Close Close

Practice Management > Compensation and Fees

Investment Fees (Much) Higher Than You Think

Your article was successfully shared with the contacts you provided.

Charles Ellis, author of “Winning the Loser’s Game: Timeless Strategies for Successful Investing” and chairman of the Whitehead Institute, doesn’t think much of investment fees as they are currently structured. The reason? Although clients might think investment fees are low, when they’re based on investment returns as opposed to assets under management, they’re shockingly high.

“When stated as a percentage of assets, average fees do look low—a little over 1% of assets for individuals and a little less than one-half of 1% for institutional investors,” Ellis writes in Financial Analysts Journal, the publication for Chartered Financial Analysts.  “But the investors already own those assets, so investment management fees should really be based on what investors are getting in the returns that managers produce.”

Think of it as taking a car in for repairs; he argues that investment fees are akin to paying the mechanic for simply having the car, not for the actual improvement in performance.

“Calculated correctly, as a percentage of returns, fees no longer look low,” he explains. “Do the math. If returns average, say, 8% a year, then those same fees are not 1% or one-half of 1%. They are much higher—typically over 12% for individuals and 6% for institutions.”

But even this recalculation substantially understates the real cost of active investment management, he adds.

“Here’s why: Index funds reliably produce a ‘commodity product’ that ensures the market rate of return with no more than market risk. Index funds are now available at fees that are very small: 5 bps (0.05%) or less for institutions and 20 bps or less for individuals. Therefore, investors should consider fees charged by active managers not as a percentage of total returns but as incremental fees versus risk-adjusted incremental returns above the market index.”

After a brief history of management fees—with a particular focus on 1960 to the present—Ellis concludes that “extensive, undeniable data show that identifying in advance any one particular investment manager who will—after costs, taxes, and fees—achieve the holy grail of beating the market is highly improbable.”

“Yes, Virginia, some managers will always beat the market, but we have no reliable way of determining in advance which managers will be the lucky ones,” he colorfully states, channeling the famous New York Sun editorial from 1897. “Price is surely not everything, but just as surely, when analyzed as incremental fees for incremental returns, investment management fees are not ‘almost nothing.’”  


© 2023 ALM Global, LLC, All Rights Reserved. Request academic re-use from All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.