Two twin Singaporean brothers earn university degrees and prepare themselves for the workforce.  And their family gives them each a $20,000 gift for them to invest.

These boys are smart.  Off they head to the bookstore to read up on investments, and after spending a full day at Borders, sifting through free books (they’re frugal lads too) they come to a conclusion that index funds give the highest chance of long term statistical success, compared to unit trusts.

Sure you can find unit trusts that have historically beaten the indexes, but funds that tend to beat the indexes during one time period generally revert back to losing to the indexes in the following period.  You can read more about this with Princeton University’s Burton Malkiel, here. 

The two brothers walk out of the bookstore, keen to buy  index funds.  But there lies the danger.  If they aren’t careful, they can be sold a very expensive product, under the guise of a low cost index fund.

Look no further than the indexed products available through the Infinity Investment Series, via Fundsupermart.  They’re fine for investors under the age of twenty-one, but make little sense for older investors.

They sell, for example, a U.S. market S&P 500 index fund charging 1.04% annually (as an expense ratio) and a 2% front end sales fee to make the purchase.

Let’s assume that one of the brothers takes this option, while the other chooses to go with Vanguard’s low cost S&P 500, costing just 0.09% annually. 

Before fees, each fund would make the same return because they track exactly the same market.  But the index purchased through Fundsupermart costs 955% more, annually (it’s more than nine and a half times the cost)

Costs given in tiny numbers—like 1.04%—look minimal.  But they’re not.  If the U.S. S&P 500 index makes 5% per year for the next 5 years, an investor paying “just” 1.04% is giving away nearly 21% of their profits to the fund company reaping the benefit.

Let’s examine those 2 brothers again:

  Brother 1 Brother 2

$20,000 given to each brother to invest for 35 years

Brother 1 invests in an S&P 500 index fund via Fundsupermart costing 1.04% annually

Brother 2 invests in a Vanguard S&P 500 exchange traded fund via DBS Vickers costing 0.09% annually

Assume an 8% return for the S&P 500 index for the next 30 years

Brother 1 makes 6.96% annually after expenses

Brother 2 makes 7.91% annually after expenses

How much will each brother have after 35 years?

Brother 1 will have $210,755.44

Brother 2 will have $287,203.17

After 40 years, assuming the same rate of return?

Brother 1 will have $295,043.30

Brother 2 will have $420,240.29

After 45 years, assuming the same rate of return?

Brother 1 will have $413,040.59

Brother 2 will have $614,902.36

It’s hard to imagine that the true cost of “small fees” can amount to more than a $100,000 difference on just a $20,000 investment. 

Think about what the difference would be on larger invested sums. Costs matter.  They really do matter.

To read how to create a diversified low cost portfolio of cheap indexes, please read this post. (Singaporeans Investing Cheaply With Exchange Traded Index Funds)