The Total Costs of Investing

Investing is often presented as a straightforward relationship between risk and return. In reality it is also a relationship between return and cost. Every layer in the investment chain introduces frictions that quietly erode performance. Some costs are transparent and regularly disclosed whilst others are implicit, behavioural or structural and only become apparent over longer horizons. Understanding this full cost stack matters because even small annual drags compound meaningfully over time (Bogle 2014). Investors who keep costs low maintain a higher hurdle rate for success and a greater proportion of the capital markets’ long term rewards.

1. Ongoing Charges: The OCF and What It Excludes

The Ongoing Charges Figure is the headline number that captures the recurring operational costs of running a fund. It includes management fees, administration, audit, depository and other routine overheads. It excludes several economically relevant items such as portfolio transaction costs, performance fees and implicit trading costs. The variation across funds is considerable. An equity index fund may charge 0.05 to 0.20 per cent per annum whilst an actively managed global equity fund may sit between 0.60 and 1.00 per cent or more. Evidence from SPIVA shows that higher charges tend to correlate with underperformance, particularly in ‘more’ efficient markets such as US large cap equities (S&P Dow Jones Indices 2024). The OCF is important, but it is best viewed as the beginning of the cost conversation.

2. Trading and Transaction Costs: The Quiet Compounding of Friction

Beyond the OCF lie trading and transaction costs that are less visible but equally meaningful. These include explicit costs such as broker commissions, spreads, stamp duty and foreign exchange charges. They also include implicit costs that arise from market impact, which is the price movement created by a fund’s own trading. Index funds with high turnover or those tracking less liquid segments such as small caps or emerging markets may incur greater friction. Systematic managers such as Dimensional and AQR devote significant research to minimising market impact through patient trading and internal crossing. Academic literature shows that for some factor strategies, especially those with high turnover, transaction costs can materially reduce expected premia (Novy-Marx and Velikov 2016). These costs rarely appear on an investment statement. They are embedded in performance and yet have the same economic effect as disclosed fees.

3. Platform, Custody and Administration Fees: The Cost of Infrastructure

To access funds, most investors use platforms or custodians. These entities charge for record keeping, reporting, tax wrapper administration, execution and custody. Fee structures may be percentage based, tiered or flat fee arrangements. The cost differences can be significant. A portfolio of £500,000 held on a platform charging 0.25 per cent per year forfeits £1,250 annually before considering any other costs. Over a multi decade horizon the difference between low cost and mid cost platforms can compound into a meaningful loss of wealth. These fees are not inherently problematic. They fund essential infrastructure. The issue is that many investors do not consider them in aggregate with all other frictions.

4. Adviser Fees: Behavioural Alpha at a Price

Financial planning, behavioural coaching and ongoing guidance provide real economic value, but they also come at a cost. Advisers typically charge through an initial planning fee, an ongoing fee of around 0.50 to 1.00 per cent, or a fixed fee structure. These charges should be viewed in relation to the value they create. Research such as Vanguard’s Adviser’s Alpha framework suggests that steering clients away from poor decisions, implementing tax efficient strategies, maintaining appropriate risk levels and reinforcing discipline during periods of market stress can more than offset the explicit fees for many households (Vanguard 2022). Adviser fees are therefore one of the few costs that can produce a net positive return, but clarity over what is being delivered and how it is priced remains essential.

5. Taxes: A Cost Often Underestimated

Tax is one of the most significant yet least discussed costs in investing. It varies across individuals, which may explain why investors often underestimate its impact. Capital gains tax, dividend tax, withholding taxes and the varying tax characteristics of wrappers such as ISAs, SIPPs and offshore bonds all influence net returns. A globally diversified equity portfolio held outside tax efficient wrappers can experience tax drag of several tenths of a percent annually due to unreclaimable withholding taxes alone. Advisers cannot change the tax code and yet asset location, turnover management and tax efficient withdrawal strategies can materially enhance long term outcomes.

6. Bid Offer Spreads and Liquidity: The Price of Entry and Exit

When purchasing ETFs or investment trusts, investors face bid offer spreads that differ across asset classes and market conditions. Less liquid exposures such as small caps or specialist credit typically display wider spreads. Even highly traded ETFs can temporarily widen during periods of stress such as March 2020. These costs manifest as slippage rather than explicit fees. For investors who contribute regularly, withdraw frequently or rebalance systematically, spreads become a recurring cost. Open ended funds introduce additional mechanisms such as dilution levies or swing pricing. These tools are designed to protect long term holders by allocating transaction costs to those who trade. They nevertheless create variation in execution outcomes that many investors overlook.

7. Performance Fees and Incentives: Costs That Shape Behaviour

Some active strategies charge performance fees. The structure of these fees can significantly influence manager behaviour. Incentive schemes without appropriate high water marks or hurdle rates may reward luck rather than skill. Academic research has shown that poorly designed fees can create asymmetric payoffs and encourage undesirable risk taking (Goetzmann, Ingersoll and Ross 2003). Performance fees can be justified in genuinely capacity constrained strategies. Investors must however examine the details closely since poorly structured incentives can become one of the most expensive and unpredictable costs in a portfolio.

8. Behavioural Costs: The Largest Cost of All

The most damaging costs in investing are often self inflicted. Performance chasing, panic selling, market timing and overconfidence can produce a behavioural gap between investor returns and fund returns that has been well documented in multiple studies (Dalbar 2022; Morningstar 2023). This gap frequently exceeds explicit fees by a wide margin. The advantage of evidence based investing is that rules, rebalancing frameworks and behavioural coaching help reduce these costs. Unlike OCFs or spreads, behavioural costs have no natural limit. They depend entirely on how investors respond to uncertainty.

9. The Total Cost of Ownership: A More Complete Perspective

When explicit fees, implicit trading frictions, platform charges, taxes and behavioural costs are combined, the true cost of investing becomes clearer. A low cost index fund with a headline fee of 0.15 per cent may, after including platform charges, spreads and tax drag, resemble a total cost closer to 0.40 to 0.60 per cent. This is still excellent value. It is simply more realistic than the marketing number. Active strategies face a far steeper cost hurdle once turnover, transaction costs and incentive fees are incorporated. The objective is not to eliminate costs, which is impossible in any functioning market, but to minimise unnecessary frictions and to pay consciously for value where it exists.

References

Bogle, John C. 2014. The Arithmetic of All In Investment Expenses.
Dalbar. 2022. Quantitative Analysis of Investor Behaviour.
Goetzmann, William, Jonathan Ingersoll and Stephen Ross. 2003. High Water Marks and Hedge Fund Incentives. The Journal of Finance.
Morningstar. 2023. Mind the Gap.
Novy Marx, Robert and Miroslav Velikov. 2016. A Taxonomy of Anomalies and Their Trading Costs. Review of Financial Studies.
S&P Dow Jones Indices. 2024. SPIVA Scorecard.
Vanguard. 2022. Adviser’s Alpha.