Why some investments cost more than others
People are sometimes unsure why different investment types cost more to manage than others.
There can be several reasons for this. Let’s look at some of the main ones.
When deciding what to invest in, there are three main factors you should consider:
- The expected return you need to meet your objectives.
- The risk you are willing to take to achieve that return.
- How costs, including taxes, affect the ability to generate returns in line with your appetite for risk. This means that higher cost investments must, over time, generate higher returns to compensate for the higher costs.
What factors make certain investments more expensive?
Access to some overseas investment markets can increase costs. For example, emerging markets such as Indonesia or Brazil are seen as attractive markets for long-term investment because of their strong economic growth profile. This growth profile means investors may look to benefit from the anticipated rising demand for goods and services that occur as these countries’ economies transition from a developing to a developed status. The costs of managing these investments in terms of trading and custody of assets are often higher than in more developed markets.
Investors may also pay higher fees for better risk protection from currency movements. This is because investing in overseas assets means taking on the additional risk of currency movements affecting the value of the investment. The value of an investment in an overseas market can also be influenced by the currency moving up or down. If the US share market is up 10% in one year but the Australian dollar appreciates against the US dollar by 10% at the same time, then effectively the investor makes no gain because the 10% drop in the value of the US dollar compared to the Australian dollar cancels out the 10% gain in the share market. In contrast, an investor who hedged by protecting themselves against currency movements would make a 10% return.(1) However, in order to have currency protection, an investor will have to pay a slight premium which translates into higher costs compared to the same investment that is unhedged.
Investment manager skill
Many investments are referred to as passive strategies. They may, for example, invest in a way that replicates a share market index, such as the ASX 200 or the S&P 500. These relatively low-skill strategies are usually inexpensive to manage. Choosing an active management approach which is reliant on the skill of the investment manager may generate higher returns or reduce risk, but it will cost more.
Access to direct investments
Instead of investing in an asset such as shares in a company on a share exchange via employing a fund manager, investors can choose to invest directly in an asset. This approach is often used with property investments. In such cases, there are additional costs that must be borne by the investor, such as maintenance, concierge staff, cleaning staff, rates and property taxes. Despite these extra costs, in some cases, the property investment will generate superior long-term performance with lower risk, making the higher costs involved worthwhile.
These are just a small selection of the reasons for some investments having higher costs than others. Higher investment costs, considered in isolation, are not a reason to reject a particular important factor but not the only one.
Before making any investment decision, please contact the team at Omnis Financial Planning in Subiaco Perth on 08 9380 3555 and we can help.
Disclaimer: This article is for information purpose only and does not constitute advice and does not take into account any of your objectives, financial situation or needs. Before you make a decision about whether to acquire a financial product, you should obtain and read the product disclosure statement. NEO Financial Solutions: AFSL 385845 ABN 64 141 607 098.
- Example is for illustrative purposes only. Please seek advice from a financial adviser before making investment decisions.