How fund managers are scamming you out of your profits

or "why low fees are quintessential to a passive investment strategy"

Ever thought about how much of your investments end up in the pockets of fund managers because of inflated management fees? Didn't think so. It's not a very nice thought experiment to be honest, but a very important one. So today we'll do some math together to help ourselves better understand what impact different fee % have over time on your investments.

Different types of funds

There are a variety different funds available on the market, but we're going to focus on 1 important distinction (which is a major driver behinds fees) and that's whether the fund is actively managed or not. So we're going to look at two kinds of funds:

• Index funds: a type of fund that seeks to track the returns of a market index (S&P 500 for example), in other words it's not actively managed.

• Actively managed funds: a type of fund in which the portfolio managers make investment decisions with the goal to do better than the market (keyword: goal).

As you might've already surmised, index funds are on the cheaper end of the scale, while actively managed funds tend to be more expensive (the fund manager has to be paid somehow). I bolded the word goal in the definition above for a reason. Goal does not mean they always succeed. Quite the opposite actually. Over the years Finansinspektionen (the Financial Supervisory Authority) has carried out several reviews of actively managed funds and the findings are quite dreadful.

In 2016 there was quite the debacle around this with Finansinspektionen scrutinising actively managed funds offered by Sweden's 4 biggest banks: SEB, Swedbank, Nordea and Handelsbanken. According to Finansinspektionen almost no actively managed fund outperformed their index when the fee was included in the calculations (which it obviously always should be!). And since then, not much has happened. Which is why it's up to us (sadly) as customers to educate ourselves so we can make better choices.

Why does the fee matter?

How big of a difference does it really make if I have 0.2% or 1.2% in fees? It sounds so little, no? Yes it does but fees in % are deceiving. Because just like compounding interest (🇸🇪 ränta på ränta) works for you in terms of gains over time, it works against you with fees. That's why keeping fees at a minimum should be at the core of your passive investment strategy.

What is a "low" fee?

But how do you know if a fee is high or low? Well, for that we have 🇸🇪 normanbelopp in Sweden. The "normanbelopp" is named after Peter Norman, the Swedish Minister of Financial Markets 2010-2014, and was introduced by Morningstar.se in 2015 (Morningstar is an independent fund rating institute). The normanbelopp is a really important key performance indicator for funds. And it's defined like this:

The normanbelopp is a key performance indicator (🇸🇪 nyckeltal), which shows how much you would've ended up paying in fees, had you saved 1000 SEK monthly in a given fund over the period of 10 years. When calculating the normanbelopp, standard amounts for yearly value increases are used, namely 6% for equity funds (🇸🇪 aktiefond), 4% for mixed funds (🇸🇪 blandfond) and 2% for interest funds (🇸🇪 räntefond).

Thanks to this key performance indicator, which is now a de facto standard in Sweden, comparing funds and their actual cost over time is much easier. Usually you can find it listed on each funds information page right next to the other key performance indicators.

High vs low fees over time

So let's look at some examples. We'll pick a random global index fund with a low fee and an actively managed global fund from one of Sweden's 4 big banks.

As mentioned we'll be theoretically investing 1000 SEK/month for 10 years with a yearly growth of 6% (the basis for normanbelopp calculations). That would result in 167 660 SEK in total, if there were no fees at all. Now let's look at how much of that will be eaten up by fees.

That's quite the difference no? But what if we stretch the example to 30 years? Now all of a sudden our no-fees investment would be worth 1 005 620 SEK, but we'd only get to keep 80% of it if we invested in Nordea Global. A whopping 200 982 SEK would've gone straight into the pockets of the fund managers. But had we instead invested in the index fund, we would've kept 98,2% of our investment, and only paid 17 617 SEK in fees. Did I say keep the fees low?

Fees and gains

I'd like to take the opportunity to further expand on what I wrote above about being scammed out of your hard earned savings/investment. You see, another way of looking at this, is how much of your gains you end up giving away to fund managers. So let's look at the example above again (30 years):

In other words, after 30 years of investing 1000 SEK monthly, your total stake is 360 000 SEK and thanks to compounding interest you've earned 645 620 SEK in gains (if there were no fees). But if you did this with Nordea Global they would've stolen 200 082 SEK in fees, corresponding to 45.2% of your total gains?! Outrageous if you ask me.

Cheat sheet

I've included a cheat sheet for the example we did above, which I want you to use whenever you're looking at fund fees. In the table below I've listed a bunch of different fund fees from really low to really high. And in each column I've listed theoretical yearly value increases. And in each cell you can see how much of your yearly gains you will end up giving away in fees for a given combination of fee % and theoretical yearly gain.

And as you can see, even at 8% theoretical yearly gain (which is high!) a fee of 1.5% ends up costing you more than 20% of your yearly gains.

Conclusion

Fees are quintessential to a successful passive investment strategy. They need to be as low as possible (index funds) and if you, despite reading this, want to invest in actively managed funds, do your homework. Make sure that fund actually has a track record of beating its corresponding index. And even so, always know that historical performance is no guarantee for future performance, ok?