Investing for Beginners , investing

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John Bogle



Total Expense Ratio

Investment Management Fees

 

Investment management fees (fees that are paid straight to investment manager) basically are one of these types:

 

  • Performance based fee. Performance based fee is calculated according to increase of investment portfolio unit value. For example, if investment portfolio value has grown over period of one year from $100k to $150k and performance fee is 15% then owner of investments should pay $7.5k to manager for the job. There are different techniques of performance management fee calculation, but usually this fee is calculated and paid once in a quarter for a total increase (water mark principle which means fee is not paid after decreases until exceeds previous value). Performance based fee normally is 15%-20% from value increase. Mostly such fee is applied for private portfolios, hedge funds or some equity funds. 
  • Asset based fee. Asset based management fee is calculated as a percentage from average investment portfolio assets value. For example, if average portfolio value was $300k and the fee is 2% then management fee would amount $6k annually. Annual asset based fee for actively managed portfolios usually is between 0.5%-2.5% depending on portfolio amount and assets class (fees for equity portfolios are higher than for fixed income).
  • Fixed fee. Fixed fee is some tax that is annually paid by investor to his investment manager. An investor may pay for his investment advisor $1000 annually, but there are no exact boundaries how big such fee should be. Fixed fee isn’t very popular and is applied exclusively for small-medium private investment portfolios.
  • Combination of mentioned fees. Some investment managers apply a combination of performance, asset or fixed fee.

 

The main advantage of performance fee is that it more stimulates investment manager to achieve better results (he gets bigger salary), but it also gives a pressure to increase risk of the investment, because in a case of loss manager would not get any bonus anyway, so it is not big pain if decrease will be stronger. But it works differently in a case of increase – bonus will be proportional to percentage of increase and it drives risk to higher level.

 

Effect of Amounts 

If we are talking about management of private investment portfolios then huge impact will have amount of invested capital. Investment managers are more willing to manage large portfolios, because it is easier to manage one large portfolio (of $10m) than 5 smaller portfolios ($1m×5). So percentage fees are smaller for larger amounts. 

 

Is It Really an Individual Investment Portfolio? 

You may face smaller fees for investment portfolio management if your portfolio will be standardized. Many brokerage or management companies have few typical portfolios segmented by risk and all clients in the same risk level gets identical portfolios. Such segmentation requires less effort, also usually such investment portfolios consist only funds but no direct securities.

 

Others Fees May Be Hidden

Remember, that you shouldn’t concentrate only on management fees. There are also a lot other investment fees. Some costs also might be hidden. For example, if your privately managed investment portfolio includes funds you have to heave those funds are charged. 

The easiest way to measure all the fees of the investment fund is to find a ‘total expense ratio’ on fund’s factsheet. Read what 'total expense ratio' is normal.

 

Few more characteristics about investment management fees:

  • Index funds (including ETFs) have much lower fees than actively managed investment funds.
  • Management fees for different asset classes vary very strongly.
  • Sales-load fee depends on distributor and may vary for the same product. Avoid it.
  • Investments in emerging markets are more difficult to handle and cost more.
  • Private investment portfolios that include only investment funds should have lower fees than portfolios investing in securities directly.

 

 



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