How do fees of index funds impact return on investment? Find out the best index fund.

So in another article we talked about investing in index funds could be a better option when done long-term. Such claim is based on two things: expert recommendation and return over long term. Advice from experts like the highly successful stock investor Warren Buffett and the historical performance of foreign and local indices appear to provide more support to such claim.

A rather popular lore goes that investors, in general, can’t beat the index.

So if Pinoys have better chances in investing in index funds, wouldn’t it be necessary to actually check which one is the best in the market?

What is the best index fund?

In a separate article, an attempt is made to answer this question by making a comparison of fees of all index funds. You may want to read that first and then you can come back once done. That article talks about index funds in general, how they are structured, operations, and ways to invest in them.

It was written with the hope you’d select the one with the least fee and in the process, lower your cost of investing. Fees drag your the returns of your investment funds especially that you’re doing this for passive income.

Impact of index fund fees on ROI

This time, the impact of these fees on your return on investment (ROI) is the focus. It’s going to involve making a forecast 30 years into the future, and then see which one actually gives you higher take-home pay. This is a fair assessment.

However, it’s impossible to do this on all of the index funds in the market. Not only because there is less space here, it is also not necessary.

Previously, the way the assessment was done was to look at the cumulative effects of fees of only a handful of funds. The disadvantage is that some of our readers might think those that were not mentioned were not worth looking into. As a consequence, the few funds that were included were given importance by virtue of them being taken into consideration at the expense of others, when absolutely no such intention was ever engendered or implied.

So an update to the article is inevitable.

To make the list more inclusive, no specific funds are mentioned. Instead, the assessment is approached in two ways. Firstly, we’re going to look at the cumulative effect of sales load (in the case of mutual funds) or stock trading costs (in the case of exchange traded funds). Secondly, we’re going to see how management fees are going to impact the bottom-line of investors.

Some considerations

The holding period and exit fee are not considered. The reason being is that this charge can be avoided. You can wait until after the holding period and then redeem your investment, and in that way you wouldn’t have to pay the fee.

It is important to bear in mind that there are limits in this attempt to track the impact of fees on investments. The fact that a projection is done means that this is not going to be what funds would perform in reality. Actual results vary. The numbers you see here do not guarantee how these funds would perform in the future.

Another thing is that it is assumed that the stock index grows 7% every year. From experience, the actual gain of the top 30 Philippine blue chip companies fluctuate widely each year. It doesn’t grow as neatly as the projection that you see here. Again the goal is not to predict the index, instead it is to measure which of the funds would yield the best return in the long run.

Also, it is assumed that these funds won’t change their fees in the future. If and when they do, then the tables wouldn’t reflect such change.

Lastly, the comparison is only on fees and their impact on your money. It doesn’t take into account other factors such as tracking error, customer service, online access, ease of doing business, total expense ratio, etc.

Effect of sales load or entry costs

Sales load or entry costs are any charges against your capital before they’re committed to be invested. In the article “How to invest in mutual funds with zero sales load“, we talked about how mutual fund companies would deduct this fee every time you invest, whether it is your first time or your additional capital for reinvestment.

Meanwhile, when you purchase an ETF share, there are costs to trading (buying and selling) shares on the exchange. They include fees, charges, and taxes that your stock broker would collect.

So the first comparison is the ROI on a one-time P1 million investment. Let’s track the growth of money invested for the next 30 years. A zero-fee fund is also included as a benchmark.

In the table, here are some assumptions.

  • Starting capital of ₱1 million.
  • Time horizon is 30 years.
  • Money grows 7% each year.
  • Withdrawal occurs at the end of 30 years and after the holding period, if there is any.
  • Cumulative gain reflects the percentage difference with respect to the starting capital.
YearCapital0%0.295%1.50%2.00%5.00%
11,000,0001,070,0001,066,8441,053,9501,048,6001,016,500
21,144,9001,141,5231,127,7271,122,0021,087,655
31,225,0431,221,4291,206,6671,200,5421,163,791
41,310,7961,306,9291,291,1341,284,5801,245,256
51,402,5521,398,4141,381,5131,374,5011,332,424
61,500,7301,496,3031,478,2191,470,7161,425,694
71,605,7811,601,0441,581,6951,573,6661,525,492
81,718,1861,713,1181,692,4131,683,8221,632,277
91,838,4591,833,0361,810,8821,801,6901,746,536
101,967,1511,961,3481,937,6441,927,8081,868,794
152,759,0322,750,8922,717,6462,703,8512,621,080
203,869,6843,858,2693,811,6393,792,2913,676,200
255,427,4335,411,4225,346,0215,318,8845,156,061
307,612,2557,589,7997,498,0717,460,0107,231,642
Total7,612,2557,589,7997,498,0717,460,0107,231,642
Gain661%659%650%646%623%
Effect of sales load or entry costs

The table above shows that the one that has no fee at all beats all others. It nets the highest cumulative gain from the initial deposit of a million pesos over a span of 30 years. The table below takes zero fee as reference and shows the percent difference with other fees.

FeeTotalDifference
Zero fee7,612,2550%
0.295%7,589,7990.296%
1.50%7,498,0711.523%
2.00%7,460,0102.041%
3.36%7,356,4833.477%
5.00%7,231,6425.263%

Are there any funds without any entry fees? Yes, there are. Out of the 20 index funds in the country, 14 don’t charge any such fees. You can read up here a summary of the local index fund fees.

