g \times f$, so the shortcut understates the cost a little. The examples below use it, so they read gently. The engine underneath is the one described in how compound interest works, pointed the other way.

The fund charge is the figure everyone quotes and it is one line of several. A realistic bill has up to six, and they are charged against the same money.

• The fund's ongoing charge. Management, administration and custody inside the fund, called an expense ratio in the United States and an ongoing charges figure across much of Europe. It accrues daily out of fund assets, which is why it never appears as a transaction on a statement.
• The platform, custody or wrapper fee. Charged by whoever holds the account, as a percentage of assets, a flat annual amount, or a tiered scale that sometimes caps. On a portfolio of cheap trackers this line is often larger than the fund charge.
• Dealing charges. A commission for each trade, a currency conversion charge on foreign holdings, and, in some countries, a transaction tax on purchases.
• The [bid-ask spread](/definitions/bid-ask-spread). Paid inside the price rather than billed, by you when you trade and by the fund when it trades.
• Advice. An ongoing percentage of assets, a flat retainer, an hourly rate or a fee for a piece of work, sometimes with an initial charge on money as it goes in. Sales loads and exit charges belong on this line too.
• Performance fees. A share of gains above a stated hurdle, charged on top of the ongoing charge. Read the hurdle, and read whether a high-water mark applies, because together they decide when the fee restarts after a bad run.

Tax is not a fee and behaves like one in a taxable account: how much a portfolio loses to tax as it runs depends on turnover, on the account type and on where you are taxed, so it belongs in the total as an estimate against your own rules rather than as a published figure.

Two costs sit outside every fee table and get paid anyway.

The first is the spread. Every quoted market has a price you can buy at and a lower price you can sell at, and the gap between them is a cost paid inside the price. Buy a holding and sell it later and you have paid all of it. A commission-free trade is not a free trade: it is a trade whose cost is in the spread rather than on the contract note, and on a thinly traded holding the spread can be many times what a commission ever was. A spread of 0.3 percent, paid in full across a purchase and a later sale, costs as much as three years of a fund charging 0.1 percent a year, though it lands at once rather than spread over those years.

The second is what the fund itself trades. A fund pays commissions, spreads and the price impact of its own orders, and none of that sits inside the expense ratio, which covers running the fund rather than dealing inside it. Those costs scale with turnover. A fund replacing most of its portfolio each year pays them each year and reports the result only as a slightly lower return, while a tracker that mostly trades when its index changes pays far less, though not nothing. Some disclosure regimes require these transaction costs to be published as their own figure, and where yours does not, the fund's published turnover is the best signal available for the line that is missing.

Both costs reward patience for a mechanical reason rather than a moral one: they are charged per transaction, so the bill is the cost of a trade multiplied by the number of trades. That is not an argument for holding a position you have decided against. It is an argument for pricing a switch before making it, because switching is never free.

A fee is not automatically bad. It is a price, and the question is what it buys.

Frame it as you would any purchase: not fee against zero, but net against net. The comparison that decides anything is the outcome after all costs of the arrangement in front of you, against the same figure for the cheapest arrangement that would do the same job. Paying nothing is rarely on the menu, because a self-managed portfolio of trackers usually carries a fund charge, often a platform or custody fee, and the spreads it pays to trade.

That framing produces a break-even you can say out loud. An arrangement costing one percentage point a year more than the alternative has to earn about one percentage point a year more before costs, or deliver its equivalent in something else you value, just to draw level after costs. Over the 25 years in the examples below, that one point is the difference between $502,646.29 and $409,866.80 on identical deposits and identical gross returns.

The equivalent in something else is real and harder to measure. Advice can be worth more than it charges when it stops a portfolio being sold in a drawdown, fixes the amount being saved, places the right assets in the right accounts under local tax rules, or replaces a concentrated position with a diversified one. It is worth less than it charges when the result is a model portfolio a cheap tracker would have matched, which is the arithmetic set out in index funds against active management.

The asymmetry to hold on to is certainty. The cost is contractual, known in advance, and charged every year. The benefit is a forecast. That does not make a fee a bad deal, but it does mean the two sides of the comparison are not known to the same standard.

Building the all-in figure is short work, and it decides the outcome.

• Start with the ongoing charge on each fund, weighted by how much of each you hold.
• Add the platform or custody fee that applies at your balance. A flat fee becomes a percentage when you divide it by the balance, which is the only way to compare the two.
• Add any ongoing advice fee.
• Keep one-off costs in a separate column: dealing commissions, currency conversion, entry and exit charges, and the spread crossed on each trade. They are charged per transaction rather than per year, so they only become an annual figure once you decide how often you trade.

Where each figure is published depends on where you are: the fund document carries the ongoing charge, the provider's charging schedule the platform fee, and an advice agreement the advice fee. Ask for the total as a percentage of your balance and as an amount in money: the two land differently.

Then re-check the shape as the balance changes. A percentage fee rises with the balance whether or not the work behind it grows, while a flat fee shrinks as a percentage as the balance grows, so the cheaper structure at one size is often the dearer one at another. A capped platform scale crosses over at a balance you find by dividing the cap by the percentage.

Finally, run it. Put your horizon into the compound interest calculator at the top of this page, once at the gross return and once at the gross return minus your total cost, and read the two ending balances side by side. Inflation deserves the same treatment, and the real return calculator does that half. This page is educational material about how costs behave, not financial advice about any particular fund, platform or adviser.