However, one other fee that you have to mind. The management fee can have bigger negative effect on the net outcome of long-term investments.

Effect of management fee

All index funds are offered, managed, and operated by investment houses. In exchange, these investment houses charge a management fee, which is a portion of asset under management (AUM) and it is assessed every year.

Unlike entry costs that are deducted from the capital before being committed to the investment, the management fee is reflected on the net asset value of the entire fund. So this brings about a kind of invisibility, investors would not feel like they are getting charged each year. But they are, only that such fee is imputed into the value of their investment.

More than that, it is also important that on the prospectus (the document that contains details of the fund) contains fees other the management fee. The sum of management fee and all other fees are called total expense ratio (TER).

In the table, here are some assumptions.

  • Starting capital of ₱1 million.
  • Time horizon is 30 years.
  • Money grows 7% each year.
  • Withdrawal occurs at the end of 30 years and after the holding period, if there is any.
  • Cumulative gain reflects the percentage difference with respect to the starting capital.
  • To make all other things equal, effects of entry costs are not taken into account.
  • Zero management fee does not exist in real life, so this is going to be used as a benchmark.
YearDepositZero fee0.50%0.75%1.00%1.50%
11,000,0001,070,0001,064,6501,061,9751,059,3001,053,950
21,144,9001,133,4801,127,7911,122,1161,110,811
31,225,0431,206,7591,197,6861,188,6581,170,739
41,310,7961,284,7761,271,9121,259,1451,233,900
51,402,5521,367,8371,350,7391,333,8131,300,469
61,500,7301,456,2671,434,4511,412,9081,370,629
71,605,7811,550,4151,523,3511,496,6931,444,575
81,718,1861,650,6501,617,7611,585,4471,522,510
91,838,4591,757,3641,718,0221,679,4641,604,649
101,967,1511,870,9781,824,4961,779,0561,691,220
152,759,0322,559,1922,464,4182,372,9282,199,379
203,869,6843,500,5573,328,7863,165,0422,860,225
307,612,2556,549,4646,073,3575,630,7884,837,269
Total7,612,2556,549,4646,073,3575,630,7884,837,269
Gain661%555%507%463%384%
Effects of management fee

It is clear. The less the costs are, the better the cumulative gain for investors. More than that, it has a higher negative impact than entry costs. And it does make sense too. In this example, you only pay the entry cost once, but the management fee is assessed annually.

The table below also shows the percent difference when zero fee is used as reference against other fees.

FeeTotalDifference
Zero fee7,612,2550%
0.50%6,549,464-13.96%
0.75%6,073,357-20.22%
1.00%5,630,788-26.03%
1.50%4,837,269-36.45%

Take-away

This article explores the impacts of entry costs and the management fee on long-term investment. The lower the cost, the better your take-home gains on your capital. Sadly, the management fee in local index funds are way higher than the ones found abroad. For comparison, two funds tracking US indices only charge 0.03%.

For retail investors, First Metro Philippine Equity Exchange Traded Fund (FMETF) despite the costs associated with buying or selling its shares may yield the most LONG TERM if projections are correct. However, if the time horizon is short term (like investing and getting back the money in a couple of years), retail investors may be better off with EastWest PSEI Tracker Fund or UCPB Philippine Index Equity Fund.

For institutional investors, PRUInvest PH Equity Index Tracker Fund offers 0.50% fee and thus may provide the most return.

Here is another table and promise, this is the last one. All index funds tracking PSEi are arranged from the least to highest fees.

NameTypeFeeEntry costs
FMETFETF0.50%0.295% (at least 8K capital)
EastWest PSEI Tracker FundUITF0.75%0.000%
UCPB Philippine Index Equity FundUITF0.75%0.000%
PRUInvest PH Equity Index Tracker Fund (Class I)UITF1.00% (0.50% for institutional investors)0.000%
BDO EQUITY INDEX FUNDUITF1.00%0.000%
BDO PERA EQUITY INDEX FUNDUITF1.00%0.000%
BDO PERA Equity Index Fund PERA1.00%0.000%
BPI Philippine Equity Index FundUITF1.00%0.000%
CTBC Bank – Sun Life Philippine Stock Index Feeder FundUITF1.00%0.000%
Metro Philippine Equity Index Tracker FundUITF1.00%0.000%
Philequity MSCI Philippine Index Fund, Inc.Mutual fund1.00%5.000%
Philequity PSE Index Fund Inc.Mutual fund1.00%5.000%
Philippine Stock Index Fund Corp.Mutual fund1.00%1.500%
PNB Enhanced Phil-Index Reference Fund UITF1.00%0.000%
PRUInvest PH Equity Index Tracker Fund (Class A)UITF1.00%0.000%
Security Bank Equity Index FundUITF1.00%0.000%
Sun Life Prosperity Philippine Stock Index Fund, Inc.Mutual fund1.00%2.000%
UnionBank Equity Index FundUITF1.00%0.000%
PAMI Equity Index Fund, Inc.Mutual fund1.12%3.360%
Land Bank Equity Index FundUITF1.50%0.000%
Fees of Philippine equity index funds

Tags

Write us

Find us at the office

Blotner- Kwas street no. 55, 39246 Canberra, Australia

Give us a ring

Dymon Rothfuss
+78 715 483 676
Mon - Fri, 10:00-22:00

Write us